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Markets disrupted

Markets have been in turmoil over the past year. The flux has been widespread, hitting finance, jobs, goods and services. For the UK, Brexit is adding to the upheaval caused by the pandemic – both will have long-term effects on our lives and livelihoods.

Newsletter from 5 February 2021

The Economics Observatory was set up to answer questions from policy-makers and the public about coronavirus and the UK economy. Many of the things we’ve been asked about so far are long-term challenges raised by the pandemic, the recession and their aftermath:

Other questions require a more immediate answer – and one such came in late last week in the form of a message from a university student I happen to know well. Not normally known for her deep concern about matters economic, my daughter inquired ‘what’s going on with the stock market?’

I quickly emailed one of our lead editors – economic historian and financial markets expert John Turner at Queen’s University Belfast (QUB) – to see if he and his colleague Will Quinn could explain what was happening with the unprecedented price volatility and trading volumes of shares in struggling US companies like Blackberry, AMC Entertainment and, most notably, a chain of high street electronics shops called GameStop.

John and Will are particularly well placed to do this. They’re co-authors of a well-received recent book about financial market shenanigans through the ages called Boom and Bust: A Global History of Financial Bubbles. Among other things, this recounts tales of previous ‘short squeezes’ – the phenomenon that had driven the share price of GameStop from $17.25 at the start of January to a peak of nearly $350 in the middle of last week.

Central to understanding the rocketing valuation of GameStop is the idea of ‘short-selling’: investors who think a share price will fall find ways to bet against it, traditionally by borrowing shares, selling them, buying them back later for a lower price and then returning them to the lender.

In this case, information that big institutional investors (hedge funds) had made big bets of this kind was acted on by millions of small investors (day traders) communicating via online message boards on Reddit. They bought GameStop shares, driving up the price and forcing some short-sellers to realise huge losses instead of the profits they were anticipating.

Gamestop share price

Source: MarketWatch

Choppy financial markets

Today, the price of GameStop is just over $53 (down 80% from its peak), and doubtless many of the latecomers to the buying frenzy have themselves experienced big financial losses. But other bubbles are likely to come and go – and as shown in some of the early Observatory pieces we published last spring, such instability in financial markets can turn into wider crises, with severe repercussions for the rest of the economy.

Dramatic stock market falls can also be a signal of investors’ fears about coming economic challenges – and they certainly were in the early stages of the pandemic last February/March when, for example, the share prices of the UK’s largest companies fell by a third. At the same time, stock markets can bounce back even when the wider economy remains in bad shape.

Managing these interactions is a key role of central banks – and the contribution of monetary policy to mitigating the economic consequences of the crisis has been something we’ve covered in some detail at the Observatory. Pieces include:

  •  An overview of how the Bank of England, the European Central Bank (ECB) and America’s central bank, the Federal Reserve (the Fed), responded with interest rate cuts, asset purchases known as ‘quantitative easing’ (QE) and other programmes to ensure a continued flow of credit to businesses and households.
  • More detailed explanations of QE and ‘monetary financing’ – what they are, why they might be needed and potential dangers.
  • And most topical given one of the announcements by the Bank of England at yesterday’s launch of their quarterly Monetary Policy Report, an exploration of the arguments for and against central banks’ use of negative interest rates.

This week in an Observatory piece from the Money Macro & Finance Society policy conference, Laura Coroneo, Arvind Krishnamurthy and Gulcin Ozkan look in more detail at the Fed’s response to the Covid-19 recession. They outline the key policy programmes, larger than any the Fed has previously implemented, and their impact on credit markets. They conclude that while the corporate bond market has improved, credit conditions for borrowers dependent on bank lending have remained challenging, potentially limiting the effectiveness of monetary policy.

An accompanying piece asks whether central banks are helping, or hindering, the quest for an environmentally friendly recovery. Julia Wdowin reports on whether corporate bond purchases by the ECB can promote green developments by favouring companies with lower carbon emissions. In fact, the evidence to date points the other way: given the comparatively thin market for ‘green bonds’, the policy supports sectors of the economy that pollute more. We plan to return to some of these issues around financing the move to a more sustainable economy.

Difficult markets for goods and labour

Elsewhere this week, we look at other disrupted markets. One is the UK labour market, where employment and working hours in certain sectors and for younger age groups have been badly hit by Covid-19. As Andrew Aitken at the National Institute of Economic and Social Research (NIESR) makes clear, some employees and some industries could face permanent displacement with the virus-induced changes to our patterns of work and social life.

Employment level by age (16 years and over)

Note: Seasonally adjusted, cumulative growth from September to November 2019, for each period up to September to November 2020
Source: Office for National Statistics, Labour Force Survey

Payrolled employees (by industry)

Note: Absolute change on February 2020, seasonally adjusted, UK, December 2020
Source: HM Revenue and Customs, Pay As You Earn Real Time Information

Another market in upheaval is the longstanding ‘internal market’ between Great Britain and Northern Ireland. Following the UK’s exit from the European Union’s single market , there are growing frictions around taxes, tariffs and regulatory compliance emerging from the so-called ‘border in the Irish Sea’, introduced to avoid a hard border on the island of Ireland.

Last month, we looked at the disruptions to food supplies that have caused empty supermarket shelves in Northern Ireland. This week, local experts on the region’s economy – Esmond Birnie at Ulster University and Graham Brownlow at QUB – consider the wider damage to businesses and consumers and likely longer-term shifts in supply chains and organisational forms.

Brexit will have big effects across the UK economy and we’ll be reporting on them in coming weeks, alongside our continuing analysis of the short- and long-term effects of the pandemic on our lives and livelihoods. If there’s anything you'd like to understand better, please do ask your question.

Author: Romesh Vaitilingam, Editor in Chief
Photo by Markus Spiske on Unsplash
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