Sunday, 28 October 2012

A Change of Tune

Predictably, Ken Clarke has retracted his statement on married-couple tax breaks, suggesting that the use of the tax system to force people to conform to Villa Tory ideals of family life will not in fact be postponed beyond the next election. But, as Isabel Hardman points out, the real story is what he said about the Conservatives' campaign strategy in 2015:
“It would be absolute folly to turn around and say it will all be fine by Christmas. Anybody who says we are absolutely certain we are bouncing back to strong growth is being very optimistic. What I am confident we will be able to say at the next election is we were a strong hand on the tiller.”
Basically, this is a recognition that the gamble the Tories decided to take in 2010 probably isn't going to pay off. The argument was that austerity measures would allow the government to say that they had been tough on debt, while the economy would be rebounding by 2015 anyway. Indeed, if austerity made the recession worse and the recovery slower, well, that just meant a bigger bounceback closer to election time.

This is starting to look increasingly unlikely. I'm still optimistic that the output gap is larger than most people think, and that we'll have a recovery eventually that gets us at least partway back to trend, but it might not happen until too late to win the Conservatives a majority. Remember that in order to do so the Tories would have to flip voters that they couldn't attract when they were running against Brown. And not winning a majority means not governing, because even if they win the most seats in a hung parliament, as last time, the Coalition is unlikely to persist beyond 2015. It would be the end of the Lib Dems.

It's not too late, of course, for the Conservatives to jump-start the recovery. Of course, George Osborne is extremely unlikely to direct the Bank of England to raise its inflation target, or in a best-case scenario target the level of nominal GDP. But there are other things the Treasury could do.

I'm more optimistic than most market monetarists about the potential usefulness of fiscal stimulus, particularly in terms of the 'balanced-budget multiplier' - shifting government spending from low-multiplier items to high-multiplier ones. It's not completely implausible that the Tories could decide to reduce low-multiplier cash transfers (i.e. benefits), and spend the money on building new roads and houses. And the standard critique of the balanced-budget multiplier, that the composition of government spending is inappropriate as an instrument of short run demand management, doesn't really apply, because we probably should be spending more on public goods and less on welfare in the long term.

Ultimately, though, the Tories are going to have to start thinking about what they're going to do in 2015 if growth over the next few years remains decidedly anaemic. It might be almost too easy for Labour to point out that a 'strong hand on the tiller' isn't a good thing if you're steering in the wrong direction.

Saturday, 27 October 2012

Why Do Too Many People Buy Houses?

Josh Barro and Noah Smith made the point today that housing is a pretty bad investment for most people to make, and it seems pretty clear that houses are overvalued. The problem is that for many people there’s something special about home ownership – people don’t see taking out a mortgage to buy a house as just any old investment. If they did, they would do a lot less of it.

Compare buying a house to investing the deposit, plus the money which you would have spent on mortgage payments above and beyond what it costs to rent, in a global stock market fund. In simple terms, housing probably offers a worse return than the stock fund would. Barro notes that it’s also much more strongly correlated with unemployment. Your savings are most important when there’s an economic downturn – you stand a higher chance of losing your job and needing to rely on those savings. But house prices are also likely to drop sharply in a recession. Because house purchases are so highly leveraged, the effects of a decline in value can be disastrous – losing your job means you can’t pay your mortgage, and suddenly the savings you had in the form of your house have been repossessed. Housing is a savings vehicle that becomes worthless as soon as you need to access it. You’d be much better off if you had your savings somewhere that isn’t likely to collapse at the same time as you lose your job, like China.

Another cost to housing as an investment is its inflexibility. If you need to tap those savings, because you’re between jobs or your car breaks down or your son really needs you to e-mail him a plane ticket back from Thailand, it’s really hard to get money out of your house. You might be able to refinance over a longer term, effectively reducing your payment, or with a higher principle, but remortgaging is time-consuming, expensive, and is subject to the whims of your bank. Equity-release schemes, meanwhile, are risky and charge exorbitant rates. It’d be much easier to sell some of a stock portfolio.

However, this inflexibility might also explain why housing is attractive. Comparing buying a house to investing in stocks assumes that you invest the same amount of money either way. If you rent, though, you’re going to have a lot more disposable income, and it’s going to require a much greater effort of will to save that money. ‘I would have to put less money into my portfolio this year’ is a much less likely to persuade Future You to forego the family summer holiday than ‘I wouldn’t be able to pay the mortgage.’ In this sense, you’re entering into an inflexible commitment to save.

You might have very good reasons for doing this. Perhaps you’re worried that Future You will be seduced by the allure of the Costa del Sol or a V8 penis substitute, and won’t save enough to finance the retirement you have in mind. By entering into a big inflexible mortgage, you force Future You to save that money. It’s the same logic as that of the dieter who puts a lock on the fridge door at night, or the blogger who pays someone to slap him when he checks Facebook. By increasing the costs of a lapse in self-control, you can make it more likely that you get the long-term outcome you want – in this case, adequate savings for later life.

Publicly forcing yourself to commit has implications for relationships, too. Home ownership is inevitably tied to the institution of marriage – and its importance is increasing as the traditional social attitudes to divorce weaken. Getting a mortgage with your partner is an explicit commitment to your long-term relationship. It makes leaving the relationship costly, forcing you to expend a lot of effort trying to make that relationship work when you might otherwise be impetuous. It’s also an important signal that you are the kind of person who places value on the importance of commitment, in the same way that the dieter’s girlfriend might be impressed by the lock on the fridge door. If, on the other hand, you extoll the virtues of your highly portable global stock index, your partner might start to worry about your motivation for trying to minimise the impact of divorce on your savings. And so you have an incentive to commit.

