What's happening in the UK

People are wondering what's happening in the UK. Persistent core inflation above the BOE target alongside a stagnating-to-declining GDP point to a supply-side crunch, but, unlike the oil crises of 1970s, there is no obvious culprit.

This is a repost of what I said in the comments on Modeled Behavior.

I have a supply shock story to tell. Housing. And it’s the exact opposite of the story you have in there – which is true for Spain but not true at all for UK.


My basic intuituion is based on personal experience/anectotal evidence of a total dearth of new home building in anything that would be considered a decent area of London (i.e., excepting Canary Wharf). Housing stock here is shockingly old, shockingly poor in condition, and (double) shockingly expensive. It is really quite something to see small, old buildings or apartments going for muliple millions of dollars – the quality vs price combination here makes even this former New Yorker blanche.

In the US, the mid naughts were characterized by at least a decent sized boom in residential construction. It has since been dwarfed by the slump, but never mind. In Spain (or so I hear), the construction boom was quite a bit bigger than the US.

In the UK, by contrast, the boom NEVER HAPPENED (graph shamelessly stolen from elsewhere):

Since 2000, there’s been a total failure of the new housing build to accomodate the population growth, and housing construction has been on a downward trajectory since before 1990! (Obviously, you’d prefer to look at household formation rather than pupulation added, but basic picture still stands). Have a look also at house price statistics: there has been a dip, yes, but much less pronounced than in the US of A, and most of the losses have already been recoved in nominal terms, with London already above the 2007 nominal peak.

Now, I do not know what the cause of this is. In London, I blame historic preservation rules. This is a pet-peeve of M. Yglesias, and rightly so – for even the somewhat far flung parts of London have basically zero new development, and “conservation areas” are spead out like buboes on a corpse dying of plague. Even outside of the “conservation areas”, all buildings are about 80-120 years old, look absolutely identical, and you can’t even replace the windows without approval and without windows looking not too dissimilar to what you’re replacing.

Whatever the cause, the consequence is easy to imagine: higher and rising per square foot rents. Which, since the commercial sector also needs the space, not only subtract from disposable incomes directly, but also result in a tax through higher than necessary retail prices and/or death of so-called “high–street retail”.

To whom does the surplus go then? Obviously, landowners. And since landlors employ very few people, it never has the chance to filter down through wages. In fact, in most cases the surplus is probably never even realized – it just sits there as paper capital gains. It’s a rentier society.

Onwards to solutions then. Easy-peasy. Supply-side problems have been solved by conservative politicians years ago and these solutions are really popular in Europe now! Generally, the process involves deregulation and the cutting of red tape. In this specific instance, you just want to abolish height restrictions in most areas (especially around existing transit infrastructure) and also reduce the number of historic preservation areas. Then you sit back and watch the construction boom unfold. Ideally, you follow up with the Keynesian-stimulus in the form of additional mass transit infrastructure development.

We could have declining living standards

Karl Smith looks at the vehicle data and concludes that people will HAVE to start buying cars soon. Similar argument is made with respect to new housing. It's a version of a mean reversion argument that basically says that the data point to an upside down bubble and it's not sustainable. I am sympathetic to this line of reasoning and would like nothing more than for things to play out the way Karl sees it. But living standards can actually decline! More specifically, it's possible that a poor and a less employed nation will buy fewer cars, houses, refrigerators and other stuff per capita than before. Not forever, probably, but for a really long time. Longer than me or Karl would be comfortable with.

Futility, ctd...

In an oddly responsive blog post, Yglesias dismisses at least a part of my quibble saying that any recovery will make gas more expensive. This is true. But not the point I am making.

The point is that in pursuing the higher levels of inflation and NGDP we need to keep in mind that distribution of gains matters. To the extent that the policy raises prices of food and commodities by a lot and immediately, while lifting wages and employment very little and over a very long time (or not at all), this could be a bad policy notwithstanding the fact that NGDP inches closer to trend line. We also need to bear in mind that it is certainly possible to achieve nominal wage growth with declining real median wages and more people slipping bingo poverty. Policies like that, I venture, are also bad.

The second point is that direct monetary transfersp to the populace suffer no obvious flaws of this kind, because it's policy that is targeted at the core of the problem very directly.

