The Riksbank’s loss is the blogosphere’s gain. If you are not following along already, Lars Svensson has a great post on Fisher and debt deflation, following an earlier VoxEU post on the effect of monetary policy on debt and income. I can’t read Swedish but Google Chrome can. Here is the translation provided:
A dangerous thing when it comes to debt is what Irving Fisher (1933) called “debt deflation”. It is usually described as deflation causes the real value of nominal debts are growing.Leverage and debt ratio also increases as the nominal debt is fixed while the nominal value of the assets and nominal disposable income falls. This could damage the economy in that it can lead to bankruptcy, “deleveraging” (savings to reduce debt) and “fire sales” (quick sale) of assets with consequent fall in prices.
But central to the idea of “debt deflation” is not in and of itself that it becomes deflation, i.e. negative inflation. What is important is that the price level will be lower than expected. This means that the real debt, leverage and debt ratios are higher than expected and planned. All probably have not realized that this is something that the Riksbank has caused by overriding objective of price stability and for a long time to pursue a policy that provides an inflation well below target. The Riksbank has therefore caused real household debt, leverage and debt ratios become much higher than the inflation rate remained on target.
This is great stuff. But one problem which the UK data illustrates perfectly is that the price level can tell us the “wrong” story about real debt burdens, whereas nominal GDP (or nominal wages) lights the way perfectly.
Growth is weaker than expected? Clearly that’s fiscal policy. Growth is much, much stronger than expected… well, let’s not worry about the details. Chris Giles has a carefully argued debunking of fiscalist revisionism, but I’m here to provide the silly charts.
More seriously, the sharp turnaround in the survey indicators since June is quite remarkable, and forecasters certainly were not expecting that earlier in the year. Supply-side adjustment plus a moderate demand-side boost from easing monetary conditions still seems like a reasonable explanation, but the long wait for the Q3 NGDP figure is going to be painful.
I’m pissed off this week, and it’s rant time. Faisal Islam has a post and video on “exporting homes” which is totally daft. I read a post from Matt Nolan describing “Housing Xenophobia” in New Zealand just a few months back, and thought it was a good thing that didn’t happen here. How naive.
Faisal makes the claim in the video that houses built in London and sold to foreigners (eek! foreigners!) are “not functionally part of Britain’s housing stock.” Yes, yes, really, they are. Just like the Nissan factory in Sunderland is part of the capital stock available for production in Britain, even though it’s owned by foreigners (eek! foriegners).
Increasing the supply of housing in Britain increases the supply of housing in Britain. End of story. This is unequivocally a Good Thing. That should be common sense; see also Matt Yglesias. Let us not hear silly claims about how middle-class Malaysian investors are buying London property to let it sit empty. Give me a break.
Now rant two. Let us not hear any rubbish about how “putting money into housing” is an “unproductive use of capital”. If I want to deploy capital improving my own standard of living, or that of somebody else, by building a lovely house, who the hell do you think are telling me what is “productive” and what is not? Some kind of central planner? Seriously, screw you too. If you think building more car factories will be a “productive use of capital” then go right ahead and build yourself a car factory, and good luck to you too.
Rant three, most important rant: It should not be an aspiration of the government to spend money building “affordable housing”. That is as daft as proposing that the government should spend money building canned spam factories, “affordable food”, because there are lots of poor people who can’t afford to eat. (I’m sure I stole this analogy from somebody so my apologies.)
If any politician proposed building spam factories (“Plan Spam”… “Help to Eat Spam”?) they would be hounded from office. But apparently it’s just fine for “progressives” to ensure poor people are stuck with low living standards by building crap, low-quality – uh, sorry – “affordable” – uh, sorry – “social” houses for them.
If you want to improve the quality of the British housing stock get rid of the crazy planning laws. To deliberately skew housebuilding towards the low end of the market will simply move the average quality of housing lower than it otherwise would be, i.e. it lowers prosperity. And if you also want poor people to afford more or better housing (or food), then raise their incomes through the tax system, absolutely fine by me. Confusing the means by which we achieve “better housing” and “lower inequality” is total nonsense.
Final rant: Saying that “rising house prices is bad” is reasoning from a price change. Because Japan. Japanese residential real estate prices collapsed by about 50% since 1991. Was that a “good thing” for the Japanese, did it somehow raise their “real incomes”? No. That’s nonsense. Rising demand for housing in Britain, which is mostly driven by rising incomes, is a another Good Thing. If you want to say the supply-side is crap, or that demand-side subsidies are crap, just say that. Don’t talk about changes in price being “bad” or “good”.
Alright, rants over, I feel better now.
The competition for “worst public policy idea of the year” is heating up. Osborne’s entry, “Help to Buy”, was striking both for its wrong-headed selection of market (housing, which is suffering exactly because of government intervention), and magnitude (twelve-figure sums of public sector guarantees). But Miliband’s entries this week are strong contenders; price controls and property confiscation.
