Stumbling and Mumbling

Housing crash: why worry?

Like Max Mosley, I have a shameful secret - mine is that I like Will Hutton. But by crikey, he writes some pish doesn’t he? Tim’s already had a pop at this, but there’s plenty left. Like this:

The blight [of falling house prices] hits everyone. The most tragic are those whose houses are repossessed, but most of the suffering is hidden. People are trapped and have to put their lives on hold because they cannot move because the housing market is seizing up: the newly retired couple who plan to move out to the country; the woman who wants to move closer to her new job; the family that wants to be nearer a school. Everybody has to abandon or defer their plans.

This is only part of the story. There are also many people for whom lower house prices are a good thing:  the prospective first-time buyer who hopes to buy a place; the young family hoping to get a bigger house as their children grow; the people who traded down at the peak of the market; the older home-owners who no longer have to give their children a fortune as a deposit on a flat; the man whose ex-wife copped for the house. And even home-owners gain from falling prices, in the sense that the opportunity cost of living at home (thus foregoing rent) falls. As Willem Buiter said, houses are not net wealth.
Or take five other perspectives:
1. Many men have borrowed thousands of pounds to buy an asset that’s fallen in price. We call them car-owners. No-one worries about negative equity in the car market. So why worry about negative equity in another consumer good?
2.  Sure, some people have lost money because they over-invested in housing. But why should we care about these any more than about those who over-invested in Laughing Boy in the 3.30 at Wincanton? It’s not the government’s job to bail out bad gamblers.
3. I’ll grant that some people are “trapped” in their existing home. But this is because capitalist presenteeism forces people to live nearish to where they work. But the problem here is the repressive nature of capitalism, not the housing market.
4. Correlation is not causality. The belief that falling house prices are a bad thing arises from memories of the 1990s recession, when falling prices were associated with rising unemployment and repossessions. But this confuses cause and effect. It was rising unemployment that caused house prices to fall. It’s far from clear that a fall in house prices will have such ill-effects if the labour market remains healthy.
5. Wouldn't it be better for us all if people wanting to get rich were forced to ask: "how can I provide a useful service to others?" rather than just buy a house and wait.
Now, you might object here that I’m taking an overly sanguine view because I traded down near the peak of the market. But then, mightn’t Will be taking an overly gloomy view because his missus is a property developer?

Osborne on credit cycles

George Osborne is showing commendable signs of starting to think about macroeconomics. However, I have several problems with his recent speech. He says:

The new economic challenge of our time, then, is to tame the credit cycle without damaging the dynamic financial sector.

And he suggests we consider using counter-cyclical capital requirements upon banks to limit their lending in good times:

financial crises are born during the financial booms that precede them - the only way to prevent the bad times is to stop the good times getting out of control.

I’ve got five issues here.
1. Is the “credit cycle” due more to supply forces - banks are readier to end in good times - or demand forces, with banks merely passively responding to changes in consumer and business confidence?
The question matters, because fluctuations in confidence can be justified. Imagine a technical breakthrough raises likely future productivity growth. It would be entirely rational for companies and consumers to borrow more in rational anticipation of better times. If you impose tougher capital controls in these conditions, you’ll just destroy sustainable and efficient economic activity.
2. Are counter-cyclical capital requirements feasible? Do governments really want to anger voters by denying them credit? And do they want to say: “the current good times aren’t the result of our good macroeconomic management - they are just a bubble”?
And even if one government does impose them, they’d be useless in just one country, as lending would merely shift offshore.
3. Is borrowing really unsustainable? Osborne says:

We have warned for several years that the boom in household indebtedness was unsustainable - as I said two years ago "an economy built on debt is living on borrowed time."