People don’t treat buying a house like they would other investments, but it’s not enough to say that this is simply irrational. There are a lot of good reasons why people might not be indifferent between owning and renting, and why they might want their chosen savings vehicle to be highly inflexible.

Wednesday, 10 October 2012

Exogenous Reality Shocks: Conservatives, Cuts and Conference

David Cameron's conference speech mostly retreads the same old ground, but one passage about developing country competitiveness stuck out:

"What do the countries on the rise have in common?
They are lean, fit, obsessed with enterprise, spending money on the future – on education, incredible infrastructure and technology.
And what do the countries on the slide have in common?
They’re fat, sclerotic, over-regulated, spending money on unaffordable welfare systems, huge pension bills, unreformed public services."

This is a common argument from moderate voices on the right - that we should be spending money on education, on infrastructure, on things that boost the economy and competitiveness, rather than squandering public money on welfare. It combines a defence of the importance of opportunity-enhancing public goods with a crusade against the wasteful bureaucracy and poor incentives that stem from overly generous welfare systems. In general, I'm very sympathetic to this argument, and Cameron (incongruous 'fat' comments aside) makes it pretty well. It's the argument I'd be making, if I was a conservative.

Of course, I'm not a Tory, and won't be so long as the NIMBY populists continue to outshout the free-marketeers on immigration and on Europe. But Cameron's speechwriters are definitely onto something here. Sadly, policymakers aren't helping out - as it turns out, the government is spectacularly failing to 'spend money on the future.' As this graph (courtesy of Jonathan Portes) shows, investment is the last thing on the Coalition's agenda:

The basic problem here is exactly the same problem that austerity governments always have. It's very difficult to cut spending. If you try and cut spending, what you end up cutting are the least visible elements of government spending, which also often happen to be the most important. That means cutting infrastructure, maintenance and R&D, where the costs of doing so are much less visible than those of taking Gran's winter fuel allowance away. It means cutting funding for administrative staff, so that you can boast about protecting frontline services while highly-paid police and doctors are forced to waste more time filling out paperwork. And ultimately it means that you end up making things worse and discrediting deficit reduction when really you started out with mostly good ideas.

Of course, the extent to which this is excessive electioneering by the Tories, rather than the unfortunate consequence of misaligned political incentives, is debatable. But the right could be doing this so much better.

Soak the Rich (In Liquidity): Monetary Policy, Left-wingers and Debt Deleveraging

Lately I've been seeing an increasingly large number of attacks on monetary stimulus, like this one, coming from the left of all places, even though there’s evidence that tight money massively increases inequality. Partly this is because denying that monetary policy is effective makes the argument for fiscal expansion much stronger, which is a good thing if you want to see a larger state and more redistribution. But even so it is baffling when QE is condemned as ‘giving money to fatcat bankers.’ There’s a perception that it inflates asset values, benefiting the rich, while not helping the working class or impoverished pensioners.

Krugman and others have modelled the Great Recession as a debt deleveraging story, with heterogenous agents – people with different preferences and constraints. What they show is that when, say, a big credit crunch leaves the poor unable to borrow, the rich (who are not liquidity-constrained) have no reason to raise their spending. This leads to an overall decline in nominal spending, plummeting output, rising unemployment and so on. The poor are busy paying off their debts, so if the government appears sublimely uninterested in fixing the housing market, there’s not much short of helicopter drops that you can do to increase their spending, especially once interest rates hit zero.

Under these circumstances, the state could step in to boost spending, confiscating the idle savings of the rich (perhaps through debt, which is essentially a promise to tax people in future periods) and putting that money to work in the economy. There are, however, good reasons why you wouldn't want to do this. It could have damaging incentive effects, and – in Europe, if not in America – we’re probably close enough to the optimum government share of the economy that we don’t want to permanently increase the size and reach of the state in response to one teensy little demand shortfall (which is arguably how the Great Depression got fixed). And there’s always the Sumner Critique to contend with. So ideally, unless you’re Ben Bernanke, you want monetary policy to shoulder the burden of boosting aggregate demand.

Unfortunately, there isn’t a whole lot you can do to get the poor spending, and so the shortfall in nominal spending has to be made up by the rich. But how do you get the rich to spend more, when really they’d rather hold cash? You make it possible for them to hold cash and spend at the same time, by buying their assets with newly-minted electronic money. The problem, of course, is that if you give the rich extra cash, most of it isn’t going to get spent, because their marginal propensity to save is a lot higher than that of the poor. But the beauty of monetary policy is that, unlike with fiscal intervention, you don’t have to worry about getting ‘bang for your buck', because the only major cost to printing money is the risk of overheating the economy. Provided you stand ready to take the punch bowl away, the actual dollar value of your stimulus package is pretty irrelevant. That means it’s fairly easy to overcome the propensity of the rich to save by giving them lots of money, so that what they do spend is enough to kickstart the economy again. Yes, this is a crude way to look at it, and it somewhat simplifies out the (vital) role of expectations, but it’s essentially what’s going on.

So is this a big transfer to the greedy plutocrats? Implicit in the monetary stimulus is that the injection of money is mostly temporary. If the central bankers are targeting inflation, they make it clear that the excess liquidity will be sucked out of the system before things get too out of hand. Under NGDP targeting, the central bank’s promise is essentially that enough of the expanded monetary base will be made permanent to get nominal GDP back to trend, but the rest is going to be removed. If we give every banker in the country a million pounds, but promise to take it all away again in five years, it might be enough to get the economy moving again, and get people back to work. It might also look like we were giving a bunch of cash to the wealthiest in our already-unequal society, even though that wasn’t what was really happening, and the poor ended up better off.

So that’s the story of QE you might tell if you were a New Keynesian. Those of a more monetarist bent, of course, don’t need to stoop to ‘telling stories’ about how a boost in the money supply affects nominal spending. Good for them.