Osborne’s “Help to Buy” and Miliband’s price controls are similar, and similarly bad policy, in that they implicitly reject the signals embedded in market price movements. Osborne thinks house prices are “high” and decides that people need “Help to Buy”, a demand-side subsidy. Miliband thinks energy prices are “high” and decides that is not “fair” for consumers (he used the phrase “fair deal” in his speech), so we need a supply-side restriction (albeit temporary) in the form of price controls.
In neither case is it possible to believe that policy is being driven by any objective analysis of the markets in question; they are both clearly populist attempts to win votes. This seems like a worrying trend. Price movements are part and parcel of how market economies allocate resources; relative price changes are signals to and from consumers and producers about supply and demand. In rejecting that most basic principle politicians reject one of the most fundamental sources of our prosperity.
Paul Tucker is leaving the MPC later in the year. That’s the good news. Here’s a quote from his speech today which I cannot resist ridiculing:
It is sometimes suggested that independent central bankers are more averse to inflation than to periods of low growth and increased unemployment.
Gee whiz, Paul, really? Why could that be?
I hope the past few years have demonstrated that, in fact, it is the credibility of the Bank of England’s commitment to price stability that enabled us to provide such exceptional monetary support to help the recovery.
Oh. So… during a period with the worst real GDP growth on record, and high unemployment, what you’re saying… as you and your colleagues have done in speech after speech… is that what really matters is the Bank’s “commitment to price stability”?
It is unimaginable that, prior to Bank independence in 1997, any government would have been able to hold the policy rate at effectively zero and make a further monetary injection of £375bn without inflationary expectations – and government financing costs – spiralling out of control.
Inflationary expectations… hmmm… wait. For some reason I am getting the impression that independent central bankers are more averse to inflation than to periods of low growth and increased unemployment. But it must be the voices in my head.
(Those three sentences really are placed together in that order in his speech, I’m not making this up. Tucker also has a delicious reference to his definition of the phrase “escape velocity”, with a footnote referencing his remarks in 2011 to the TSC. It’s hard to know what he is getting at.)
Here’s a quick look at what has happened to the UK data over the summer.
1) Forward-looking indicators: Inflation expectations have been stable and remained relatively high over recent months. This is good news, particularly given the rise in Sterling we’ve seen. 3% expected RPI is roughly consistent with 2% expected CPI. (As usual the non-reform of the RPI methodology is an annoying distortion.)
2) Indicators of current real activity were strong for July and even better for August, with the aggregate PMI hitting an all-time high. This leaves a little egg on the faces of the supply-side pessimists, in my view; arguments that we should have been raising interest rates because low real growth was the “new normal” are starting to look a bit silly. But that argument can always turn into one about “unsustainable growth” and bubbles, and will no doubt continue.
3) Labour market. Official data has only caught up to the May-July period; optimism there in that employment and total hours worked continue to hit record high levels, the latter rising 2.5% year-on-year. On the other hand the optimism, the claimant count and unemployment rate are falling, but only very slowly. August survey data looks very strong for the labour market too.
4) The really interesting question: is there a demand-side explanation for a real recovery? There could be two sources for a real recovery:
a) An adjustment to very slow nominal growth. Two pieces of supporting evidence here: firstly that nominal hourly wage growth has been pushed down to very low rates. Secondly that the GVA deflator in Q2 suggested that whole-economy price inflation was negative q/q to Q2. But neither of these data points are conclusive. The wage data has been distorted by timing of bonuses against the higher rate tax cut. And the deflator is particularly unreliable in early estimates. Here’s the graph of the Eurostat nominal hourly wage data and the ONS estimates, anyway:
b) An alternative explanation is a recovery in nominal demand growth. Two main pieces of evidence again here: the rise in equities, the FTSE 250 is up 30% year on year; and the rise in inflation expectations mentioned earlier. The fact that real activity has apparently turned so sharply around does in itself suggest a demand-side change.
The Q3 nominal GDP data will be of particular interest.
There was an almighty showdown: Mr. King found himself confronted by a powerful coalition including Chancellor of the Exchequer Alistair Darling, top Treasury officials, the Financial Services Authority led by its then-chairmen Adair Turner, and senior members of the BOE’s Court. All demanded that he do something to stem the deepening credit crunch. Much to Mr. King’s fury, Bank of England Deputy Governor Paul Tucker had circulated a paper to top officials at the BOE suggesting the central bank set up a new long-term funding facility that would allow banks to use their illiquid mortgage portfolios as collateral. A concerted effort was made to force Mr. King to agree to the plan. In a night of high drama involving a series of late phone calls, Mr. King relented and the Special Liquidity Scheme was born.
The SLS was arguably the single most successful crisis response deployed in the U.K.
Stop right there Mr. Nixon, I can’t resist this one…
The UK’s major foray into creditism co-incided with the worst collapse in aggregate demand on record, before or since. If that’s success, I’d hate to see what failure looked like.