File under: futility of it all

Long time - no post… But let’s talk about something that’s becoming the last best hope for the developed economies due to bad politics: monetary policy.  Let’s just say that I am rather less optimistic about the ability of monetary policy than Paul Krugman and especially Matt Yglesias to resolve our present economic difficulties, and basically agree with Macro Resilience here but have a few extra quibbles of my own.
Krugman, Karl Smith and others have, while acknowledging the severe limitations of monetary policy at zero lower bound, have nonetheless pushed for more aggressive policy – primarily, I think, through the communication channel. Karl Smith calls it “classic central banking” where the policy is the message and has also called for an explicitly higher inflation target to give us more headroom in the future. Paul Krugman, I think, generally agrees although, in fairness, Krugman’s preferred policy lever is always fiscal. Greg Mankiw and Ken Rogoff are in the same boat here. (See also this Mike Konczal chart which basically summarizes the scope of possible monetarist solutions). Yglesias, in the meantime, has posted this as his monetary policy ideal: in the nutshell, Fed announces a higher inflation target, and further states that it is committed to achieving it via purchases of unlimited amount of stuff, doesn’t really matter what.
So here I have no problems with higher inflation targets generally and think they would be great. Here is a query, however: what’s the mechanism by which policy of the kind described above now would help us achieve full employment. I think there is a bit of magical thinking involved on the part of monetary policy optimists here, not unlike the magical thinking of trickle down economics. I other words, there is a link that I am missing, and I think comes across as readily apparent in Yglesias’ policy proposal. It’s almost like the underpants gnomes story. Step 1: announce higher inflation target. Step 2: buy stuff to achieve inflation target. Step 3: ???? Step 4: full employment.
Let’s suppose for a minute that the communication channel worked it’s magic, and just by virtue of stating it’s commitment to higher interest inflation, the Fed was able to achieve it. Aren’t we even a little bit concerned that the inflation would pop up in places we don’t like? What we want, in other words, are primarily higher wages and possibly higher rents (the latter because eventually higher rents would lead to higher construction employment). But what if what we get are just higher commodity and food costs? It seems to me that we’d get in practice very much depends on which market is tight at the moment. And, of course, we have the least slack in commodities markets: food stuffs and oil (don’t underestimate how much the price of the former is driven by the price of the latter). We have the most slack in the labor market. Rental market is reasonably tight and we might see inflation here regardless of what the Fed does or does not do. Something tells me then, that if we see inflation bumping up, the components of CPI that go up first are likely to be commodities. Then rents. Wages will come last, and we may never get to them: because it’s entirely possible that the price bumps in commodities will just continue to sap demand from the overall economy, as they are of no help at all to the deleveraging consumer.
 
On the interest rate channel (aka, “the Fed buying stuff”) I can see, for example, how Yglesias’ monetary policy would work if the stuff that the fed would buy were units of labor. That would indeed quite directly result in lower unemployment. But the Fed can’t do that. Instead, it buys debt – mostly government debt, but it could probably buy corporate debt too. So how does that help a deleveraging consumer??? At best, what you get on the consumer side is declining mortgage rates. But does anyone seriously think that this is stimulus enough? Mortgage market, including refinancing market, is not very fluid, there are high costs to refinancing, and cash flow problems, adverse appraisals and tighter credit problems – all of which are already preventing consumers from taking advantage of low rates – are not issues that will disappear when rates are another 50 bps lower.  (I suppose another thing you might get is lower corporate credit rates. But again, corporate balance sheets are not holding back the hiring). In wonkish terms, what you have is a situation where the Fed’s newly created reserves simply become the bank’s excess reserves, as the velocity of money is low. This makes it difficult for the Fed to achieve it’s goal of higher inflation (even if it had such a goal).
What we need are indeed helicopter drops. We need direct transfers of money to the consumer. That’s primarily a fiscal mechanism, but I suppose one could imagine it as a monetary solution. In fact, I’ll propose one: the Fed (or the Treasury – take your pick) should get into consumer banking and propose that each of its new customers gets $10,000 in the account just by signing up. If $10,000 proves insufficient, the Fed/Treasury could do another promotion: use your debit card 10 times in a month and receive another $10,000.

Breaking: finance professionals don't want to live in Utah

Karl Smith tries to find skills mismatch to answer Paul Krugman's "it's the demand, stupid" story of unemployment, and cites an anectode of Extend Health, a Medicare health insurance exchange firm in Salt Lake City, Utah, which is struggling to find it's ideal candidate: "over 40, with a background of financial services in order to qualify for insurance licensing."

Wait... what??? We have a lack of people in their 40s with finance backgrounds? No, that can't be right. We have too many of them. They are just too busy grabbing bonuses on Wall Street (or have already retired to St Kitts) to bother showing up for an interview in Utah. This is an outrage, but not news: finance, as an industry, has weathered the crisis very well, despite having caused it.

