Monopsony, Starbucks, and Unions

 A Seattle branch of Starbucks voted to unionize on Tuesday (3/22/22) following 6 other branches in the US doing so recently. Five branches in New York and one in Arizona. This branch is the first of all the branches to unionize in Starbuck's founding city of Seattle. Starting a chain reaction, more than 150 locations in the US are now petitioning to be unionized. Investors are citing Starbucks’ reputation as an employee-friendly workplace (tuition breaks etc.) and asking Starbucks to work with their unions, taking a neutral stance on them, even asking the corporation to stop sending anti-union emails to their employees. These sentiments may be in vain after the new CEO steps in for Kevin Johnson. The new CEO Howard Schultz reportedly has a long history of being anti-union. This movement of unionization comes at a time when the Labor force participation rate is particularly low, likely due to early retirement following covid. Labor force participation rate is everyone in the Civilian Labor force out of all the Noninstitutionalized civilian population. This lowered labor force participation rate, in combination with the normal (not inflated due to covid unemployment rate) unemployment rate, is resulting in a labor shortage. Many factors contribute to this evolving trend, but the leading factor is growing monopsony power from firms over labor input from organizational restructuring that has outgrown the legal definition of employer, unfavorable anti competitive employment contracts, and underenforcement of antitrust and labor rights laws. 

Our article, “Structural Labor Rights” by Hiba Hafiz (February, 2021), discusses in detail the effect of firm market power of setting input prices, monopsony, on unemployment and wage stagnation through many studies of economics, and defines equal bargaining power purpose of the National Labor Relations Act (NLRA). Within the article, Hafiz describes the negative effects of monopsony power on laborers as the unequal ability to bargain price of labor; with firms holding overwhelming power as a “price setter” in the labor market, rather than a competitive outcome of all firms being “price takers”, stating concisely, “While employers retain rights to integrate, disintegrate, consolidate, or tacitly coordinate their power to their advantage under corporate, antitrust, contract, and property law, workers’ collective rights have eroded to the point where they lack any substantive ability to function as counterstructure—as effective countervailing power against employers” (Hafiz, 2021) from this understanding, and decisions made by the National Labor Relations Board (NLRB) and judicial system, we can clearly see businesses are evolving quicker than both the laws that govern them, consequently this severely negatively affects a laborer’s unionization abilities. It is from this unequal distribution of bargaining power that we see labor unions being further obliterated by firms with help from federal agencies, courts, and even the NLRB themselves. While not all of those aiding employers in the drive to create a stranglehold on American laborers are active players, underenforcement of antitrust and labor rights laws from federal agencies and departments has the exact same outcome as taking an active role in the extinction of labor unions. Unlike the indirect attacks on laborers stated above, there are more direct and obvious attempts at circumventing competition in the labor market and creating disadvantages for workers found within employment contracts given to employees. Described by the article, “Workers who sign non-competes in their employment contracts earn less than equivalent workers who do not, and workers subject to no-poaching agreements are even worse off because they are often unaware that those agreements exist. Workers are not parties to such employer-to-employer agreements, and employers agree to them in secret because they can violate the antitrust laws” (Hafiz, 2021). This, again, stems from an issue of underenforcement from federal agencies and departments. Viewing these points through the WS/PS model, its not all bad news. There are still grassroots movements to unionze, like the one happening in our backyard. These unions will still have an effect on wage setting and price setting curves.

On the WS/PS framework, the presence of labor unions could affect both the wage setting and price setting curves. Labor unions in the Starbucks corporation will result in lowered markup, or market power for Starbucks as they are setting their wages. Markup is a determinant of the price setting curve. A decrease in market power will decrease the denominator in the real wage equation, causing the real wage to see an increase. On the WS/PS model we will see the PS curve shift up. It is possible that the presence of labor unions will have an effect on the Wage setting curve as well. Though possible, it is unlikely that in the case of Starbucks we will see this shift because there aren't enough unions to have much power over the corporation. The price of labor is found within the relationship between price determination, or a firm's market power (their ability to raise price over the competitive rate), and real wages. This can be represented as a function of unemployment, denoted as "u", and other employment factors, denoted as "z", deflated using a price deflator to turn nominal wages into real wages. With the relatively normal unemployment rate we currently have, it is expected that the “other factors,” or z will be the determinant of wage setting. Using this understanding, adding labor protections and benefits through collective bargaining (an outcome of labor unions) increases the "z" value while protecting current workers from further unemployment within the firm or industry. This will cause the Wage Setting curve to shift right. While this may result in a higher unemployment rate, increased worker protections are likely to keep people in the workforce longer as people are more satisfied with their jobs.