But is there a problem here? Put yourself in my position. In a couple of week’s time, my credit card bills will look horrible, as I’m buying a car and lots of furniture for my Oakham abode. And because I’ll not (I hope) repeat these purchases, my spending will crash later. In this sense, my debt and spending are unsustainable. But this is no problem, as I’ve got cash in the bank to pay these debts.
And the aggregate consumer is in a similar position to me. Households’ bank deposits are equivalent to over 12 months’ disposable income, and are six times as high as their non-mortgage debt (table A4.1 here). And individual insolvencies have fallen recently, suggesting over-indebtedness isn’t a serious aggregate problem.
The notion that households in general recklessly over-borrow in good times - a notion Osborne comes too close to supporting - owes more to a prejudiced contempt for individuals’ rationality than to the data.
4. Are asset price “bubbles” really destabilizing? The remarkable thing about the bursting of the tech bubble in 2000-01 was how little impact it had - it caused only the mildest recession in the US, and none at all in the UK.
Even the allegedly gloomy IMF believes the same could be true of the current credit crunch. It expects the global economy to grow by 3.7% this year. And even its forecast for the UK, of 1.6% growth, is only around a percentage point below our trend growth rate. This is hardly a catastrophe. And it might be too pessimistic. Latest data show that manufacturing and retail sales were stronger than expected in February, suggesting the economy is starting 2008 from a stronger base than thought.
This shouldn't be surprising. House prices are not net wealth, so a fall in them shouldn't greatly depress activity.
5. Is Osborne - like Brown and Darling - guilty of statistical fetishism here? What matters is not the volatility of GDP - which is small, even if the gloomiest forecasts are right - but the uncertainty faced by real individuals. People matter; statistical aggregates don’t. The task for a Chancellor, surely, should be to find ways of protecting people from risks they cannot control without overly reducing incentives. This is not so much a task for macroeconomic policy - even stable GDP growth can be consistent with massive insecurity for real individuals - as for the microeconomics of designing a welfare state or private insurance markets. 

What's behind the credit boom?

Apparently, the credit crunch is causing people to borrow more.
No, it doesn't make much sense, does it? So there might be something else behind the big rise in personal borrowing in February reported by the Bank of England yesterday.
That rise is consistent with the fact that retail sales were strong in the month too. And there's a reason for this which is obvious on the high street but which City economists, understandably obsessed with financial market conditions, are overlooking - technical progress.
The prices and quality of gadgets - flat screen TVs, sat navs, games consoles - are improving rapidly. And this is boosting demand for high-ticket goods and therefore credit.
We can roughly quantify this. RPI data show that the rate of deflation for audio-visual equipment (which includes computers) has recently been running at a record rate - 20%. Big price falls are usually a sign of technical progress.
And our chart shows that there's a rough link between this rate of deflation and retail sales volumes growth in the subsequent 12 months; troughs in sales growth (in 1998, 2003 and 2005) followed low rates of technical progress and peaks (1999, 2004) followed rapid progress.
There are many reasons why there might be a lag; people are slow to realize what's on offer; they wait for prices to fall further; they have to talk the missus into wanting a 42in telly; or, if you're like me, it takes time to get round to buying stuff.
Whatever, this progress is helping to raise demand. And past relationships suggest it might continue to do so.
There's more to the economy  than the credit crunch. And perhaps real business cycle theorists  are onto something in emphasizing the importance of productivity fluctuations as a cause of booms and slumps - because these can affect activity via consumer spending, as well as capital formation.

The curse of CSI

This line from the latest Case-Shiller house price report caught my eye:

Las Vegas and Miami share the dubious title of the weakest markets in January, reporting double-digit annual declines of 19.3%.

Now, what do Las Vegas and Miami have in common? Yup, they are locations for two of the three CSI franchises.
Even if we allow for the fact that prices in the third CSI area - New York - are holding up relatively well, the CSI effect seems big. Prices in the three CSI cities have fallen by an average of 14.8% in the last 12 months, compared to an average fall of 8.7% in the other 17 metropolitan areas covered by the Case-Shiller indices.
Coincidence? No. There's an obvious reason for this - the salience effect. CSI causes people to exaggerate the extent of violent crime in its cities, causing people, at the margin, to avoid them.
Granted,  the CSI effect doesn't seem significant in conventional statistical terms. Regressing annual price changes upon a CSI dummy (1 for Las Vegas, Miami and New York and zero for the other 17 cities) yields a p-value of 15.1%, against the null hypothesis of a zero effect. But remember:
1. Why should we be classical statisticians about this? If your Bayesian prior is that there is a CSI effect - as theory predicts - the evidence provides some corroboration.
2. Don't confuse statistical and economic (in)significance. As we've seen, the effect is economically significant - worth over $15,000 for a house priced at $250,000 this time last year.
3. CSI is not the only show affecting perceptions of crime and therefore prices. If we add a Numb3rs effect (giving LA a dummy value of 1 as well), then the p-value for a combined CSI+Numb3rs effect drops to 5.9% - significant at the 10% level, as they say. Papers have been published with less.
Pedants will moan that this is just a nonsensical excuse to carry a picture of Emily Procter. But what do they know?

