Category Archives: aggregate demand

8/8/17: Did Irish Household Spending Fully Recover from the Crisis?

I have recently seen several research notes claiming that in 1Q 2017, Ireland has finally fully recovered from the shock of the Great Recession. These claims were based on consumer demand regaining its pre-crisis peak.

What do the facts tell us about this claim? That it is a half-truth.

Consider the following chart plotting consumer demand (consumer expenditure on goods and services) computed on an aggregate 4 quarters running basis. I use official CSO data for both expenditure figures and population figures. And I compute per-capita expenditure on the basis of these statistics.

In 1Q 2017, aggregate household expenditure on goods and services stood at EUR96.16 billion against pre-crisis peak of EUR94.118, using constant prices to account for official inflation. Incidentally, there is nothing new in the claim of recovery on that basis, because Irish households' aggregate spending on goods and services has surpassed pre-crisis peak in 2Q 2016.

The problem with the aggregate expenditure figure is that population changes. So the chart above also shows per-capita real expenditure, expressed in 1,000s of constant euros. Here, the matters are a bit less impressive. Per capita household expenditure on goods and services in Ireland peaked pre-crisis at EUR21,508.75. At the end of 1Q 2017, this figure was EUR 20,574.71.

There is another problem with analysts' celebrations of the 'end of the lost decade'. Aggregate household expenditure peaked (pre-crisis) in 1Q 2008, so it took 32 quarters to recover that peak. Per-capita household expenditure peaked in 2Q 2008, which means we are 35 quarters into the crisis and counting. Neither comes up to a full decade.

Finally, there is a really big problem. This one relates to what a 'recovery from the crisis' really means. In the above, we implicitly assume that a recovery from the crisis is return to pre-crisis peak. But there is a major problem with that, because our current state of life-cycle incomes, savings and debt in part reflect decisions made under the assumptions that operated back in the pre-crisis period. In other words, our income, savings, investment, career choice and debt carry a 'memory' of the times when (pre-crisis) trends did not incorporate any expectation of the crisis.

What does this mean? It means that psychologically, materially and even economically, the end of the crisis is when the economy returns to where it should have been were the pre-crisis trend extended into the present. To make this comparative more robust, we should also recognise that, in part, the pre-crisis trend should have omitted at least some of the most egregious excesses of the bubble years.

Let's do that exercise, then. Let's take pre-crisis trend in household expenditure (aggregate and per-capita) for year 3Q 2000-2004 (eliminating the explosive years of 1997-2000 and 2005-2007) and see where we are today, compared to that trend.

On trend, our aggregate personal expenditure should have been around EUR111.7 billion marker in 1Q 2017. It was EUR96.16 billion. This hardly reflects a recovery to the pre-crisis trend.

Also on trend, our per capita expenditure should have been around EUR24,140 in 1Q 2017. It was EUR20,575. This hardly reflects a recovery to the pre-crisis trend.

As some of my friends in Irish stuffbrokerages have been known to remark in private: "Shit! Damn numbers." Indeed... the recovery will have to wait... but, lads, you know you can do these calculations yourselves, right? You are paid six figure salaries and bonuses to do them. Or may be you are not. May be, you are paid six figure salaries and bonuses not to do these calculations...

31/1/16: Why is Inflation so Low? Debt + Demand + Oil = Central Bankers

One of the prevalent themes in macroeconomic circles in recent months has been what I call the “Hero Central Banker” syndrome. The story goes: faced with the unprecedented challenges of dis-inflation, Heroic Central Bankers did everything possible to induce prices recovery by deploying printing presses in innovative and outright inventive ways, but only to see their efforts undermined by the falling oil prices.

Of course, the meme is pure bull.

Firstly, there is no disinflation. There is a risk of deflation. Let’s stop pretending that negative growth rates in prices can be made somewhat more benign if we just contextualise them into a narrative of surrounding ‘recovery’. Dis-inflation is deflation anchored to an invented period duration of which no one knows, but everyone assumes to be short. And there is no hard definition of what 'short' really means either.

Secondly, there is no mystery surrounding the question of why on earth would we have ‘dis-inflation’ in the first place. Coming out of the Global Financial Crisis, the world remains awash with legacy debt (households) and new debt (corporates and governments). This simply means that no one, save for larger corporations and highly-rated governments, can borrow much in the post-GFC world. And this means that no one has much of money to spend on ‘demanding’ stuff. This means that markets are stagnating or shrinking on demand side. Now, the number of companies competing for stagnant or shrinking market is not falling. Which means these companies are getting more desperate to maintain or increase their market shares. Of these companies, those that can borrow, do borrow to fund their expansions (less via capex and more via M&As) and to support their share prices (primarily via buy-backs and further via M&As); and the same companies also cut prices to keep their effectively insolvent or debt-loaded customers. slow growing supply chases even slower growing (if not contracting) demand… and we have ‘dis-inflation’.