302- Originally Posted 2/17- Issues in Measuring Real GDP

 Chloe Benson

Nicole Waldron

ECON 302

February 15th, 2022

Topic: Issues in Measuring Real GDP

During our first class meeting of the semester, we discussed one of the most prevalent and important topics in macroeconomics, gross domestic product. GDP is one of the main measurements used to compare economic standing across different countries. The large drivers in economic growth that matter in the comparison of economies across countries include output, employment rate, inflation rate, interest rates, and productivity of the workforce. However, the most prominent measure we use is GDP even though the forecasts and predictions of GDP can often be misjudged due to not considering the impacts of other measurements. As we have seen in the last few years there have been many drastic changes and fluctuations in the economy and our markets are making an effort to rebound from the negative impacts of Covid and return to a time of economic growth and strong GDP. In order to be able to calculate GDP and have an accurate prediction for 2022 economists need to look beyond the standard calculation and also take into account other variables, one of them being inflation. In class, we discussed the three main ways of calculating GDP yet they all represent only the pure statistics of productivity and our goods and services. However, inflation rates and unemployment have a huge impact on the data inputs as well and can create major discrepancies in predictions if these rates change. These methods include the sum of final goods and services, the sum of value-added, and the sum of incomes in the economy. While objectively these methods of calculating GDP are efficient, failing to consider the effects of outside influences while forecasting can lead to difficulties in calculating GDP.

 Problems in measuring real GDP include the need to weight goods and services to ensure that items count for the correct percentage of GDP, as some goods and services are worth significantly more than others (Blanchard, p25). Furthermore, determining the weights as well as how they need to change over time adds to the complexity of calculating real GDP. This work is necessary as GDP is seen as a highly helpful tool for analyzing economies. However, some wonder if utilizing real GDP for comparisons might have outlived its usefulness. James Sweeney, in the Journal of Applied Corporate Finance, argues for Rethinking Macro Measurement in light of the COVID-19 pandemic and technological advancements. Sweeney discusses the shortcomings of using GDP, the main complaint being that GDP measurements do not delve deep enough into what is truly occurring within economies. This argument can be supported by our textbook, as it discusses the utilization of GDP in chained (2009) dollars (Blanchard, p25). While in 2009 real and nominal GDP equaled one another, Sweeney questions “whether a [GDP] statistic is an accurate measure of what it purports to measure,” calling into question the usefulness of the 2009 weights in calculating real GDP (p8). The proposed use of GDP is to keep it as a base measurement, but utilize technologically curated data to improve upon the accuracy of the measurement as well as allow for more accurate inferences to be drawn from the data. Within the textbook there are multiple mentions of accuracy issues in calculating real GDP, supporting Sweeney’s idea. Furthermore, Kliesen’s article discusses the uncertainty of inflation which affects real GDP. This uncertainty, especially during a pandemic, demonstrates the usefulness of other measures in comparing and contrasting economies against each other or prior years.

