Thursday, 26 December 2013

Graph(s) of the week: The year in review

The Economist ends the year with a series of eye-catching charts characterizing the state of last year's recovery. 

We are all still aware of the recovery being a slow and painful one (in some places more than in others), but what's even more interesting is that some of the negative effects of a poor response to the aftermath of the crisis are already being visible. 

For example, in the private sector stock indices are booming, but corporate debt issuance is higher than ever, as the companies are taking advantage of the historically low interest rates and using this mainly to refinance their debts (see graphs below). Interestingly enough, the stock market indices are far above their pre-crisis peaks. Many like to point out that this is a signal of another potential bubble rising on the stock market, but I would beg to differ. 

Source: The Economist
The Dow is higher than its 2007 pre-crisis peak, but so is the US GDP (see below). Does this mean the US has by now completely recovered from the financial crisis? Not really. It is simply following a new trajectory, a new trendline, or to be completely precise, it is on a new (lower) potential output path. The stock market is noting but a reflection of this. That's why I wouldn't call it a bubble. 

Source: FRED
The same thing, however, can't be said for the potential monetary policy bubble. Low interest rates combined with massive QE are still mainly reflecting on the banks' balance sheets and are not entering the private sector as fast as the policymakers are hoping for. However, the question is what will happen when all this money does enter the real economy? If we continue down the path of a "lost decade" then the answer is probably nothing. At least in the short run. 
US monetary base. Source: FRED

On the other hand the losers seem to be the SMEs where loans (as % of GDP) are still falling:

Too bad the policymakers aren't making it any easier for them to rebound.

On the other hand fiscal policy has had partial success - depending on how we define the goals of fiscal policy. The austerity package has at least succeed in curbing the budget deficits: 

But the wrong way of conducting austerity (via mostly tax hikes without reforming the spending side) means that unemployment is still a huge issue for the developing economies: 

Maybe Richard Koo is right, maybe this is a typical "balance sheet recession". It certainly has all the symptoms. That would mean that by continuing with the current type of policy responses we really are in for a lost decade of the Japanese type. Or maybe even a few. Just look at the UK


  1. I do agree with you on the stock market story. Monetary bubble story...not sure. Actually Im not sure what you mean by "monetary bubble". Reserves created trough QE are not same as (mostly temporary) excess reserves created trough traditional deposit creation. "Drainage" of reserves would mean also a reduction in Fed's asset holdings which would be tightening. Households and corporations do hold a higher share of liquid assets than before the crisis, so do the financials and depository institutions in the US. For depository institutions, reserves are the liquid asset they prefer, especially since the IOER was introduced. People calling S&P gains a bubble usually blame the Fed for the stock's high levels, which is incorrect. There could be a minor correction coming though...
    Potential for inflation? Don't see it.

    The "corporate debt chart" is showing issuance - a flow. If they are using low rates environment, they could be as well refinancing and actually reducing total debt burden, or at least interest burden which could improve UFCF since they do not seem to be investing much. Nonfinancials did deleverage, but last data (debt/gdp) I saw was for 2011.

    With current policy responses most countries are damaging their long term prospects - you mentioned "wrong" austerity + more regulation and intervention. Just look at how Germany is set to reverse some success they had due to agenda2010. On demand side, well...we had that discussion.

    Koo argued that the liquidity trap was real and a reason for government to step in. Massive fiscal stimulus did nothing, but abenomics (monetary arrow at least) will work - both details showing Koo was wrong. Its also good to se that Abe is looking for a way to dismantle the gentan system. That will modernize the agriculture and open doors for more free trade talks.

    Different nations face different sets of challenges for 2014 and beyond. Mostly I don't see much decisiveness to tackle them thoroughly or efficiently.

    Anyways, I wish you a successful 2014!

    1. First off, thanks for the kind wishes! I also wish to you a successful and happy new 2014.

      Now let's take one step at a time. Monetary bubble. I suggest you read this new NBER working paper by Bordo and Landon-Lane in which they evaluate the impact of loose monetary policy from 1920 to 2011.
      Here is their main implication:
      "We show that “loose” monetary policy – that is having an interest rate below the target rate or having a growth rate of money above the target growth rate – does positively impact asset prices and this correspondence is heightened during periods when asset prices grew quickly and then subsequently suffered a significant correction. This result was robust across multiple asset prices and different specifications and was present even when we controlled for other alternative explanations such as low inflation or “easy” credit."
      “The issue still remains that asset price booms in addition to sometimes ending with damaging busts can be the precursors to a future run up in inflation...This then leads to the question of when central banks should tighten their policies to prevent inflation from becoming embedded in expectations."

      So basically, I agree that in the short run we won't experience this problem of asset price rises, since the Phillips curve isn't vertical so stable inflation is a likely result of a stagnating economy (or an economy growing below its potential).
      But we simply cannot be sure of there being no inflationary effect whatsoever when asset prices start rising, when the economy starts fully recovering. I might have been a bit imprecise in my initial claims.

      You're right about debt issuance, I dropped the word up there, thanks for that, I'll correct it.
      And I agree, they certainly are refinancing, that is actually ALL they are doing.

      Finally, as for Koo, I was merely pointing out that he could be right about a balance sheet recession, but I certainly don't agree with his proposed policy responses.

      anyway, I'm preparing a text on Abenomics sometime in January, and the few upcoming ones will be on the global predictions for 2014. Just as I did last year