There has been a lot of talk in the media about an Auckland housing bubble and its impact on the New Zealand economy. Below is a very informative graph I got from http://www.housepricecrash.co.uk which looks at the anatomy of a bubble.
When house prices are increasing rapidly we tend to feel better off but also have increased mortgage debt. House price inflation is a zero-sum game in that society as a whole does not benefit from a rise in house prices as those on the property ladder can only gain at the expense of prospective homeowners that cannot afford to enter the market. Over a short period of time house price inflation can provide a boost to economic growth if they deceive people into believing they are wealthier.
However, when a business invests it tends to have a positive-sum game in that if it employs 50 more workers that doesn’t mean that there are 50 other workers in the economy that are going to lose their jobs. This is real GDP growth rather than investing in property which tends not to generate growth as it is a finished asset – however some will argue that maintenance will always be needed.
Part of the Cambridge A2 syllabus studies Macro Economic conflicts of Policy Objectives. Here I am looking at GDP, Unemployment, and Inflation (improving Trade figures is another objective also). The objectives are:
* Stable low inflation with prices rising within the target range of 1% – 3% per year
* Sustainable growth – as measured by the rate of growth of real gross domestic product
* Low unemployment – the government wants to achieve full-employment
New Zealand Growth, Jobs and Prices — 3 Key Macro Objectives Inflation, jobs and growth
1. Inflation and unemployment:
From the graph above you can see that low levels of unemployment have created higher prices – demand-pull inflation. Also note that as unemployment has increased there is a short-term trade-off between unemployment and inflation. Notice the increase in inflation in 2010-2011 as this is when the rate of GST was increased from 12.5% to 15%. Also today we have falling inflation (0.4% below the 1-3% band set by the RBNZ) and unemployment is on the rise – approximately 6%
2. Economic growth and inflation
With increasing growth levels prices started to increase in 2007 going above the 3% threshold in 2008. This suggests that there were capacity issues in the economy and the aggregate supply curve was becoming very inelastic. In subsequent years the level of growth has dropped and with it the inflation rate.
3. Economic Growth and Unemployment
With increasing levels of GDP growth unemployment figures have tended to gravitate downward. This was apparent between 2006-2008 – GDP was positive and unemployment did fall to approximately 3.6%. From 2009 onwards you can see that growth has been positive with unemployment falling. 2015 saw the unemployment rate rising with lower annual growth rate.
Below is a very informative video from the Reserve Bank of New Zealand about smoothing out the boom bust cycles in the New Zealand economy. There are some notes that follow which have been edited from the transcript.
Objectives macro prudential policy.
- To build resilience of the financial system so that it can cope with the business cycle if it turns from boom to bust.
- To be proactive in dampening the risk to begin with. This could include dampen the growth of credit, house prices or other asset prices. An example of this was in New Zealand in the late 1980’s – share market crash and the plunge in commercial property prices.
Macro Prudential Tool Kit – 4 Tools
1. Counter-cyclical capital buffer
This is where the banks are required to hold an extra margin of capital during the boom part of the cycle so that if the boom turns to bust the banks have an extra margin of capital that they can then call on to meet loan losses.
2. Sectorial capital overlay
This is very similar to a counter-cyclical capital buffer but it is about holding extra capital against a particular sector that the banks might be leaning to, for example the household sector, the farming sector, or potentially the commercial property sector.
3. Loan to value ratio for residential housing lending
This is a limit on the amount of high loan to value ratio lending or low deposit lending that the banks are able to do for the household sector. High LVR lending potentially fuels rapid house price growth and so that might be another reason why you would use that particular instrument.
4. Core funding ratio
This is a tool that has been a permanent fixture for the banks. There are a number of reasons why the core funding ratio might change. Potentially if the banks are facing an increase in risk, the Reserve Bank could require them to hold more core funding, funding that would be more likely to remain in the system during a downturn. By holding more of that stable funding, they’d be less likely to stop lending in a downturn because the funding would remain in the system.
Boom bust cycles are cycles in the economy and in the financial system are of course a fact of life. Macro-prudential policy certainly won’t prevent those cycles from occurring. What it will do is provide some cushioning to the cycle. It will hopefully clip the highs and the lows to some extent so that the flow of credit and the flow of financial services in the economy continue through time. It’s not about preventing the cycle or dampening it completely. It’s about taking some of the extremes out of the cycle.
Yesterday on Radio New Zealand Kim Hill interviewed Paul Mason – Channel 4 economics correspondent – about his new book entitled PostCapitalism: A Guide to Our Future. The book gives a very radical and innovative view of history, and offers a vision of a post capitalist society.
Mason believes that after two centuries in which capitalism has dominated the western world, this economic system has become desperately dysfunctional: inequality is growing, climate change is accelerating and nations are beset with bad demographics, debt burdens and angry voters. He makes three assertions according to Gillian Tett of the Financial Times:
- “information technology has reduced the need for work” — or, more accurately, for all humans to be workers.For automation is now replacing jobs at a startling speed
- “information goods are corroding the market’s ability to form prices correctly”. For the key point about cyber-information is that it can be replicated endlessly, for free; there is no constraint on how many times we can copy and paste a Wikipedia page. “Until we had shareable information goods, the basic law of economics was that everything is scarce. Supply and demand assumes scarcity. Now certain goods are not scarce, they are abundant.”