After experiencing the drastic effects that COVID 19 has had in global economies over the last couple of years, the US economy experienced rapid growth and increases in productivity at the beginning of 2021 which only began to slow when entering into the third quarter of 2021. However, accompanying the rebound in economic growth were high inflation rates, predicted to be the highest in 30 or more years (Federal Reserve Bank). The US is expected to report strong growth in GDP in 2022, but if the high rates of inflation continue to persist and decrease household purchasing power, economic growth could be at risk. The impacts of COVID 19 included large disruptions to the product and labor markets, which are now making a comeback, and the market conditions suggest the fourth quarter will be the strongest since 1983 and expect this trend to continue into 2022 (Federal Reserve Bank). GDP growth will have positive impacts on the labor markets and currently, there is a large demand for labor which will lower unemployment by three and three and a half percent by the end of 2022. Unemployment rates and the number of people actively seeking employment are at record low numbers relative to the number of job openings which is leading to a rise in employee compensation. With shortages in labor and materials along with supply disruptions, the volume of consumer demand for goods and services is becoming hard to meet across a variety of industries globally. These factors have led to raised input costs, unit labor, and non-labor costs, yet due to the high demand producers have been able to counteract these changes by substantially raising their prices at a shocking level. The rise in employee wages is helping mitigate the rise in prices and reduction in household purchasing power, but if this continues consumers will need to reduce real spending or increase their savings. Both of these actions pose major threats to consumer spending which will, in turn, halt economic growth and decrease GDP. With all of these factors creating the rise in inflation rates, the continual growth of GDP is at risk and the forecasts and trends that have suggested strong reports in the fourth quarter and into 2022 could be inaccurate or rapidly decreasing. 

The graph below shows the predictions for the main economic measures over the next few years and a forecast for long term growth. For the last quarter of 2021 and into 2022 there is a very high GDP percentage change that correlates to a high inflationary change as well. If inflation is changing at a rate that is faster than what the market can adjust for it could lead to GDP slowing and not growing as quickly as purchasing power decreases in relation to the final price of goods and services prices increases. When forecasting economists tend to look at these categories separately but using them all to create a holistic forecast considering a variety of angles and factors could result in more accurate predictions of the economic market indicators and allow for businesses and consumers to prepare for the market climate. It's important to realize the chain reaction that occurs within the market when input prices, labor shortages, or supply disruptions occur, and the effect that will have on the macroeconomic analysis tools such as GDP, inflation, and unemployment. When measuring GDP, one small change in the market can cause a ripple effect that economists and businesses can't anticipate. These ripples are always occurring and may not be detected which can create difficulties when attempting to measure GDP and why it might not be an accurate indicator of economic growth and the market conditions. 

Sources Cited:

Blanchard, O. J. (2017). Macroeconomics. Pearson.

Federal Reserve Bank of St. Louis. (2022, January 13). Inflation remains wild card in U.S. GDP outlook for 2022: St. Louis Fed. Saint Louis Fed Eagle. Retrieved February 15, 2022, from https://www.stlouisfed.org/publications/regional-economist/fourth-quarter-2021/inflation-wild-card-us-gdp-outlook-2022

Sweeney, J. (2020). Rethinking Macro Measurement. Journal of Applied Corporate Finance, 32(1). https://doi.org/10.1111/jacf.v32.1

Econ 302- Wage Determination and Bargaining Power

    In Blanchard’s Macroeconomics Seventh Edition Textbook, bargaining power is listed as an important input that affects wage determination. The amount of bargaining power workers have is dependent on the type of job as well as the labor market conditions. Throughout the Covid-19 pandemic, the labor market conditions have changed drastically. Specifically, we see that inflation and unemployment have risen, and the labor force participation rate has lowered. We would expect to see that “the lower the unemployment rate, the higher the wages (Blanchard, p.144). However, the high demand for labor paired with the lower labor force participation and high inflation have pushed wages higher than expected (Furman). Furman’s article discusses three points that affect real compensation: the tightness of labor markets, employers adjusting compensation for inflation, inflation expectations. The tightness of labor markets can be seen in the high demand for labor paired with the high unemployment. We would expect to see an increase in bargaining power for workers to increase their real compensation, as employees are in high demand by employers. Yet the higher levels of inflation have been pushing up prices in the market. Employers adjusting wages for inflation “was standard in contracts and bargaining in earlier periods of high inflation but has been largely absent for several decades,” (Furman). When employers adjust for inflation, they are taking into account the higher prices within the market. The lack of this adjusting in recent decades creates an impact on the compensation of today’s workforce, as higher wages are not increasing the buying power of employees. 

