Sep 13 2011

Sample IB Economics Internal Assessment Commentary – Understanding the ECB’s bond-purchasing program

Once again, my IB Economics students are working on yet another Internal Assessment Commentary, this time on syllabus section 3, Macroeconomics. Since they found my sample Microeconomics commentary so helpful, I thought I’d punch out a quick sample of a macro commentary for them and for anyone else who is working on their IB Economcis Internal Assessment.

The commentary below (not including the selection from the article) is 749 words in length. This does NOT include words in the graphs, so let’s not have that debate in the comment section. The new IB economics internal assessment model (first examinations 2013) will not count words on graphs, so this sample commentary is perfectly suited for the new assessment model. If you’re a 2012 student, you would be wise to count words in graphs as part of your word count.

If you like what you see, or have any quesitons, please leave your comments below the post.

Article highlights:

An Impeccable Disaster – NYTimes.com

Paul Krugman clearly explains the problems faced by two or Europe’s largest economies today:

So why is Spain — along with Italy, which has higher debt but smaller deficits — in so much trouble? The answer is that these countries are facing something very much like a bank run, except that the run is on their governments rather than, or more accurately as well as, their financial institutions.

Here’s how such a run works: Investors, for whatever reason, fear that a country will default on its debt. This makes them unwilling to buy the country’s bonds, or at least not unless offered a very high interest rate. And the fact that the country must roll its debt over at high interest rates worsens its fiscal prospects, making default more likely, so that the crisis of confidence becomes a self-fulfilling prophecy. And as it does, it becomes a banking crisis as well, since a country’s banks are normally heavily invested in government debt.

Now, a country with its own currency, like Britain, can short-circuit this process: if necessary, the Bank of England can step in to buy government debt with newly created money. This might lead to inflation (although even that is doubtful when the economy is depressed), but inflation poses a much smaller threat to investors than outright default. Spain and Italy, however, have adopted the euro and no longer have their own currencies. As a result, the threat of a self-fulfilling crisis is very real — and interest rates on Spanish and Italian debt are more than twice the rate on British debt.

Commentary:

The European Central Bank (ECB) is engaging in a new form of monetary policy in which it buys government bonds directly from the Spanish and Italian governments. Essentially, the goal is to bring down the interest rates on Italian and Spanish government bonds, which should reassure private investors that Italy and Spain will be able to pay them back and thus reduce the upward pressure on interest rates in the Eurozone, a situation which threatens to reverse the already sluggish recovery from the recessions of 2008 and 2009.

Monetary policy refers to a central bank’s manipulation of the money supply and interest rates, aimed at either increasing interest rates (contractionary monetary policy) or reducing interest rates (expansionary monetary policy). The ECB is currently buying government bonds from European governments, effectively increasing the supply of money in Europe with the hope that more government and private sector spending will move the Eurozone economy closer to its full employment level of output, at which workers, land and capital resources are fully employed towards the production of goods and services.

If successful, the ECB’s “quantitative easing”, as the new type of monetary policy is known, should bring down interest rates on government bonds and thereby reallocate loanable funds towards Italy and Spain’s public and private sectors.  The increase in supply of loanable funds should bring down the private interest rates available to borrows (businesses and households), making private investment more attractive.

The ECB’s bond purchases make it cheaper for Italy and Spain to borrow, lowering the interest rates on their bonds, restoring confidence among international investors, who may be more willing to save their money in Italy in Spain. The inflow of loanable funds into these economies (seen as an increase in the supply of loanable funds from S1 to S2) should bring down private borrowing costs (the real interest rate), encouraging more firms to invest in capital and more households to finance the consumption of durable goods, increasing aggregate demand and moving the Eurozone economy back towards its full employment level of output, from AD1 to AD2 in the graph on the right.

In certain circumstances, monetary easing like this could be inflationary, but in reality inflation is unlikely to occur given the large output gap in Europe at present (represented above as the distance between Y1 and the dotted line, signifying the full employment level of output). Any increase in aggregate demand will lead to economic growth (an increase in output), but little or no inflation due to the excess capacity of unemployed labor, land and capital resources in the European economy today.

With private sector borrowing costs increasing due to growing uncertainty over their deficits and debts, the Italian and Spanish governments will find expansionary fiscal policies (tax cuts and increased government expenditures) are unrealistic options for achieving the goal of full employment. The ECB, however, as Krugman argues, should continue to play an increasing role in the expansion of credit to cash strapped European governments, with the aim of keeping interest rates low to prevent the crowding-out of private spending that often occurs in the face of large budget deficits. Inflation, always a concern for central bankers, should be a low priority in Europe’s current recessionary environment. Only when consumer and investor confidence is restored, a condition that requires low borrowing costs, will private sector spending resume and the Euro economies can begin creating jobs and increasing their output again.

In the short-term, Italy and Spain should take advantage of the ECB’s bond-buying initiative, and make meaningful, productivity-enhancing investments in infrastructure, education and job training. If their economies are to grow in the future, Eurozone countries must become more competitive with the rapidly expanding economies of Asia, Eastern Europe, and elsewhere in the developing world.