Note: much of this dynamic is driven by the QE that makes debt cheaper for those who can get it, but more on this later.

Thirdly, we have oil. Oil is an expensive (or used to be expensive) input into producing more stuff (more stuff that is not needed, by the companies that can’t quite afford to organically increase production for the lack of demand, as explained in the second point above). So demand for oil is going down. Production of oil is going up because we have years of investments by oil men (and few oil women) that has been sunk into getting the stuff out of the ground. We have falling oil prices. Aka, more ‘dis-inflation’.

Note: much of this dynamic is also driven by the QE which does nothing to help deleverage households and companies (supporting future demand growth) and everything to support financial sector where inflation has been all the rage until recently, and in Government bonds continues to-date.

Fourth, when Heroic Central Bankers drop policy rates and/or inject ‘free’ cash into the economy. Their actions fuel  borrowing in the areas / sectors where there either exists sufficient collateral or security of cash flows to borrow against or there is low enough debt level to sustain such new borrowing. You’ve guessed it:

  • Financials (deleveraged using taxpayers funds and sweat with the help of the "Heroic Central Bankers" and protected from competition by the very same "Heroic Central Bankers") and 
  • Commodities producers (who borrowed like there is no tomorrow until oil price literally fell off the cliff). 
When the former borrowed, they rolled borrowed funds into public debt and into financial markets. There was plenty inflation in these 'sectors' though they didn't quite count in the consumer price indices. For a good reason: they have little to do with consumers and lots to do with fat cats. However, part of the inflows of funds to the former went to fund ‘alternative’ energy projects - aka subsidies junkies - which further depresses demand for oil (albeit weakly). Both inflows went to support production of more oil or distribution of more oil (pipelines, refineries, export facilities etc) or both.

Meanwhile, inflows from the financial institutions to the markets usually went to larger corporates. Guess where were the big oil producers? Right: amongst the larger corporates. Thus, cheap money = cheaper oil, as long as cheap money does not dramatically drive up inflation. Which it can’t because to do so, there has to be demand growth at the household level, the very level where there is no cheap money coming and the debts remain high.

Now, take the four points above and put them together. What they collectively say is that the risk of deflation in the euro area (and anywhere else) is not down to oil price collapse, but rather it is down to demand collapse driven by debt overhang in the real economy (corporates and households and governments). And it is also down to monetary policy that fuels misallocation of credit (or risk mispricing). Only after that, risk of deflation can be assigned to oil price shock (in so far as that shock can be treated as something originating from the global economy, as opposed to from within the euro area economy). And across all these drivers for deflation risks up, there are fingerprints of many actors, but just one actor pops up everywhere: the "Heroic Central Banker".

A recent paper from the Banca d’Italia actually manages to almost grasp this, albeit, written by Central Bankers, it just comes short of the finish line.

Antonio Maria Conti, Stefano Neri and Andrea Nobili published their “Why is Inflation so Low in the Euro Area?” in July 2015 (Bank of Italy Temi di Discussione (Working Paper) No. 1019: They focus on euro area alone, so their conclusions do treat oil price change as an exogenous shock. Still, here are their conclusions:

  • “Inflation in the euro area has been falling steadily since early 2013 and at the end of 2014 turned negative. 
  • "Part of the decline has been due to oil prices, but the weakness of aggregate demand has also played a significant role. …
  • "The analysis suggests that in the last two years inflation has been driven down by all three factors, as the effective lower bound to policy rates has prevented the European Central Bank from reducing the short-term rates to support economic activity and align inflation with the definition of price stability. Remarkably, the joint contribution of monetary and demand shocks is at least as important as that of oil price developments to the deviation of inflation from its baseline.” 

Do note that the authors miss the QE channel leading to deflation and instead seem to think that the only thing standing between the ECB and the return to normalcy is the need to cut rates to purely negative nominal levels. In simple terms, this means the authors think that unless ECB starts giving money away to everyone, including the households (a scenario if nominal rates turn sufficiently negative) without attaching a debt lien to these loans, there is no hope. In a sense, I agree - to get things rolling, we need to cancel out household debts. This can be done (expensively) by printing cash and giving it to households (negative nominal rates). Or it can be done more cheaply by simply writing down debts, while monetising write-offs to the risk-weighted value (a fraction of the nominal debt).

I called for both measures for some years now.

Even "Heroic Central Bankers" (for now within the research departments) now smell the rotten core of the QE body: without restoring balancesheets of the households and companies, there isn't much hope for the risk of dis-inflation abating.