Much ado about little

Depending on which report you read, the CBI's latest economic forecast is "gloomier than the Chancellor's", "sharply below the level Chancellor Alistair Darling forecast" or a "challenge" to the Chancellor.
The truth, though is more mundane. This table shows the quarterly GDP growth forecast by the CBI and Chancellor, based upon my interpolation of the mid-point of the Treasury's range (pdf) and the CBI's profile of annual growth.
You can see that both agree upon  two things - that growth will be weak in the first half of this year, and that it'll return to around trend by late 2009.
The disagreement is simply about when the up-turn will come.
And even this is small. The 0.2 percentage point difference between the  forecasts for Q3 and Q4 is less than the average revision in official estimates of quarterly GDP growth between the initial release and the latest numbers. This means it's quite possible that reports this time next year will vindicate the CBI and yet later revisions will vindicate the Chancellor (or vice versa). It'll be years before we know who's right.
What's more, of course, forecasts are subject to a big margin of error; the Treasury estimates its average error to be 0.5 percentage points for its 2009 forecast of 2.5% growth; the CBI's average error will be about the same. 
Both forecasts, then, are consistent with GDP growing around 2% for a while.
How dull is that?

Credibility and public borrowing

I had hoped to avoid the Budget, being unable to improve upon the mighty Mash's coverage. But I had the misfortune to hear Darling on the Today programme, which reminded me of why I so loathe the whole pantomime. It's a perversion of economics.
Darling was repeatedly asked: why should we believe your forecasts for public borrowing? His answer was pretty much wibble.
But the thing is, there's an answer which is both consistent with reasonable economics, and which defends him. It runs roughly thus:

You shouldn't believe my forecasts. Forecasts for public borrowing have always been subject to huge margins of error. There's a rule of thumb, which dates back at least as far as Nigella's dad, which says that the average error is 1% of GDP for each year of forecasting horizon - for both Treasury or private sector forecasts. That means my forecast for net borrowing of £43bn next year (pdf) should read £28-58bn, and the £38bn for 2009-10 should read £8-68bn, with a roughly one-third chance of borrowing being outside these ranges.
One reason for such big margins of error is that the government  isn't much in control of the public finances. Government borrowing is, by definition, the counterpart of private sector lending (Table I of this pdf). And this has recently been much higher than could have been expected, in two senses. First, company profits have persistently been higher than capital spending. Second, fast-growing Asian economies have generated high savings, which - because of asset shortages in the region - have been invested in developed economies such as ours; balance of payments figures (table J of this pdf) show that  foreign buying of UK debt (not just gilts) have been a record levels in recent years.
If someone's lending, someone's got to borrow. That's the government.
This flood of savings explains an important  fact - that despite the prospect of continued public borrowing, gilt yields are very low; index-linked yields are below 1%. Debt markets, then, are acting as if there's no problem with the public finances. And if the people who are stumping up the money don't seem to be worried about public borrowing, why should you be?

This answer, of course, raises other questions - not least about the fact that borrowing is only ever deferred taxation. But it answers the question about the credibility of borrowing forecasts.
But the thing is, Darling didn't say anything like this. He preferred to give the impression that he's on top of things, rather than give an economically coherent answer.
Which is why I hate Budgets. They are part of a folie a deux, in which both Chancellors and their media interlocuters pretend that it's possible to manipulate the public finances in detail. But the truth is that Chancellors don't have such control. And, with gilt yields so low, it doesn't - for now at least - much matter.

The costs of stability

One of Gordon Brown's favourite words is "stability." As he said the other day: "We have steered a course of stability through difficult times and so my message is: stability is our watchword and will remain so."
However, this new paper suggests that stability might be positively damaging. It estimates that, within G7 countries, there's a negative relationship between stability and long-run growth. "Stability", then, can make us poorer in the long-run.
One reason for this is that short-term volatility means there'll be lots of temporary booms and slumps. In the booms, firms and workers might learn new productive tricks in an effort to meet demand. And if they don't forget these tricks in the downturns, the stock of knowledge will be higher as a result of boom and slump than it will if growth is stable. Productivity - and hence output - will then be higher on average in the long-run.
This is not an isolated finding; as I showed in my book, the empirical evidence that stability is good for growth has long been highly doubtful.
Which raises the question. If stability doesn't make us richer - and might even make us poorer - why is Brown so keen on it?
It can't be because stability reduces individuals' risk of unemployment. Macroeconomic stability is entirely consistent with huge fluctuations in individuals' fortunes, if these are negatively correlated. The solution to individual uncertainty lies in better insurance mechanisms - either markets or the welfare state - not macroeconomic management.
Instead, my hunch is that Brown's talk of stability is a managerialist trick. It's an effort to convince us - and perhaps himself - that he is in charge and on top of things. But the thing is, he might not be. There's some evidence - albeit controversial - that the UK's great economic stability is due to just luck (pdf).

