What I don't understand (and I hope someone can shine some light on!) is the basket of goods they use to measure inflation doesn't seem to be very impacted by low interest rates - therefore how will the low rates increase inflation? i.e. banks will only lend to me at below 5% if I'm buying fixed assets like a house - which isn't included in the inflation measure. If I want to borrow to buy groceries, gas, or the other things they measure for inflation I would be borrowing at >19.99%. Therefore all low rates does is cause the price of fixed assets to skyrocket. But those assets are tremendously difficult to convert into consumer spending - i.e. You sell your now inflated house, but rather then spending that "profit" (due to the value of your house increasing) on more groceries and gas most people just roll it into another expensive house as they gotta live somewhere. I guess ultimately there will be a trickle down where everything will get more expensive, but seems like it would be a very long process...
But, anecdotally, home services, energy cost, health services, food and clothing are all more expensive now than a few years ago, the only exception I can think of off the top of my head is gasoline, which has fallen.
Edit: This StatCan paper (http://www.statcan.gc.ca/pub/62-553-x/62-553-x2015001-eng.pd...) explains CPI in detail and it seems like the basket is thorough and well-thought-out. Appendix B outlines all the components and their weights, and both homeowner costs, rents, and mortgage interest costs do factor into the shelter calculation.
Ex2: many government benefits are tied to "inflation" . If your personal basket inflates faster than their example basket then they can get away with paying you less than promised (in spirit).
EG you buy more electronics and gas (cheaper), and less clothing and food (more expensive), but your overall spending remains ~50% of your income, which hasn't changed.
Wages are usually the primary driver of higher CPI measured inflation.
Inflation has occurred outside of CPI basket, most notably in equity markets and real estate prices in large urban cities - and bitcoin :)
Those are assets rather than goods. They are neither produced nor consumed. That being said, yeah, it's no mystery that low rates have caused asset price inflation, not consumer price inflation.
You are consuming housing when you pay rent/mortgage. A house is built, and then its owners consume it in "housing units", or rent those "housing units" to other for consumption.
Likewise that ground beef you have in the fridge is an asset - you can sell it to your neighbor at any point before you consume it.
Equity is a claim on a company's assets. If General Electric goes bankrupt and you own GE stock, you will get paid out (after everyone else) a share of the bankruptcy proceeds. So in a way you own some of what GE produces, some of the inputs it consumes, etc.
You can look at literally any transaction as an investment into an asset (generally durable goods) or the purchase of a good for consumption (generally non-durable goods). It depends on how you want to record it on your personal balance sheet...
When you pay rent you are consuming housing. When you pay a mortgage it is a financing transaction on the asset. Your consumption cost nets out because you are both paying and receiving rent. Yes all transactions are for either an asset or a good, as Y=C+I...
And whilst land may not be particularly portable, land ownership is.
Other productive assets: metals, grain, productive plant, etc., may also have financial asset value. Also goods which aren't particularly useful such as fine art.
But from an economist perspective relative price changes of one good to another are usually not very relevant.
The measure for real domestic deflation you want to look at is the 'GDP Deflator'.
The problem of conecting the economists theoretic definition of general price level is quite tricky to nail down. The commenly used CPI or even Core CPI does not perform very well.
Many economist would now argue that instread of focusing on CPI price level measure we should use either total spending directly, or use a different price level measure like the 'GDP deflator'.
What I did not talk about is that many prices are foreward looking, so prices start adjusting before demand if things are expected.
The first part happened. The last two don't seem to be happening, which is puzzling. Central banks are having to consider that the old model may not hold anymore. No one's really sure what to do.
Consumer tendencies weren't really supposed to enter into it, as far as I know.
Also of note is that more economic activity is concentrated in fewer and fewer regions, so while a select few (urban) regions experience growth and whatnot, most other areas do not.
We've seen since the last recession that top 2% have grown incomes while most others are stagnant, perhaps this is part of it.
