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In the red – when more money goes out than comes in. A budget deficit occurs when public spending exceeds government revenue. A current account deficit occurs when exports and inflows from private and official transfers are worth less than imports and transfer outflows (see balance of payments).
Industry:Economy
Failure to fulfill the terms of a loan agreement. For example, a borrower is in default if he or she does not make scheduled interest payments on a loan or fails to pay off the loan at the agreed time. Judging the likelihood of default is a crucial part of pricing a loan. Interest rates are set so that, on average , a portfolio of loans will be profitable to the creditor , even if some individual loans are loss-making as a result of borrowers defaulting.
Industry:Economy
Cancelling or rescheduling a borrower’s debts to lessen the pain of the debt burden. Debt forgiveness is increasingly viewed as the best way to relieve the financial problems facing poorer countries. Some of these countries have to pay so much in interest each year to foreign lenders that they have little money left to spend on the long-term solutions to their poverty, such as educating their workers and building a modern infrastructure. In 1998 the World Bank calculated that around 40 of the world’s poorest countries had an “unsustainably high” debt burden: the present value of their total debts was more than 220% of their exports. Debt forgiveness has potential drawbacks. For instance, there is a risk of moral hazard. If countries that borrow too much are let off their financial obligations, poor countries may feel they have nothing to lose by borrowing as much as they can. This is why policymakers often argue that debt forgiveness should come with a conditionality clause, for instance, a requirement that countries have a track record of implementing economic reforms designed to prevent a repeat of the errors that first created the need for debt forgiveness. This is the approach taken by the World Bank's HIPC (highly indebted poor country) initiative, launched in 1996 and expanded in 1999. However, by 2003, only eight of the 38 poor countries eligible under the program had made enough progress in reform to have some debt forgiven.
Industry:Economy
“Neither a borrower nor a lender be,” wrote Shakespeare in “Hamlet”. Actually, the availability of debt, and the willingness to take it on, is a crucial ingredient of economic growth, because it allows individuals, firms and governments to make investments they would not otherwise be able to afford. The price of debt is interest. Until recently, lending was an activity dominated by banks (although mortgages for individuals buying their homes have long been available from special housing savings institutions). Since the 1960s, debt has become increasingly available from other sources. Companies have sold trillions of dollars worth of bonds to investors in the financial markets. Individuals have been able to borrow with credit cards, and for those who have nowhere else to turn there are pawn shops and loan sharks, which charge very high rates of interest. Total private-sector debt in 2003 was around 150% of GDP in the United States, compared with less than 100% in 1928. In most countries, by far the biggest single borrower is the state, through the national debt.
Industry:Economy
The extent to which the value and impact of a tax, tax relief or subsidy is reduced because of its side-effects. For instance, increasing the amount of tax levied on workers’ pay will lead some workers to stop working or work less, so reducing the amount of extra tax to be collected. However, creating a tax relief or subsidy to encourage people to buy life insurance would have a deadweight cost because people who would have bought insurance anyway would benefit.
Industry:Economy
If you pay your cleaner or builder in cash, or for some reason neglect to tell the taxman that you were paid for a service rendered, you participate in the black or underground economy. Such transactions do not normally show up in the figures for GDP, so the black economy may mean that a country is much richer than the official data suggest. In the United States and the UK, the black economy adds an estimated 5—10% to GDP; in Italy, it may add 30%. As for Russia, in the late 1990s estimates of the black economy ranged as high as 50% of GDP.
Industry:Economy
The third of 17 children of a wealthy banker, David Ricardo (1772–1823) was disinherited at the age of 21 after he married a Quaker against the wishes of his parents. He became a stockbroker and did so well that he retired at 42 to concentrate on writing and politics. A friend of fellow classical economists Thomas Malthus and Jean-Baptiste Say (see Say's law), he developed many economic theories that are still in use today. The most influential was comparative advantage, the theory underpinning the case for free trade. In his 1817 book, The Principles of Political Economy and Taxation, he outlined a theory of distribution of output in an economy. In this he argued that the allocation of factors of production to any area of economic activity is determined by the level of economic rent that can be earned from it. As this gradually falls because of diminishing returns, capital and other resources shift to more profitable projects. He examined the split between wages and profit, arguing that “there can be no rise in the value of labor without a fall of profits”. He also claimed that changes in the government deficit did not affect the level of demand in the economy (Ricardian equivalence).
Industry:Economy
When a government announces that the exchange rate of its currency is fixed against another currency or currencies. (See also currency board. )
Industry:Economy
A means by which some countries try to defend their currency from speculative attack. A country that introduces a currency board commits itself to converting its domestic currency on demand at a fixed exchange rate. To make this commitment credible, the currency board holds reserves of foreign currency (or gold or some other liquid asset) equal at the fixed rate of exchange to at least 100% of the value of the domestic currency that is issued. Unlike a conventional central bank, which can print money at will, a currency board can issue domestic notes and coins only when there are enough foreign exchange reserves to back it. Under a strict currency board regime, interest rates adjust automatically. If investors want to switch out of domestic currency into, say, US dollars, then the supply of domestic currency will automatically shrink. This will cause domestic interest rates to rise, until eventually it becomes attractive for investors to hold local currency again. Like any fixed exchange rate system, a currency board offers the prospect of a stable exchange rate and its strict discipline also brings benefits that ordinary exchange rate pegs lack. Profligate governments, for instance, cannot use the central bank’s printing presses to fund large deficits. Hence currency boards are more credible than fixed exchange rates. The downside is that, like other fixed exchange rate systems, currency boards prevent governments from setting their own interest rates. If local inflation remains higher than that of the country to which the currency is pegged, the currencies of countries with currency boards can become overvalued and uncompetitive. Governments cannot use the exchange rate to help the economy adjust to an outside shock, such as a fall in export prices or sharp shifts in capital flows. Instead, domestic wages and prices must adjust, which may not happen for many years, if ever. A currency board can also put pressure on banks and other financial institutions if interest rates rise sharply as investors dump local currency. For emerging markets with fragile banking systems, this can be a dangerous drawback. Furthermore, a classic currency board, unlike a central bank, cannot act as a lender of last resort. A conventional central bank can stem a potential banking panic by lending money freely to banks that are feeling the pinch. A classic currency board cannot, although in practice some currency boards have more freedom than the classic description implies. The danger is that if they use this freedom, governments may cause currency speculators and others to doubt the government’s commitment to living within the strict disciplines imposed by the currency board. Argentina's decision to devalue the peso amid economic and political crisis in January 2002, a decade after it adopted a currency board, showed that adopting a currency board is neither a panacea nor a guarantee that an exchange rate backed by one will remain fixed come what may.
Industry:Economy
When the state does something it may discourage, or crowd out, private-sector attempts to do the same thing. At times, excessive government borrowing has been blamed for low private-sector borrowing and, consequently, low investment and (because the economic returns on public borrowing are typically lower than those on private debt, especially corporate debt) slower economic growth. This has become less of a concern in recent years as government indebtedness has declined and, because of globalization, firms have become more able to raise capital outside their home country. Crowding out may also come from state spending on things that might be provided more efficiently by the private sector, such as health care, or even through charity, redistribution.
Industry:Economy
