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of the Lawson boom in 1989 to Harry Goodman’s International Leisure
Group； which collapsed spectacularly in the 1991 economic downturn；
leaving crippling debts and thousands of people without jobs。
Wright bought the pany back for a nominal ￡1； financing working
capital with backing from 3i； the venture capital firm。 Over the next 8
years he and his team built the business up； now renamed City Flyer
Express； selling out in 1999； just ahead of the dot stock market
collapse； to British Airways for ￡75 million。
INFLATION
Inflation is defined as too much money chasing too few goods and if it
gets out of control it can devastate an economy。 Not all goods and services
have to experience price increases。 The inflation rate itself is measured
by defining a basket of goods and services used by a ‘typical’ consumer
Economics 205
and then keeping track of the cost of that basket using such indices as the
retail price index。 During the upswing stage of a business cycle there is a
tendency to overshoot； which can lead to the economy ‘overheating’。 As
there is usually a lag while production struggles to catch up with demand；
prices rise to ‘ration’ goods and services。 Inflation is generally seen being a
problem for a number of reasons：
。 ‘Inflation makes fools of us all’ is a truism about the misleading signals
sent by rapid changes in price。 Consumers and businesses like certainty；
and fluctuating rates of inflation make planning more difficult； which
in turns leads to a loss of confidence。
。 Inflation redistributes wealth in a haphazard and o。。en unfair manner。
For example； savers will find their purchasing power diminish as
their fixed sum saved will buy fewer goods and services in the future。
Borrowers will benefit as they are effectively paying back a capital sum
that is being eroded in value by inflation。
。 If the inflation rate is greater than that of other countries； domestic
products bee less petitive； so exports will be reduced and economic
growth will slow。
。 High inflation can lead to high wage demands； which can in turn lead
to an upward spiral in costs and so feed further inflationary pressures。
Current economic wisdom has it that a modest degree of inflation is healthy
provided that everyone knows what it will be and can factor it into their
decision making。 That is why central banks have as one of their functions
monitoring inflation rates and taking action to keep below a certain figure
– in the UK this is 2 per cent。 Three further aspects of inflation that need to
be considered are：
。 Deflation is the opposite of inflation and occurs when the general level
of prices is falling。 This can occur a。。er a major bubble collapses and
will lead to people pu。。ing off purchasing decisions in the expectation
of being able to buy later at even lower prices。
。 Hyperinflation is unusually rapid self…feeding inflation； in extreme
cases； this can lead to the collapse of a country’s monetary system。 This
occurred in Germany in 1923； when prices rose 2；500％ in one month
and in Zimbabwe in April 2008 when the annual inflation rate hit
165；000％。
。 Stagflation is the bination of high economic stagnation with inflation；
such as happened in industrialized countries during the 1970s；
when OPEC raised oil prices。
206 The Thirty…Day MBA
INTEREST RATES
Around half the money used to finance businesses is borrowed and private
individuals use mortgages； hire purchase and credit cards to fund many
of their purchases。 Governments too have to use debt through the sale of
bonds； when taxes are insufficient to meet their spending plans。 The ‘price’
of borrowed money is the interest paid。 Governments can stimulate both
business and consumer expenditure by lowering interest rates or choke off
demand （see ‘Micro vs macroeconomics’； above） by raising it。 Interest rates
are the favourite tool of central banks to control inflation as it can be used
to bring supply and demand back into balance。
Interest rates also have a direct bearing on a country’s exchange rate。 If
it is higher than that in other parable economies it will tend to support
the exchange rate at a higher rate； and if lower； the currency will tend to be
weaker （see also ‘The exchange rate’）。 There are； however； several different
interest rates and governments do not directly control them all：
。 Bank Base Rate： This is the interest set by governments； for example
by the Bank of England’s monetary mi。。ee； the US Federal Reserve
and the European Central Bank。 It is a reference point from which other
interest rates are set； but is not the actual interest rate charged by clearing
banks to their many and varied clients。
。 Libor （London Inter…bank Offered Rate）： This is the rate of interest at
which banks borrow funds from each other； an essential activity to
facilitate global trade and to se。。le contracts on futures and options
exchanges。 As such； it is the primary benchmark for short…term interest
rates globally。 The rate is set by a panel representing around 500 banks
and depends on a number of factors； including local interest rates；
expectations of future rate movements and the prevailing banking
climate。 Usually the Libor rate is lower than the rate set by central
banks to allow banks a small margin。 But if banks lose confidence in
their peers’ ability to repay then either they stop lending or they charge
a premium over the Bank Base Rate。 This was the case during the subprime
crisis in 2007/08。 Libor is both sensitive and plex。 Rates are set
in 10 currencies and for 15 different maturity dates； from an ‘overnight’
rate maturing tomorrow； a ‘spot/next’ rate that covers the period to the
day a。。er tomorrow； through weeks and months out as far as （but never
further than） one year。
。 Lending Rate： This is the rate at which banks will lend to businesses
and private individuals。 It can be anything from a fraction of a percent
above either Bank Base Rate or Libor （whichever is the higher） for blue
chip firms； a percent or two above for mortgages； and up to 15％ above
for credit card loans； the higher the perceived risk the higher the rate。
Economics 207
ECONOMIC POLICY AND TOOLS
Keeping the economy growing； holding inflation in check and a。。empting to
both anticipate and mitigate the worst effects of downturns in the business
cycle are the primary economic goals of government。 Dials showing the GDP
growth rate and inflation are on every government’s economy management
dashboard。 But these are not the only factors that affect an economy； nor is
se。。ing interest rates the only club in a central banker’s locker。
Policy options
The UK’s 1981 Budget； designed to remove several billion pounds from
the economy when the UK was in the depths of recession； provoked an
unprecedented le。。er from 364 economists published in The Times stating：
‘There is no basis in economic theory or supporting evidence for the
government’s present policies。’ In fact the UK economy recovered and
eventually prospered。 Even today； no politician； yet alone economist； can
agree on whether the 364 economists were right or Lady Thatcher’s then
Chancellor of the Exchequer； Sir Geoffrey； now Lord； Howe。 Although
economists disagree on almost everything； they do accept that there are
two broad categories of policy； fiscal and monetary。
Monetary policy
Monetarists； as the adherents of this school of thought are known； believe
that as the economy runs on money； controlling the supply of the amount
of money in circulation is the key to achieving growth without inflation。
If the supply of money grows faster than the economy； inflation will rise
as too much money will be chasing too few goods； too slow and growth is
stifled。 There are a number of difficulties in actually executing monetary
policies：
。 Measuring money： In the first place； agreement has to be reached on
what exactly money is。 There are at least five different and to some
extent overlapping measurements； all a。。empting to measure the liquid
assets at large in an economy。 Designated with the prefix M； these
measures range from M0； the narrowest definition which includes only
the cash held in banks and in circulation； through to M5； the broadest
measure which extends to a wide range of other short…term highly
liquid financial assets held as a substitute for deposits。 Not content
with these five measures； some now have le。。er prefixes to subdivide
further the types of liquid assets included。 If you can imagine trying
to drive a car with several speedometers you will get a feeling for the
problem。 In the world boom of 1972–73； for example； the UK’s M3 and
208 The Thirty…Day MBA
M4 grew at nearly 25％ per annum； M5 grew at over 20％； yet M1 grew
at only 10％。
。 Velocity of circulation： Money’s use is as a medium of exchange； we
swap it for goods and services； which in turn create the value in an
economy that result ultimately in GDP。 Over any interval of time； the
money one person spends can be used later by the recipients of that
money to purchase other goods and services； the suppliers of which