That central banks and treasuries insist on inflation above zero when we should probably be deflating and letting technology make everyone wealthier...no wonder there are property bubbles. (Note this inflation argument encompasses the effect of trade deficits in creating asset bubbles, because inflation/treasury debt breaks the trade/currency feedback loop)
More money circulating means more of the economy is active.
More money in the economy increases inflation because more supply lowers value.
Inflation is good because it is not deflation, but it is not good because it devalues monetary assets over time. Low inflation is best.
The problem is simple. The additional money from cheap loans is not circulating. It is being sunk into mortgages and other debt.
The truth is that the policy is working in the sense that the alternate would have been deflation. Deflation kills retail because it is hard to stay in business if you buy low, sell lower.
[1] http://www.nytimes.com/2011/04/02/business/02charts.html?mcu...
I'm under the impression most people are ready to spend a certain portion of their income on their living arrangement and low interest rates just encourage them to buy ~bigger~ more expensive property, rather than actually turning the "savings" into other types of spending. I'd be interested to find actual data and research about the relationship between interest rates and mortgage spending for given incomes...
In other words, the fixed factor is the spot rent market - how much you can get renting out a house in a certain location. When you lower interest rates, the monthly payment remains relatively constant, which drives up the principle to compensate.
For another thing, if the monetary base is expanding, it could be that all the new cash gets sucked into fixed asset wealth like land and stock value, but the number of transactions fall so that these price increases don't leak out into broader consumer prices or wages.
Finally it could be that technological change is causing deflation on the same order of magnitude as the banker's monetary inflation.
http://www.slate.com/blogs/moneybox/2014/02/24/housing_infla...
In the US, credit cards are often a fixed + prime rate, so changing national bank interest does affect credit card rates.
As as aside, ~20% is an insanely high rate for credit card purchases (again, in the US).
Even though I agree with the spirit of your statement, I don't think that central banks "let this happen" -- on the contrary, fiat currencies and central banks BY DESIGN massively exacerbate (and arguably cause) the boom and bust cycle [1].
Without central banks unilaterally determining the price of borrowing money (AKA interest rates) and propping up bankrupt institutions (e.g. see 2008 bank bailouts), the natural boom and bust cycle would have a much lower amplitude as the market would determine the price of borrowing money rather than disconnected bureaucrats sitting in the room pouring over the latest econometric reports. Price controls don't work for goods and services (see the USSR) and they certainly don't work for money either!
[0] Worldwide Government Debt - https://data.worldbank.org/indicator/GC.DOD.TOTL.GD.ZS
[1] Austrian Business Cycle Theory - https://en.wikipedia.org/wiki/Austrian_business_cycle_theory
The gold standard over the past 100 years was mostly a government controlled gold standard, where paper money's tenuous link to gold was slowly eroded until it was completely eliminated (Nixon severed the final ties to gold in the US in 1971). If governments had never mettled with money, I suspect the world would already have a well-functioning monetary system (most likely gold).
I'm a big cryptocurrency fan, but as you mention Bitcoin has recently had issues with unconfirmed transaction delays. Without going into the details (don't know how familiar you are with the politics of Bitcoin), I think this will ultimately get resolved, and the transaction delay / high transaction costs / full blocks are ultimately what lead to Bitcoin forking into Bitcoin and Bitcoin Cash.
As for Bitcoin lacking a stable value, that's also an issue, but if it actually has a shot at replacing fiat currencies worldwide (and I think it does), its value will increase massively but ultimately it will plateau and have a relatively stable value (I suspect this would've happened with gold already if governments hadn't mettled with it)!
Not for long they don't! Cryptocurrencies have finally found a way to get around such unethical control of the world's monetary systems.
And government controlling the monetary systems does not make government debt irrelevant -- even if they can always print more money, they can't always avoid hyperinflation. And regardless, printing money is stealing from savers, so it's not exactly some noble activity.