In the medium-term, the Eurozone countries must demonstrate a commitment to fiscal restraint and more balanced budgets. Eliminating loopholes that allow businesses and wealthy individuals to avoid paying taxes, for example, is of utmost importance. Also, increasing the retirement age, downsizing some of the more generous social welfare programs and increasing marginal tax rates on the highest income earners would all send the message to investors that these countries are commited to fiscal discipline. Then, in time, their dependence on ECB lending will decline and private lenders will once again be willing to buy Eurozone government bonds at lower interest rates, allowing for continued growth in the private sector.


About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate's Economics for the IB Diploma and REA's AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

32 responses so far

32 Responses to “Sample IB Economics Internal Assessment Commentary – Understanding the ECB’s bond-purchasing program”

  1. Maphridaon 15 Sep 2011 at 3:09 pm

    This is a good role model commentary. It flows smoothly and is easy to read. The analysis and article information is well integrated in laid-back yet sophisticated text.

    Evaluation is done throughout the entire text, more subtle in the body, but is very noticeable in the last two paragraphs. Definitions don't take up too many words and are well incorporated in the text. Reference to the graph is done constantly throughout the commentary.

    Nice!

  2. Juleson 18 Sep 2011 at 8:05 pm

    I have just started teaching IB Econ and I'm getting conflicting advice about the evaluation part of an IA. This blog says that the evaluation should be different from external examinations; students should question the assumptions of the economic models they have used. What do you think?
    http://ajmccarthynz.wordpress.com/2010/09/11/the-

  3. Jason Welkeron 18 Sep 2011 at 8:16 pm

    Hi Jules,

    This came up in a meeting I attended with the chief examiner of the IA a few months ago. On the old IA criteria, evaluation did require questioning the validity of the economic theories themselves. But on the new criteria (first examnations 2013, or this year's year 1 group), the evaluation requirement is that students make a "judgement supported by effective and balanced reasoning". There is no longer the emphasis on evaluating the economic theories themselves, although this would still be an effective form of evaluation.

    For example, in a macro commentary, it would be highly effective evaluation for a student to consider the short-comings of monetary policy as a means of achieving macroeconomic objectives like full employment. Theory says that when a central bank increases the money supply and lowers interest rates, investment rises and AD rises. But this "theory" can be evaluated in the context of real world evidence, which points to the fact that during demand-deficient recessions, investment demand is depressed and firms are relatively unresponsive to lower interest rates. Therefore, expnasionary monetary policy has a limited effect during deep recessions.

    See, that was effective evaluation of economic theory, but also of a macroeconomic policy that works "in theory".

    There are countless ways to evaluate effectively. In my opinion, the key to good evaluation is that students express their own judgement based on evidence and information from the extract, if there is one (their article in a commentary, the document or data in a paper 2 question).

    I hope this helps. I know Andrew, whose post you linked to above. He knows what he's talking about, but he wrote that post over a year ago, based on the requirements of the old IA criteria. The new criteria does not require evaluation of the theories, although this remains a possibility for students.

    Regards, Jason

  4. Miwaon 03 Oct 2011 at 2:29 pm

    First, as we know, the change of the interest rate would have effect on two different areas. One is investment and another is saving. This article shows us reduce the interest rate can promote the investment, because busniess can borrow money for paying lower extra cost. That is why government would try thir best to decline the interest rate. Also, if the interest rate lower, households would be unwilling to save money because they can earn lower extra money. However, the effect on saving is much smaller than the effect on investment. So we always ignore the effect on saving.

    Then, I disagree the article that education and worker trainning are short-term. These two things need time and processes. Goverment should make sure every one can have the chance to get the education and trainning. It is uneasy. Goverment should make sure the income for every households. For this thing, I agree with this article that goverment should increase the marginal tax from the households who have higher income. That can make more people have the chance to take the education. Then, we can reduce the unemployment.

    Finally, every country consider about the economic growth and any increase in aggregate demand will lead to economic growth. That is a sinificant point in study Economics. When government consider about this, should make sure the labor resource and other resources' quality and quantity I think.

  5. paulineon 19 Jan 2012 at 1:58 pm

    Thanks for sharing
    I am going to writing my first IB Economics Commentary
    and your model commentary have helped me a lot
    Thanks

  6. Yvonneon 26 Jun 2012 at 5:28 am

    Thank you so much ! I am doing my first Economics Commentary now as well!

  7. Alion 09 Sep 2012 at 5:28 pm

    This is my first year doing IB Economics, today was our 2nd lesson and the teacher wants us to bring a newspaper article related to a job or an event which is related to the way Production possibilities curves (PPC) or (PPF) work. She gave us an example "Training Nissan workers in a specific country for improving their skills" so that they would be able to increase their potential output. Any articles related to that?

  8. Anonymouson 29 Oct 2012 at 11:24 pm

    Good commentary! Thanks for the sample. It really helps when your writing a commentary for the first time!

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