    Diving deeper into the effects of unemployment and inflation upon employee wages, data from the Current Population Survey (CPS) demonstrates that as of February 2022 the participation rate was 58%, based off of numbers from the Labor Force Employment Status Table (PEMLR). Participation rates have largely remained in the 60th percentile as far back as the 90s, but has been decreasing since 2000 (Statista). Some have argued that the low participation rate is due to the unemployment benefits rolled out by the government during the pandemic. However, Nicolas Petrosky-Nadeau and Robert G. Valletta of the Economic Research Department of the Fderal Reserve Bank of San Fransisco found that these benefits were only decentivizing the lowest paid brackets, and most preferred to return to their jobs with their previous salary (2021). Despite these low participation rates pushing up compensation due to the tight labor market, we see that adjusted for inflation, workers’ compensation has actually decreased from the pre-pandemic trend by 2% (Furman). 

    The article by William Van Lear shows a different way of displaying bargaining power in terms of profit and stock valuation. In that model, wages and profit have a negative relationship since the lower wages from the firm means they have less costs and higher profit. From the model of stock valuation they argue that times of relatively low wages can drive stock market booms with the help of expansionary policies. If the workers have greater bargaining, relatively more of the income will go towards them which in turn increases the propensity to consume and aggregate demand. Greater worker bargaining power can be created by different factors that are pro-labor like greater unemployment benefits and higher minimum wages.

Bibliography

Blanchard, Olivier. “7- The Labor Market.” Essay. In Macroeconomics, 7th ed., 137–56. Harlow:                     Pearson, 2021.

Furman, Jason, and Wilson Powell. “Worker Bargaining Power Has Been No Match for High Inflation.” PIIE, October 29, 2021. https://www.piie.com/blogs/realtime-economic-issues-watch/worker-bargaining-power-has-been-no-match-high-inflation.

Petrosky-Nadeau, Nicolas, and Robert G. Valletta. Extra Unemployment Benefits Are Not Primarily to Blame for Labor Shortages. Barrons, September 9, 2021. https://www.barrons.com/articles/altria-stock-philip-morris-goldman-sachs-upgrade-51647956262.

Statista Research Department. “USA - Civilian Labor Force Participation Rate 1990-2021.” Statista, January 31, 2022. https://www.statista.com/statistics/191734/us-civilian-labor-force-participation-rate-since-1990/.

Unites States Census Bureau. “CPS Basic Monthly FEB 2022.” MDAT, 2022. https://data.census.gov/mdat/#/search?ds=CPSBASIC202202&cv=PEMLR,PREXPLF&wt=PWCMPWGT.

Van Lear, William. “Stock Market Booms and Labor Bargaining Power.” Challenge 64, no. 4 (2021): 292–302. https://doi.org/10.1080/05775132.2021.1950449. 

"A Working Model" (Originally Submitted 3/17/22)

By Isaac Kim

March 16, 2022

 

            The IS-LM framework has fallen out of fashion in the economics sphere for its simplicity. Some argue that it cannot account for future recessions, thus dismissing its utility. Others say that it is outdated by the superior models used by the Federal Reserve. While these grievances could be valid, this blog seeks to explore how this framework can still be used to explain certain economic trends.

            Since the COVID-19 pandemic started, the Federal Funds Rate has been operating at a near zero figure. (Figure 1) The rationale behind this was to stimulate borrowing (and thus spending) in the economy, spurring economic growth in a time of future uncertainty. This has had rippling effects across the economy, and only now are we seeing the effects of that policy (due to policy “lag”) in factors like inflation. However, in the case of bond yields, they are unusually high and rising despite the low interest rates. (Figure 2) This is the opposite of what one would expect since lower interest rates require lower discount rates thus increasing bond prices and decreasing bond yields.

            Some economists argue that this is due to an increase in global saving due to the fears of recession from the pandemic. An increase in saving is an increase in investment which in turn increases the demand for buying bonds. An increase in the demand of bonds should increase bond yields. Other economists argue that excess liquidity is at play. With these low interest rates and stimulus checks and their effects finding their way into the economy, this theory could also be sound. As interest rates lower and money supply increases, this should increase nominal GDP. A higher output from higher liquidity means inflation, and asset and bond prices should go down (bond yields should go up) to combat the inflation.