In Canada this is because the real estate bubbles were confined to Vancouver and Toronto. Raising interest rates to cool down real estate in those two cities would have been bad for the rest of the country.
Property ownership in those two cities also isn't limited to being a resident of those cities either. A significant amount of properties are rented out and the landlord can live outside of the cities, so the effects of a drop in prices will be widely felt. Combined with the fact those two cities and surrounding areas represent a significant percentage of the total population.
The US housing crisis was itself limited to a group of areas in the country in varying degrees as well, for example Florida got hit way harder than most places. The group was just far larger given the country's population is 10x the size of Canada.
And Bank of Canada has started to add mortgage restrictions this year country-wide so they too see it as something that needs to be addressed nationally.
Canada isn't facing a housing bubble as much as they are facing a debt bubble. Most of the recent household debt that has been record breaking year after year has been with credit cards, autos and lines of credit.
Are you sure? I've seen articles mentioning increasing debt in general, but that's mostly tied to mortgages, which isn't a big deal (unless rates rise quickly, which is unlikely).
For example: http://www.cbc.ca/news/business/canada-credit-cards-transuni...
"[credit card] delinquency rates in British Columbia and Ontario dropped by 2.1 per cent and 3.3 per cent, respectively." (by contrast to Alberta and Saskatchewan)
Car loans are ~ 2% of total debt, at least in Quebec: https://www.desjardins.com/ressources/pdf/pv170828f.pdf?resV...
[edit: note that TO is in a short term downwards price adjustment due to the 15% foreigner tax put in recently, that will stabilize this year, but still over the last 8 years TO pricing has skyrocketted]
Even so housing across Canada has gotten more expensive. Through gentrification in these big cities, smaller cities have seen people move in causing some nominal increases too.
The result is that people all around are needing to allocate more and more money towards housing leaving them having to use credit cards and loans more. You can do a Google search on Canada household debt and there's no shortage of articles declaring record breaking household (non-mortgage) debt levels.
So yeah it's all one big problem, but it's the household debt that's going to kill them, not the mortgage debt. Foreigners will continue to invest in Canada even during a recession, because Canada will still be a good investment on a relative basis. Big cities like Vancouver and TO will hold their value as all big cities tend to even during recessions. Just look at how quickly NYC managed/recovered post 2009 compared to other US cities.
All this leads me to believe that people are in financial trouble due to household debt, though maybe it's semantics. For some when, mortgage renewals come about, does it really matter which?
Summary: govt created a housing bubble let's see what happens.
I don't believe that. Somehow the other 90-95% don't have a greater impact? If the roles were reversed you wouldn't even consider that possibility.
I don't understand your comment on roles being reversed. I didn't realize I had a role in this and I don't know what possibility you're referring to or how it might relate. Maybe you can elaborate.
In Sweden we moved from interest only mortgages to 100 years as the norm. Still too long. Doesn't work well with near zero interest rates.
As a result, people who bought homes in 2012/2013 will be affected by rising rates as well as a new affordability test. They'll need to prove they could qualify for the loan at 2-3% higher rates in anticipation of the rate environment at their next renewal.
As a result, people who qualified & budgeted for loans at 2.5% in 2013 will suddenly have to be qualified for 6% loan interest within the next few months.
In terms of financial impact, this could represent an additional $1300 monthly expense people will have to budget for on a ~$450,000 loan.
What if they are not? If the loan isn't granted, then the lender will have to go elsewhere, and worse case they will have to sell the property, possibly at a loss. That would seem like it just exposes the bank to more risk? Situation here is that you simply keep paying and the bank doesn't care whether you pay 110% of your income because you are unemployed, or 10% of your income because you got promoted - so long as you are paying.
Stress tests/qualification can therefore be against a "high interest rate" which is typically 7-8%.
