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ESCAPING THE DEBT ADDICTION:Monetary and macro-prudential policy in the post-crisis world
Adair TurnerSenior Fellow,
Institute of New Economic Thinking
Center for Financial Studies
Center for Financial Studies
Frankfurt, 10 February 2014
www.ineteconomics.org | www.facebook.com/ineteconomics 300 Park Avenue South - 5th FloorNew York, NY 10010
Escaping Debt Addiction |2
Banks create credit, money and purchasing power
Loan to entrepreneur
Bank
100 Credit to entrepreneurs deposit account
100
Escaping Debt Addiction |3
Dynamics of real GDP and credit(Year on year % change)
Source: Monthly Bulletin, European Central Bank, January 2014
Real GDPReal credit to householdsReal credit to NFCs
United States United Kingdom
Escaping Debt Addiction |4
Household deposits and loans: UK 1964 – 2009
Source: Bank of England, Tables A4.3, A4.1
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
% o
f GD
P
Securitisations and loan transfers
Deposits
Loans
Escaping Debt Addiction |5
Private and public leverage cycles: US
Source: McCulley and Pozsar
1915 1925 1935 1945 1955 1965 1975 1985 1995 20050
50
100
150
200
250
Financial Repression
Hou
sing
bur
sts
WW
II en
ds
Private debt as a % of NGDPPublic and
Escaping Debt Addiction |6
Private domestic credit as a % of GDP: 1950 – 2011
Advanced
Emerging
Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013
Escaping Debt Addiction |7
China: total social finance to GDP
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013100
120
140
160
180
200
220
% o
f GD
P
Escaping Debt Addiction |8
Non-financial private sector* credit outstanding: % of GDP
Brazil
China
India
Hungary
Indonesia
Korea
Mexico
Russia
South Africa
Turkey
0 20 40 60 80 100 120 140 160 180 200
2012
2007
2002
Source: BIS, Citi Research*Households + corporates
Escaping Debt Addiction |9
4.9%
7.1%6.5%
13.9%
0%
2%
4%
6%
8%
10%
12%
14%
16%
Real GDP Growth Real Domestic PrivateCredit Growth
1996-20032004-2011
Source: IMF, Haver Analytics, Citi Research
Real annual credit and GDP growth in emerging markets: 1996-2011
Escaping Debt Addiction |10
Total German private sector leverage: 1991 - 2010
1991-Q1
1991-Q4
1992-Q3
1993-Q2
1994-Q1
1994-Q4
1995-Q3
1996-Q2
1997-Q1
1997-Q4
1998-Q3
1999-Q2
2000-Q1
2000-Q4
2001-Q3
2002-Q2
2003-Q1
2003-Q4
2004-Q3
2005-Q2
2006-Q1
2006-Q4
2007-Q3
2008-Q2
2009-Q1
2009-Q4
2010-Q3
0
20
40
60
80
100
120
140
160
Private sector debt as % of GDP
Escaping Debt Addiction |11
Private credit to GDP and growth
Source:"Reassessing the impact of finance and growth“, S. Cecchetti and E. Kharroubi, BIS Working Paper No. 381
Escaping Debt Addiction |12
Credit and asset price cycles
Expectation of future asset price increases
Increased credit extended
Low credit losses: high bank profits• Confidence reinforced • Increased capital base
Increased asset prices
Increased lender supply of credit
Favourable assessments of
credit risk
Increased borrower demand for credit
Escaping Debt Addiction |13
The Dilemma
Pre-crisis path of nominal GDP growth
Pre-crisis path of credit growth
6͠ 4% - 5%
6͠ 10% - 15%
If central banks had raised interest rates to slow credit growth…. this would presumably mean slower nominal GDP growth?
We seem to need Ċ ˃ NGḊP to ensure adequate NGḊP… but this produces financial instability and post-crisis recession
E͠ 2% real growth
E͠ 2% inflation
Escaping Debt Addiction |14
Categories of debt: UK, 2009
227
1235
243
232 Primarily productive investment
Some productive investment and some leveraged asset play
Mainly purchase of existing assets
Pure life-cycle consumption smoothing
Other corporate
Commercial real estate
Residential mortgage (including securitizations
and loan transfers)
Unsecured personal
£bn
Escaping Debt Addiction |15
Corporate loans by broad sector: 1987 – 2008
Source: ONS, Finstats
Note: Part of the increase in real estate lending may be due to re-categorisation of corporate lending following sale and lease-back of properties and PFI (public finance initiative) lending, but we do not think these elements are large enough to change the overall picture. Break in series from Q1 2008 due to inclusion of building society data. Sterling borrowing only.
