Sunday, July 06, 2014

Two elephants in the economics room

The post-crisis period of low interest rates has boosted asset prices, e.g. real estate and shares, as a deliberate policy to try and make the real economy grow. But don't get confused about 'real' here - 'real estate' (as in 'property' for the UK) is not part of the 'real economy' measured by GDP figures. High house prices are not a meaningful indicator of how well the economy is doing but just an indicator of how the economic policy benefits those with assets. The FT on Friday 4 July, wants  the US Federal Reserve to sort the bubbles: 'Yellen should act on asset bubbles'  but admits that 'the Fed's macroprudential tool kit is limited'.  JY is said to regard 'tighter interest rates are almost always the wrong tool to curb asset price inflation'.

In Sweden an experiment (2010 to date), has maybe proved JYs point - FT 4 July (Richard Milne):  'Sweden's Riksbank changes course with rate cut' explains that Sweden's central bank first raised  the rate from 0.25% to 2.0% by 2011and then lowered it again with a final bump on Thursday to 0.25%. This raising was an attempt to 'stop a nascent housing bubble'. But the nominal house price index is now up about 18% from 2010 -so no great success there. The rate hike was also supposed to counter high household debt but this was ineffective too, as it is as high as before at around 174% of income.

The reason for the volte-face now is a stagnating economy - high unemployment and possible deflation. The bank wants to use 'macroprudential measures' to counter household debt. So these 'stick' measures will be set against dangerous lending practices whilst the 'carrot' measures of low interests rates will hopefully grow the real economy. Will either work?

Lord Turner in this paper Credit Creation and Social Optimality presses for an extension of normal macroprudential policy to include the allocation of credit into those parts of the economy that are socially optimal. He says we cannot leave such matters to the free market - and the asset bubbles that have grown since he said this in 2011 prove his point. He relies heavily on Richard Werner's work on credit creation and allocation by banks as they make their everyday business decisions. See the book: New Paradigm in Macroeconomics.  But no central banker or finance minister is specifically targeting positive credit allocation into specific productive business sectors and this is an obvious elephant in the room being studiously ignored.    

A study dealing with asset prices in the Australian real estate market by  Philip Soos and Paul Egan, with David Collyer (Feb 2014):  Australia’s Land Bubble: The Cause of Unaffordable Housing adds another ignored lurking elephantIt explains that macroeconomic measures are indeed needed, such as (p16): safeguards against excessive mortgage debt (loan to value ratios and others); banking capital and liquidity ratios, thus agreeing with the Riksbank and Yellen. But Soos and Egan also say that an essential way to curb real estate bubbles is land value tax which would (p16)  'certainly lower bubble-inflated land prices...
(p 17). Property ownership and speculation has been elevated to the status of religion in Australia, ...
A prohibitive entry point for housing symbolises a triumph of self-interest over the national good, as benefits flow to those Australians who already owned or invested before prices began to inflate during the mid-1990s. Families entering this grossly inflated market bear a heavy burden: decades of dutiful employment and stress to pay down ever larger debts. Enormous mortgages detract from national living standards, given a greater proportion of household income is diverted to mortgage repayments.
They conclude that a sufficiently large LVT (1%) applied to all land could minimise house price cycles. When such bubbles burst, horrific costs most often fall on the poorest who never gained during the boom. The renter/ homeowner divide is as disquieting an influence in Australian society as it is in the UK.

Whether in Australia or the UK and many places elsewhere, this second elephant of land value gain is ignored and left untaxed for homeowners alone, their gain often having been fed by public infrastructure improvements.  Meanwhile renters pay the tax for the public improvements but receive no compensating gain in land / house prices.     

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