What's interesting is that even a 4% interest rate at this point would probably lead to a recession because people are so highly in debt that they would cut saving/spending immediately. That recession would likely see interest rates plummet again. So the "new equilibrium" is a scary low.
Personally I believe many older/sick people would have died if central banks hadn't dropped interest rates and embarked on QE asset purchasing schemes to keep the system afloat.
Credit/lending would have all but disappeared for a while, many would have lost access to financial instruments necessary to secure housing, healthcare, insurance.
As a young person I'm not happy that we've propped up the status quo, that my rent is stupidly expensive, and that the majority of recovery has gone to the wealthy/those who owned existing equity/assets/real estate, but I can see why it was necessary.
CB's just kept repurchasing until unemployment bottomed out, and now that we've hit the bottom, they will start to shrink their balance sheets. That's their mandate - maximize employment, keep consumer prices relatively stable.
All CBs can really do is make sure banks have enough money to lend into the economy by adjusting reserve requirements and interest rates. They could massively screw up the economy by jamming interest rates up right now, or dumping all their purchased QE assets back on the market, but they can't really improve the economy strictly through monetary policy.
That would require better fiscal and regulatory policy, such as tax code reform, increased spending on R&D and infrastructure, spend on education, etc. Even then it's not guaranteed this spending would lead to any technology-advancing breakthroughs that could raise the standard of living across the economy.
Ultimately I believe that low productivity (we've hit a ceiling on the returns to the internet, computer, and smartphone for the moment), plus a lot of the rest of the world catching up in terms of infrastructure, is to blame for the stagnation.
I just don't have enough economic knowledge to say with confidence that unemployment would have bottomed out without QE2 and QE3, and that monetary policy post QE1 has been bad/unnecessary. I have to defer to CBs judgement on this matter.
If you have studies/data to the contrary I would definitely want to read them.
https://www.federalreserve.gov/econres/feds/files/2017093pap...
Any source for this?
Also, another issue is that you can cause a housing market crash and financial crisis by abruptly increasing the rate when household debt is at a high.
Housing prices went nuts in Canada because Canadians felt they were being priced out and "real estate always goes up".
They are doing the right things here and targeting increased rates for investment owners over home occupiers
I agree with your sentiment and artificially is a powerful word for conveying that. But strictly speaking the rate the central bank sets for lending new money is artificial, or fiat, no matter what we decide it should be (So long as it is > 0).
My point is that the connotation we associate with the word artificial varies with our opinion of the legitimacy of the monopoly in question. People who are disinclined toward the federal reserve will read artificial differently from those who think it does a good job.
Why would interest rates be zero without intervention? Who would lend money to someone else for free?
When they buy bonds, it pushes the yields lower, if things were where they were naturally the fed/ecb etc wouldn't have the sheer number of bonds they do on their balance sheet.
In the absence of central banks it's likely the world would eventually settle on a single commodity to be used as money, and it's unlikely to be a commodity that's inflated into oblivion like fiat currencies. Additionally it's unlikely that people will somehow start loaning out money for a rate of almost 0%, why would people loan money (and therefore risk losing it) for a return of 0%? They'd be better off just holding onto it.
A central bank has to conduct montary policy for the economy as a hole. Attempts by central banks to 'clamp down' on bubbles have generally been catastrophic.
Also the low interest rates are simply not just 'artefically low' because of central banks. The montary effect of the interest a central bank sets is determained by the difference to the natural rate.
Propery bubbles or any other bubbles by themselfs don't relay cause much problems beyond the markets in question if montary policy stays on target.
Aditionally the idea that all these things are bubbles is quite suspect in a lot of places there is real demand for property.
Contracting montary policy in order to fight a property bubble would lead to the hole economy going into a recession.
The last time the 'fighting bubble theory' was really popular was in 1929. I'm not saying that was the only reason for the Great Depression, but its one of the major reasons.