            To distinguish which explanation could be at play in this current climate, the IS-LM framework comes in handy. A look at Figure 3 shows both theories at work. A decrease the demand for goods and services from increased savings shifts the IS curve down, and a movement along the LM curve brings the new equilibrium GDP and interest rates down. This is somewhat incorrect since nominal GDP has increased in the last year. Also, this does not account for factors like the stimulus checks which could also boost GDP. The second theory holds up well under scrutiny. An increase in the money supply from low interest rates and the stimulus checks increases the LM curve up and a movement along the IS curve decreases the interest rates and increases the GDP. This is more alike reality where nominal GDP has risen. Using this framework, one can see that the bond yields have increased due to excess liquidity. Perhaps the United States Treasury is using the higher yields to incentivize investors to buy bonds to curb inflation.

Several conclusions can be drawn from this case study. First, the stabilization policies used to fix this excess liquidity will be difficult to map since policy lag is at play. This means that these historically low interest rates will ripple out into the economy and future and plans on what to do will be difficult to know if their effects are still not known (as aforementioned, we are only now seeing the start of inflation grip the nation). Second, changes in interest rates should lead to movements along the LM curve and increase nominal GDP. Third, investors will continue to lower prices of bonds by not investing in them and in turn increase yields. Fourth, expansionary monetary policy through the lowering of interest rates could increase the danger of a liquidity trap. Fifth, as long as the United States remains loose with their monetary policy and the global economy becomes more interconnected, global liquidity will continue to rise. Lastly, this historical account displays the usefulness of the IS-LM model and its ability to describe current events. Perhaps in the future, economists will not be so quick to dismiss it.

Visual Aids

(Figure 1)

(Figure 2)

(Figure 3)

COVID Era Fiscal and Monetary Policy: Using the IS-LM Model to Analyze $1.5T in Government Spending

 What is The New Spending Bill and What is in it?

Last Thursday evening a massive $1.5 trillion dollar spending bill was passed by the senate after months of negotiating which included three stopgap bills that funded the government in the meantime.  This bill is the first major spending legislation by the Biden administration and included substantial increases for domestic and national security programs by roughly a 6% increase from the prior year (Lobosco, Luhby 2022).  Fiscal expansion policy has always been a hard point of negotiation between Democrats and Republicans mainly due to disagreements on where federal funds should go and how much should be spent on given programs. The two were able to meet in the middle as Republicans negotiated a $42 B increase in military spending and Democrats negotiated a $46 B increase in domestic programs. The increase in spending potentially could have been much more than 6%, but Republicans pushed that no further funds would be allocated to COVID response efforts, and so $15.6B was dropped from the bill that would have been allocated to such (Cochrane 2022). This suggests that the government spending is starting to look more like it did pre pandemic with more spending on the usual defense and domestic programs rather than allocating any more funds to COVID related responses. 

Fiscal Policy: In Recessions Past

It is first important to understand why fiscal expansion policy is used, what it seeks to accomplish, and how it works in revamping an economy. In an article from Dr. Linas Čekanavčiusi, professor of Economics at Vilnius University in Lithuania, he explains that “The idea is that during the recession the best way to stop a downslide and to induce recovery is to pour money into the economy…” (Čekanavčiusi 2018). He stresses the importance of fiscal policy as he references the Keynesian conclusion that when interest rates are already low the economy will remain in decline with monetary policy alone and it requires the government to increase its spending. The Keynesian thought here is that the government is the most efficient player in “allocating idle resources” in a recession. Fiscal stimulus helps increase demand and then pulls up the supply side of the economy which promotes more jobs to balance with the higher demand. Dr. Čekanavčiusi points to the New Deal in the United States as well as Sweden’s policies implemented during the Great Depression. FDR’s New Deal included massive public works programs that was followed by massive military spending in WWII that boosted the U.S economy.  The Swedish government in 1933 started programs that funded public works as well as support to the agriculture sector. The Swedish were able to recover their economy much faster than other countries and by 1936 they had returned to pre-depression numbers for both their level of production and real wages. Čekanavčiusi warns that there are many factors that impact the effectiveness of these policies including the timing and the sustainability. A country must be able to finance the new debt they take on at a reasonable rate or they risk falling into crisis again.  (Čekanavčiusi 2018)