What do mortgage approvals mean?

The Bank of England reports that mortgage approvals fell to a 12-year low, of 73,000, in December.
This chart shows one implication of this - house price inflation will fall further. Mortgage approvals have been a good lead indicator of house price inflation in the following 12 months; the correlation has been 0.61 since January 1992, with an R-squared of 37.8%. This relationship points to prices rising just over 1% during this year, with a highish probability of a fall.
The question is: so what? As Willem Buiter argued, house prices are not, in aggregate net wealth.
But there's another point that should add to our indifference. It's that the macroeconomic picture tells us nothing about individual experience.
By rights, I should be more conscious than most about the housing market, as I'm hoping to sell my flat  very soon.
But the aggregate housing market doesn't interest me. What matters is the market for flats in Belsize Park (top location, bags of potential, low outgoings, extensive views over Helena Bonham Carter) and for houses in Oakham. Macro news tells me little about either.
I'll say it again. The main function of macroeconomic data is to make work for macroeconomists. And this is a very valuable function; how d'you think I got that flat?

Big government & growth

Big government is bad for economic growth. That's the finding of this new paper (pdf) from economists at the ECB.
The effect is large. Controlling for a few obvious things, they estimate that, within OECD countries a one percentage point  rise in the share of government spending in GDP cuts growth by 0.13 percentage points a year. This implies that the rise in government spending we've had in the UK since 2000 (from 37.2% of GDP to 42%) would, if sustained take half a point off GDP growth, making us more than 5% worse off in 10 years' time than we would have been had spending stayed at 2000's levels.
The cross country growth equations that this finding is based upon are, of course, subject to many problems. Not least is omitted variables bias. Could it be that there's something that's correlated with big government which itself depresses subsequent growth?
However, the paper doesn't altogether uphold the orthodox neoliberal case for smaller government. It estimates that it is indirect taxes, and not income taxes, that depress growth most.
This implies that a a cut in excise duties and VAT and rise in income tax could actually increase growth. As indirect taxes are regressive, it would also increase equality.

What's bad about recession?

What's so bad about recession? All those reports about stock markets falling "on fears of recession" give the impression  that recession is self-evidently a terrible thing.
But it's not. Robert Lucas once famously estimated (pdf) that the welfare cost of economic fluctuations were minute - a mere one-twentieth of one per cent of consumer spending. This is simply because such fluctuations are small - a fall in GDP of 2% is a deep recession - and the average person just isn't very risk averse  so wouldn't pay much to eliminate a small chance of a loss as small as 2%.
Stock markets, however - or at least market reports thereof - tell us Lucas was wrong.
But markets have always been telling us this. As John Quiggin pointed out here (pdf), the very fact that investors require high expected returns to compensate for holding equities suggests that people are somehow more averse to losses than Lucas-style calculations suggest.
But why? One possibility is that we're creatures of habit. Even small losses - on equities or from recession -  force us to change our way of life. And tiny changes - a smaller car, going to less fancy restaurants - can disturb us.
Another possibility lies in the fact that recessions don't hit equally. Recessions don't make us all 1% worse off. They make 2% of us 50% worse off as some people lose their jobs and businesses. And because we can't tell in advance who these 2% will  be, we all get scared.
What's more, we might think: "I don't want to risk losing money on shares at the same time I lose my job. So I'll stay of of the market."
This might explain why average long-term returns on shares are high; such people need high returns to tempt them to hold shares (though this is controversial - George Constantinides thinks it is significant, but Martin Lettau doesn't).
It might also explain why the stock market falls "on fears of recession" - it's because such thinking looms larger as the prospect of recession increases.
And here's the point. If we had better institutions to pool recession risk - Shiller-type macro markets - these fears would diminish. Share prices would be higher (as more people were willing to buy them) and less sensitive to recession.
In other words, the stock market is suffering this year because financial markets are so woefully incomplete. Shareholders are paying the price for not having adequate markets.
As an entity, society is very hypocritical in bellyaching about recession but doing so little to spread its risks better.
Wouldn't it be a nice idea if financial innovation were used to help ordinary people avoid risks, rather than help egomaniacs become rich?