What do you define as 'real demand'? There are three main areas of demand for housing property:
1. People requiring shelter (i.e. people who will purchase a property to live in themselves) or
2. People purchasing property to extract rents (landlords) or
3. People purchasing property to later on-sell for a greater amount (property investors)
It's the third class of buyer that many believe is driving demand, and there's certainly a strong argument that the property investor class is bigger today because of depressed interest rates. Because of this increased demand, prices increase. But that price increase is driven only by the perceived future sale value of the property. This is why it's a bubble - The returns are predicated only on continued buy-in to the market. It's little more than a ponzi scheme.
This assertion falls apart if you don't accept the premise that current activity is being driven by investors, of course.
Also, investment however flawed is simply not the same as a ponzi scheme.
Fundamentaly however you have to realise that low interest rates are not artefical. If the natural interst rate were as high as in 2006 with the rates we observe now we would see a massive collapse of the money supply and a recession worse then the great depression. Interest rate in the hole world have been going down since 1970. A recession itself depresses real rates, because investment is simple not as profitable.
The idea that the central bank can indepentenly fix housing bubbles and create stable demand is just flawed, its simply not possible. Its the wrong tool for the thing you want to fix.
The central bank could simple start buying and selling property instead of bonds, but that just replaces stability in one market with instability in another.
I was responding specifically to your statement:
>Aditionally the idea that all these things are bubbles is quite suspect
I agree with your point that monetary policy may not the right place to solve a property bubble. I disagree only with the assertions that property bubbles might not currently exist and that bubbles can never be easily identified.
>Also, investment however flawed is simply not the same as a ponzi scheme.
It is if the return on your investment is solely dependent on the continued input of other people's investments.
>Fundamentaly however you have to realise that low interest rates are not artefical.
I am not arguing that they are. Are you confusing me with another poster?
>The idea that the central bank can indepentenly fix housing bubbles and create stable demand is just flawed, its simply not possible. Its the wrong tool for the thing you want to fix.
I agree.
If your meaning of 'bubble' is that at some unknown time in the future the price will be lower then it is now, then the concept is economically speaking useless.
> It is if the return on your investment is solely dependent on the continued input of other people's investments.
Still not the same thing. There is still a real asset that exists, it might change in price but it exists.
In a Ponzi scheme that is not the case, it falls apart if there is no further and nobody will have anything.
That is why you can go to prison for a Ponzi scheme but not for property speculation.
Which is why Central Banks don't make sense as independent arms of Government.
Bubbles are very very dangerous (as we all discovered in 2007/8) but they cannot be fought with interest rates alone. It takes a combination of government regulation, legal reform and government spending adjustments to bring bubbles under control before they infect the entire economy (which they will always inevitably do if left to fester).
By the way, calling people out for trying to stop the 1926-29 boom is a bit like blaming firefighters for fires getting out of control. The real mistakes were made after the bubble burst.
Just as after the great depression when everybody believed overspeculation on the stock market had been the problem. Economist have studied this for 70 years and the practically universal conclusion was that montary policy errors was the real problem.
In Australia montary policy did not fail and they did not experiance a recession, the have not had one since the early 1990s. Whatever housing prices might do.
Simularly the stock market crash of 1987 (just as big as the one in 1929) did not even cause a blip in GDP.
Montary policy might have caused a little boom between 1926-1929 but if you really believe that the reslution of that boom required the US economy to contract by 30% then you are totally misguided. The problem was a contractionary montary policy.
The same goes for 2008, montary policy was the problem. Its the same story, everybody blames bubbles and speculators but economist have increasingly rejected this view.
Your story of 1926-1929 is basically the Rothbardian story, even his the majority of his studends and others influenced by him have since rejected this story. Its an intellectually dead idea that refuses to die because it perfect for the political left to demand control over all markets. Exactly what you advocate.
An independend central bank focus on macro economic stability should only have one job, stability of nominal demand.
Outside of that we can have political debates about how much banks and markets must be controlled.