Connecting the Dots: IS-LM and COVID Era Policy

Now we can take a look at the spending bill and other COVID fiscal policy and how the mechanisms of fiscal policy fit into the IS-LM model.  In 2020, the Federal Reserve responded to the COVID crisis and used a variety of monetary tools to prevent the economy from plunging into what could have been a historic recession. This was accompanied by fiscal policy including the CARES Act that came from congress that also stimulated output. Using the IS-LM model we know that both the 2020 fiscal and monetary policies work in the same direction and increase output, producing the similar results we saw from fiscal policy like the New Deal.  The increase in government spending increases the demand side of our IS relation and in response firms will match that on the supply side. On our IS-LM model this would be shown by shifting the IS curve to the right resulting in an increase in equilibrium Y. On the monetary side, the lower interest rates make it cheaper and easier for firms to expand and grow, especially as they need to produce more. As in the previous paragraph, since the interest rates are already so low, fiscal policy is the largest player in keeping the economy afloat and avoiding recession. On our IS-LM model, this would be shown by shifting the LM curve down. This is an example of policies moving in the same direction, but now in 2022 we are seeing something slightly different policy wise.

 We see the same increase on the demand side of the IS relation with the 2022 bill, as government spending increased by 6%. Just as in 2020, recovery is being induced by pumping money into the economy, which should increase employment and GDP. With this new bill we should again see a shift in the IS curve to the right. This is key for increasing output since interest rates are already incredibly low and we wish to avoid a liquidity trap. This however looks to be coming to an end since the Fed is looking to hike up interest rates which would mean using policies that work in opposite directions. The idea is to reduce the budget deficit created from the 2020 spending, but not reduce demand enough to push the economy into recession. This covers what Čekanavčiusi mentions as that the government must be able to handle their debt and finance it accordingly. So in terms of our IS-LM Model we would see a shift of the IS curve to right for fiscal expansion and the LM curve shift up for monetary contraction.  The rise in interest rates helps get the debt under a little more control while still keeping the economy healthy. Based on the numbers from policy implemented in 2020 and looking back to the Great Depression area fiscal policy use, it is easy to see that this spending bill will help induce the economy to full recovery and what we hope to be the end of the COVID crisis. We should expect to see an increase in output as we did from the 2020 policies. But we will also see a slow down to a more stable rate due to upcoming monetary policy. All in all, we can hope to see our economy back to pre-COVID performance after a long and difficult two years.

See Supplemental Graphs and Visuals  Below

The breakdown of spending. Largest area going to DOD

FRED Graphs

As we discussed in the third paragraph, the US government used fiscal policy at the start of the pandemic to prevent a historic recesion. In our first graph showing the federal surplus/deficit, we see the steep increase in the deficit at the start of the pandemic where we threw everything we had into the economy to keep it afloat. We also see the deficit increase during the 2008 crisis where we know the government poured massive amounts of money into the banking industry. In the second graph we see the evidence of budget deficits at the end of the Great Depression and a huge deficit with the onset of WWII. All these deficits represent the use of huge fiscal policy to save a sinking economy. Looking at the third graph the percent change in government surplus/deficit is graphically represented. We see spikes in deficit during the Great Depression and most of WWII. As we discussed in the blog, these fiscal policies greatly increased the deficit but were what brought the economy back to  health. Hopefully just like after the other recessions we see a decrease in our deficit and we return to normal.

 We know that the 2020 policies worked by looking at the final graph. We see GDP and its sharp drop in the early months of the pandemic, but then see that GDP took a sharp turn for the better and now is on a more steady incline to normal numbers. The 2022 bill and upcoming monetary policies will look to put the finishing touches on getting the economy back to normal.

