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. 

Comments

  1. Unknown26 December 2013 at 21:42

    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!

    ReplyDelete
    Replies
    1. Vuk Vukovic27 December 2013 at 11:42

      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

      Delete

Post a Comment

Popular posts from this blog

Short-selling explained (case study: movie "Trading Places")

Image
After seeing the movie "Trading Places" (1983), starring Eddie Murphy and Dan Aykroyd, for the thousandth time during the holiday season, I decided to write a quick post explaining what happened at the end of this movie that gets so many people puzzled (including me for the first couple of times I've seen it). This entertaining 80s comedy can actually teach you more about finance and trading than any other Hollywood movie (not counting documentaries), including the infamous "Wall Street" (1987), starring Michael Douglas as the ruthless Gordon Gecko, and especially the latest Scorsese film "The Wolf of Wall Street" (2013). Anyway, we all know the story from Trading Places. Dan Aykroyd plays a snobbish investor Louis Winthorpe ("the Third"), while Eddie Murphy plays a street con artist Billy Ray Valentine whose lives get reversed as a result of a bet between two cruel millionaires, the Duke brothers. The Dukes own a commodities bro...
Read more

Economic history: mercantilism and international trade

Image
All too often during poor economic times many debunked economic fallacies of the past get reinvented. The reason is simple: a search for ideas and solutions alternative to the "mainstream" (however we define it) allows those who succumb to these fallacies to repeat the ancient errors classical economics was hoping to get rid of. The short-termism of politics plays a crucial role in the process of persistent perpetuation of such fallacies. This is why in times like these it is essential to go back in economic history and debunk some of the ideas that tend to surface repeatedly. In the following couple of posts, I attempt to do just that.  Misunderstanding trade  One of the most misunderstood areas of economics is international trade. More precisely, the idea that if we were to boost net exports - by subsidizing exports and constraining imports - we can achieve higher GDP growth. If one looks at the simple arithmetic of a standard Keynesian macro model: Y=C+I+G+NX, the...
Read more

Rent-seeking explained: Removing barriers to entry in the taxi market

Image
The taxi market is undoubtedly one of the best examples of something economists like to call rent-seeking . What does this phenomenon stand for and why do economists (particularly political economists) devote a lot of attention to it?  The classical definition was given by Gordon Tullock back in his  1967  seminal paper "The welfare cost of tariffs, monopolies and theft" , even though the phrase itself was coined by Anne Krueger in 1974 .  Rent-seeking is a process of gaining private benefits through the political process (by lobbying or logrolling for example). It implies gaining protection for a certain privileged group, which in return promises political support, large campaign contributions, or even bribes. This protection varies from giving a monopoly status to a certain company, regulating market entry than hampers competition (such as introducing licences to specific occupations), imposing tariffs to import goods to protect the domestic indus...
Read more

Graphs (images) of the week: Separated by a border

Image
Usually comparing countries or regions requires looking at GDP growth data, GDP per capita, living standards, relative income or even the happiness index. But even a simple areal glimpse at the borders separating two systems can be more than enough to conclude which country is richer, healthier, more educated and on average more prosperous. It tells us that the causes of between-country differences have to be more than just climate, geography, culture or mentality. Particularly when the same nation is separated by nothing more than a border depicting the striking differences in political systems of the two countries (a classical example here are East and West Germany, but an equally good example can be North or South Korea).  As a result I found that the following set of images paint a better  picture  on between-country differences   than any existing data on global inequality.  The first one is from a  blog post I encountered on the Why Nations ...
Read more