There's a direct line from Bear through AIG and Lehmans to the wider economy. Everyone was over-leveraged and GDP growth was predicated on the understanding that other people would keep on spending more. With house prices tanking that fantasy collapsed and everyone immediately started re-trenching. Cue recession. Any bubble large enough will always trigger a recession.
The government did everything it could to lessen the impact (sadly pretty much guaranteeing the next bubble will happen sooner and be larger in the process) but a recession was inevitable because people couldn't keep on spending money they din't have.
The Great Depression wouldn't have been as bad if economic stimulation had been applied earlier (although it may well turn out to have ended sooner, thanks to better targeted stimulation) but it couldn't have been avoided with better monetary policy. The boom relied on stocks continuing to climb exponentially. It was a ponzi scheme. And it burst.
Ultimately Central Bank policy is failing now because it doesn't have enough levers to restore balance to the economy. What lift we got in 2009 was from the automatic counter-cyclical kick of government spending that has largely petered out.
ps I didn't provide any story for 1926-29 boom so I have no idea what you're talking about there. You appear to be projecting.
There might have been a slight recession even if monetary policy was on point but its hard to see one sector declining so much that it shows up as a recession in macro data. In smaller less diversified economy that can happen easier.
> The government did everything it could to lessen the impact (sadly pretty much guaranteeing the next bubble will happen sooner and be larger in the process) but a recession was inevitable because people couldn't keep on spending money they din't have.
That is just false. If you look at the data you will see that nominal GDP was dropping like crazy in 2008 and even at the end of 2008 the central bank had not changed policy.
In fact they refused to change policy for so long that they literally ran out of (or at least went to low level that they did not want to go below) that they were forced into easing.
You can see this very clearly in the data during 2008.
When people talk about 'they did everything they could' they usually refer to stuff that started to happen well after that QE2 and QE3 for example. The big mistake was made in 2008 and early 2009, the later monetary policy action just insured that NGDP would not flatten out completely (as it did in Eurozone).
> The Great Depression wouldn't have been as bad if economic stimulation had been applied earlier (although it may well turn out to have ended sooner, thanks to better targeted stimulation) but it couldn't have been avoided with better monetary policy.
Australia practically avoid it. Sweden and Israel did way better in the early years and this was because of monetary policy. Australia keeped up NGDP growth and thus they did not suffer a recession.
> Ultimately Central Bank policy is failing now because it doesn't have enough levers to restore balance to the economy. What lift we got in 2009 was from the automatic counter-cyclical kick of government spending that has largely petered out.
A central bank is job is not to find some mythical balance. A central bank job is targeting demand and the Fed does a sort of OK job at it.
The argument that fiscal policy was the determining factor simply holds no water. Changing in government spending have absolutely no predictable impact on overall demand. The Fiscal Cliff of 2013 was the best example, everybody who believes in these fiscal theory were predicting disasters even writing a open letter signed by many economics. Their predictions proved to be absolutely wrong.
The magnitude of automatic stabilizers is simply not large enough to account for massive swings in the macro economy. If you however look at NGDP relative to trend line you will see that those swings are in fact large enough.
> ps I didn't provide any story for 1926-29 boom so I have no idea what you're talking about there. You appear to be projecting.
I implied that there was a unsustainable boom between 1926-29 and that the mistakes were made there. That is simply incorrect and basically no economist today who believes in that story as a large contributor to the Great Depression.
Which is fascinating to consider that the Bank of Canada, et al, have let this happen for so long and are only reacting now...
By artificially keeping rates near 0% the idea was to 'stimulate' the economy by making capital freely available, so for example, banks can more easily loan money to businesses generating long term economic growth and add new jobs. But the side effect has been that retail banks were incentivized to hand out cheap mortgages and the public was incentivized to speculate on the 'hot' property market.
If this bubble doesn't deflate smoothly this will be yet another very expensive side effect of mainstream monetarist policy.