- “goods, services and organisations are appearing that no longer respond to the dictates of the market and the managerial hierarchy”. More specifically, people are collaborating in a manner that does not always make sense to traditional economists, who are used to assuming that humans act in self-interest and price things according to supply and demand.
He also makes the point that we are going to live through a long transition from capitalism – the state and the market to post capitalism which is the state, the market and the shared collaborative economy. With technology taking a lot of the jobs in traditional industries in the UK he states that further development in this sector is not the way of creating new jobs. He talks about delinking work from wages by just paying people to actually exist – rather than tax to exist. He does come up with some very interesting thoughts and it is well worth listening to. Click below to hear the interview:
Last month the drop in the Chinese stockmarket – Shanghai Composite – sent alarm bells ringing around the world economy that the world’s second largest economy was in trouble. A recent Economist article (‘Taking a Tumble’ – August 29th 2015) suggest that all is not lost for the Chinese economy and the developed world should not be agitated. Several arguments were made to ease the concern of the West:
1. The Shanghai Composite in relation to the over all size of the Chinese economy is very small – 33% of GDP compared with over 100% in developed economies.
2. Stocks and the economic fundamentals are not strongly correlated – share prices increased 30% last year but this data didn’t reflect improved Chinese growth forecasts.
3. Less than 20% of Chinese household wealth is invested in shares.
4. The money borrowed by consumers to invest in the sharemarket amounts to just 1% of total banking assets – not significant.
5. For the Chinese economy the property market matters more than stocks and shares do. Housing and land account for the vast majority of collateral.
6. The service sector now accounts for a bigger share of national output than industry.
7. With regard to the fiscal position of the Chinese government things are looking quite positive. It aimed for a budget deficit of 2.3% of GDP this year, but as of July it was still in surplus, having raised more in taxes than it had spent. Therefore it has the ammunition if required to stimulate more growth.
8. The economy is rebalancing, albeit slowly, away from investment and towards consumption (see chart 3). China still has many more homes, highways and airports to build, but the trend away from them is unmistakable.
9. Economic growth is almost certainly lower than the rate reported by the government but it appears to be in the range of a soft landing.
10. The People’s Bank of China (central bank) still have room to cut rates – benchmark one-year lending rates are at 4.6%. Furthermore the required reserve ratios are at 18% for trading banks. The central bank has room to cut both rates whilst most developed countries don’t have that luxury.
Bad news for China’s trading partners
As a result, China’s appetite for commodities has probably peaked. That is bad news for companies and countries that prospered over the past decade by selling it mountains of iron ore, copper and coal – e.g. our cousins across the ditch in Australia. A decline in Chinese consumption would be of huge consequence: it absorbs about half the world’s aluminium, nickel and steel, and nearly a third of its cotton and rice.
The countries most exposed to shifts in China’s economy, meanwhile, are the commodity exporters who supply the raw materials for the steel girders and copper piping that have underpinned the construction boom.
The plunge in the Chinese stockmarket was not evidence that the economy is on the edge. However, there are those that now doubt China as having such a safe economy.
A short animated video by the Reserve Bank which shows how the economy works. It also outlines the role of the Reserve Bank of New Zealand. Good for an introductory lesson.
The Greeks vote on Sunday whether to accept a June 25 offer from the International Monetary Fund, European Union and the European Central Bank (collectively known as “the Troika”) to provide Greece with desperately needed bailout money. In exchange, the Troika demanded that Greece implement a list of tax increases, spending cuts, and economic reforms. If there is a no vote then there could be the following scenario.
* Overnight the Greek authorities would have to circulate a new currency (most likely the Drachma)
* The Drachma would depreciate against the Euro – according to some analysts this would increase Greek debt from the current level of 175% to 230% of GDP.
* Interest rates would increase causing businesses to go bankrupt – some have indicated that this would be around 50% of businesses
* The risk of a run on the banks would mean that the monetary authorities would have to introduce controls on money flows – especially abroad.
* Social unrest would no doubt escalate in the short-term and many Greeks will leave the country (if they can afford it).
* The Greek government would find it difficult to raise funds from overseas as investors become more prudent and see Greek bonds as an even bigger risk than before.
* A devaluation will would do nothing to change Greece’s structural problems.
* The euro will lose credibility in the long run and its weaker members will be exposed to bank runs which will ultimately extinguish any chance of a recovery.
* A weaker currency would make Greek exports a lot cheaper and may resurrect the textile industry that collapsed a few years ago.
* However the biggest benefit would be the tourism industry where holidays would become very cheap relative to similar destinations in Europe.
* The Greek government could keep printing money to finance the promises made Alexis Tsipras’ government – maybe an inflationary threat.
* Interest rates would no longer be determined by the ECB and a more expansionary monetary policy could be implemented by Greek authorities to tackle the downturn.
We’ve been here before as Jeff Sachs mentioned in his piece from Project Syndicate.
Almost a century ago, at World War I’s end, John Maynard Keynes offered a warning that holds great relevance today. Then, as now, creditor countries (mainly the US) were demanding that deeply indebted countries make good on their debts. Keynes knew that a tragedy was in the making.
“Will the discontented peoples of Europe be willing for a generation to come so to order their lives that an appreciable part of their daily produce may be available to meet a foreign payment?” he asked in The Economic Consequences of the Peace. “In short, I do not believe that any of these tributes will continue to be paid, at the best, for more than a few years.”
The Greek government is right to have drawn the line. It has a responsibility to its citizens. The real choice, after all, lies not with Greece, but with Europe.