Just goes to show that if only the fall in demand for finance industry professionals were commensurate with the peripheral damage they have caused, if they could somehow be forced to pay for the externalities of their activities, labor market efficiency would hardly suffer.  Of course, were this to happen, we'd have "socialism."

Inequality, uncertainty, etc.

I've been pondering lately how it's come about in the U.S. that a person with income in the 95th percentile does not feel rich. There are many angles to see this through. One argument is that someone earning, say, 250K in Manhattan lives in a very expensive place, so isn't really rich, especially if she's got some expensive education to pay off. Another is that the same person's actual and aspirational "peer" group are people that earn the same or a lot more than she, and, to boot, she is likely to be working in an industry where money earned is a primary metric of achievement and so when someone of the same age and similar educational background is making 10x the amount that puts a significant damper on spirits.

So much for the 250K earner then. We don't have to stop there, but let's think of the poor sod making 2.5M. Does he (and it's probably a he) feel any different? Does he feel "rich"? I would suggest that it's unlikely. Why? Here we can go deeper and ask - what is it to be "rich" anyway? From a subjective perceptive (which is what we're talking about, and as opposed to the objective perspective, for which metrics like multiples of median income generally suffice), to feel "rich" is to think that one earns and has in excess of what one needs for the lifetime. This state is a very difficult one to achieve for very nearly everyone who depends on a salary/bonus for a living, and it scarcely matters how much that salary/bonus is - for that salary is seldom assured for even one year hence.

The 2.5M per year chap's problem, you see, is that he has built up for himself, the missus and the Jr. a system of consumption that requires extremely high inputs, and yet his job is such that he can never assure himself of being able to procure the necessary income to sustain this system of consumption, and feels trapped as a consequence. The guy with a $50K per year and a cheap rental will absolutely justly say: well, fuck that guy, his $5 million mortgage, $10K per week summer rental in the Hamptons and the use of a helicopter as occasional personal transport. And fuck his missus too, with her insatiable appetite for $1000 pairs of shoes and $10K handbags. Our Richie Rich, however, doesn't feel that way. He may even comprehend, on a moral level, that his level of consumption is noxious -- but that will not make abandoning that consumption entirely and abruptly any less stressful. Think about it: he may loose that $2.5M income at a drop of a hat, for jobs like his are rarely secure. But his consumption is, in economist terms, sticky, and difficult and even painful to unwind on short notice. I am not asking you to have sympathy for Richie Rich. I am asking you to understand that he too, very likely, mutters to himself, "Fuck all of the other SOBs too, I do not feel secure and have far too little assurance in what the future holds to feel rich enough to share." Less quietly, our Richie Rich will, if he can, lobby his congressman to keep taxes in check - for he needs to squirrel away every dime that is left of his income, after his system of consumption is through with it, to shore up his future well-being.

This, then, is the mysterious uncertainty that CNBC was harping about all of last year. Increasing marginal taxes, in this line of thought, reduces private sector savings of the high-spenders and therefore increases their nervousness/uncertainty in their ability to sustain the same level of consumption in the near and far future. As a matter of social justice, it is very proper to assert that, hey, perhaps this level of consumption should not be sustained. But social justice is very rarely a primary concern for anyone on a personal level, where stability and continuity are paramount and, I think, more important to the level of happiness than the actual level of income (an empirical study on this is overdue).

The same sentiment is also what makes the job of a teacher a "cushy" one in the eyes of the quacks on CNBC. Teachers have what no financier has: stability. It's a lower middle-class kind of stability, but it's stability nonetheless. The social justice argument (a very misguided one) for the Scott Walker-style union busting is that it is unjust for public sector employees to enjoy the level of stability (not income) that they do, and we should strip that away to make society more egalitarian. Nevermind that this just makes the country as a whole a less happy place.

P.S. To be sure, the foregoing should not be new to microeconomics and behavioral economists, who have long known that risk aversion pervades personal desicion-making. But I think that this concept has been very much underutilized in macro analysis and especially in policy making.

Public Sector Pay

To all those complaining about how the public sector workers in Wisconsin are paid too much, allow me to retort ... with a question: "How much do you make?" And in the likely event that it is considerably more than the 46K that the average teacher in Wisconsin gets: "What it is that you do that is so valuable as to justify the lavish level of your compensation? Hmm???"

It's a tough one, but I'd say that on balance the relative levels of compensation in - to pick two industries out of the hat - banking and education, have very little to do with the social value of an average worker in those industries. And while the incentive structure of teacher's compensation in America may well be all fucked up, the level, if anything, is WAY too low, given the importance of the job.