Russian Financial Markets in response to Sactions imposed for the invasion of Ukraine

Authors:

Logan Rosell

Noah Ferguson

One of the main world events which has taken place recently, is the Russian invasion of Ukraine, which has caused disturbances not only in diplomacy around the world, but has placed considerable strain on the Russian economy. The reason for such strain, is that nations around the world, rather than provoking world war by providing military aid, are placing harsh economic sanctions on the Russian government as a potential deterrent to the continuation of the Ukrainian invasion. One of the major sanctions announced by the United States and its allies is around the ability for “Russia’s central bank to support the country’s currency” (Gibson, 2022). After sanctions began to be released against Russia and its currency, the value of the ruble fell 30%, being worth less than 1 cent against the US dollar. In light of this sudden decrease, bank runs are becoming a more frequent occurrence as payment methods such as Apple Pay and Google Pay are no longer available for usage, resulting in the need for cash. In an attempt to combat the rapid fall of the ruble value, Russia’s central bank has raised interest rates from 9.5% to over 20%. While this may initially be able to stave off the effects of these sanctions in the short-term, such interest rates will result in drastic increases in the prices of goods and services which are essential for the survival of Russian citizens. A major potential lifeline, however, for the Russian economy is the People’s Bank of China, who has the ability to provide a “lifeline” in a sense to Russia by supporting the ruble and the rest of Russia’s economy. However, this seems highly unlikely as any potential aid provided to Russia by China or the People’s Bank of China could result in additional sanctions being levied against the Chinese. This could be disastrous for the world economy because of the widespread influence which China has production-wise around the world. 

There are a couple of interesting points in regards to Russia financial markets in this story. 

1. Russia had previously built up a massive $600 plus national reserve of assets including foreign currencies within their central bank prior to invading Ukraine. 

2. Demand for Russian currency has plummeted in recent days, however this is not the first time this has happened even recently. 

Russia is not alone in their expansion of international reserves relative to their GDP since the 1990s. As noted in a 2010 paper published in American Economic Journal: Macroeconomics, “Since 1999, reserve accumulation has accelerated sharply. Asian and some Latin American emerging markets, Japan among the industrial countries, and oil exporters (notably Russia) have been the primary drivers of this trend.” However, the magnitude of Russia’s reserve may be an outlier. Taking a rough figure of Russian GDP in 2020 form the World Bank to be $1.48 Trillion and using a very general estimate of Russian reserves to be about $600 billion we find their reserves to be about 40% or annual GDP which is exceptionally high. That would be like the US holding about 8 Trillion dollars in foriegn reserves. Why then would Russia hold such large reserves? The authors of the same 2010 paper conclude that “We therefore build on the view that a primary reason for a central bank to hold reserves is to protect the domestic banking sector, and domestic credit markets more broadly, while limiting external currency depreciation.” As reported in our news article, Russia is currently trying to protect its major banks from runs and collapse and international sanctions apply pressure to these insitutions. As we talked about in class, Russia could theoretically use these massive holdings to buy up government, corporate, and bank bonds to inject liquidity into the financial markets which is desperately needed at the moment. However, Much of these foreign held assets are being frozen as part of sanctions by the West so it remains to be seen whether the Russian central bank will be able to act on this strategy. 

The situation which is occurring in Russia with the devaluing of the ruble is important not only within the financial markets of Russia, but also in financial markets in different areas of the world. In regard to world markets being affected, many countries choose to invest in the currencies of other countries. The financial markets within Russia are currently in shambles as the Russian central bank tries to stave off inflation by raising interest rates to over 20% from its previous 9.5% as mentioned above. Such an increase in the interest rate will have a negative impact on firms within Russian markets as their share prices and earnings will decrease as a response to this interest rate increase. Additionally, because of the freezing of many financial assets within the Russian markets and in their holdings abroad, it is forcing Russians to resort to the usage of cash or other liquid assets. Because of this, it may further decrease the value of the ruble and could result in hyperinflation within Russian markets, resulting in the potential collapse of the Russian economy.

Works Cited:

Blanchard, O., & Johnson, D. R. (2017). Chapter 3. In Macroeconomics. essay, Pearson. 

Gibson, K. (2022, March 1). Russian people may not be able to withstand "economic siege," experts say. CBS News. Retrieved March 3, 2022, from https://www.cbsnews.com/news/ukraine-russia-economy-ruble/ 

Obstfeld, M., Shambaugh, J. C., & Taylor, A. M. (2010). Financial Stability, the trilemma, and international reserves. American Economic Journal: Macroeconomics, 2(2), 57–94. https://doi.org/10.1257/mac.2.2.57 

World Bank. (2022). GDP (current US$) - russian federation. Data. Retrieved March 3, 2022, from https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=RU