0%
5%
10%
15%
20%
25%
30%
35%
Q11987
Q11989
Q11991
Q11993
Q11995
Q11997
Q11999
Q12001
Q12003
Q12005
Q12007
Q12009
% o
f G
DP
Non-commmercial real estate PNFC lending Commercial real estate lending
Escaping Debt Addiction |16
The dominance of real estate in bank lending
Total bank credit to domestic
private sectorMortgage
creditMortgage credit
as % of total129% 74% 57%
206% 131% 64%
155% 78% 50%
175% 101% 57%
122% 78% 64%
130% 91% 70%
+ Commercial real estate at
typically around 20% - 25% of total
lending
Source: Jordá, Schularick and Taylor, “Betting the Home”, forthcoming 2014
(*Bank and non-bank combined)
*
Escaping Debt Addiction |17
Three conceptually distinct functions of lending
Finance of new capital investment
• Enabling inter-temporal shift of consumption within life time income
Finance of purchase of existing assets
Finance of increased consumption
• Non-real estate• Commercial real estate• Residential real estate• Human capital
• Real estate• Collectibles• Existing business assets – e.g. Leveraged Buy Outs
Escaping Debt Addiction |18
National non-financial assets as a % of GDP
Source: Blue Book 2013 Source: Vermoegensbilanzen 1991-2012 Destatis
Escaping Debt Addiction |19
UK household net worth £trillion: 2012
4.5 1.5 1.3 4.3
3.2 0.1 7.6
Houses, other buildings and land
Loans Deposits & currency
Real estate + net monetary assets
Other financial assets – claims against business debt and equity
Other - mainly cars
TOTAL
Source: ONS National Banking Sheets
Escaping Debt Addiction |20
Variation in land value per hectare:UK 1983 – 2010
UK
Source: Blue Book 2013
10
9
8
7
65
4
32
1
£ million
Escaping Debt Addiction |21
Credit extension and house prices
House prices 2000 – 2007 Household debt as a % of GDP 2000 – 2007
Source: BEA; ONS; ECB
0
20
40
60
80
100
120
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007%
G
DP
US UK Spain Ireland
0
50
100
150
200
250
Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007
Ind
ex:
20
00
= 1
00
Spain US UK Ireland
Source: Ministry of Housing (Spain), S&P (US), DCLG
Escaping Debt Addiction |22
Interactions between credit categories and effects
Increased apparent wealth
Reduced saving:
increased consumption
Increased price of
existing real estate
Increasing credit supply
/ demand
Equity withdrawal mortgage supply & demand
Boom in new real estate
construction
Increased prices for new real
estate
Borrower and lender net worth, confidence
and expectational effects
Escaping Debt Addiction |23
Inequality, demand and credit
Rich have higher
marginal propensity to
have than poor
Rising inequality
Deflationary impetus – growth on NGDP falls
Deflationary impetus offset:
• NGDP growth maintained
• Growth in credit intensity
•Rich lend to poor
•Central banks facilitates
Savings not matched
by ______
investment
+
Escaping Debt Addiction |24
Changes in housing wealth: UK 2003 – 2013
Households with no mortgage debt
Buy-to-let landlords
Households with mortgages
£bn
556
434
-59
Source: Savills, Private landlords gain the most from rising property market, Financial Times, 18 January 2014
Escaping Debt Addiction |25
Global current account balances as a % of world GDP
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-2
-1.5
-1
-0.5
0
0.5
1
United States Germany+Japan Developed Rest OPECDeveloping Rest China
Source: IMF BOPS
Escaping Debt Addiction |26
Eurozone current account deficits: 2000 – 2008
% o
f G
DP
20
00
– 2
00
8
Source: International Monetary Fund, World Economic Outlook Database, October 2012
2000 2001 2002 2003 2004 2005 2006 2007 2008-16
-14
-12
-10
-8
-6
-4
-2
0
GreeeIrelandPortugalSpain
Year
%
GreeceIrelandPortugalSpain
% o
f GD
P
Escaping Debt Addiction |27
Decomposition of cumulative capital inflows: Spain (% of 2007 GDP)
1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 91 97 103 109 115 121 1270%
10%
20%
30%
40%
50%
60%
PRIVATE INFLOWS TARGET Liab. TOTAL INFLOWSTARGET 2 Liabilities to ESCB
Escaping Debt Addiction |28
Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012
Source: IMF, Bank of Japan Flow of Funds Accounts
19901991
19921993
19941995
19961997
19981999
20002001
20022003
20042005
20062007
20082009
20102011
-15
-10
-5
0
5
10
PNFCs Government
%
Escaping Debt Addiction |29
Japanese government and corporate debt:1990 – 2010
Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations
% G
DP
0
50
100
150
200
250
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20010
Bank lending to non-financial corporates General Government debt
Escaping Debt Addiction |30
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201235
50
65
80
95
110
125
Household PNFCs Public
Source: OECD National Accounts
Shifting leverage: private and public debt-to-GDP
Spain
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201250
60
70
80
90
100
110
120 US
Household PNFCs
Source: OECD National Accounts
%GDP %GDP
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201220
45
70
95
120
145
170
195
220
Household PNFCs Public
% G
DP
Escaping Debt Addiction |31
Policies required to achieve more stable growth
Reduction in inequality or at least reduced pace of increase in inequality
Reduction in global current imbalances between surplus and deficit nations
Remove biases to credit creation in deficit countries Remove biases to excessive savings in surplus countries
Integrated set of monetary, macro-prudential and fiscal policies to lean against ‘too much of the wrong sort of debt’.
Escaping Debt Addiction |32
Monetary, macro-prudential and fiscal policies to combat excessive debt creation
Level as well as rate of growth of leverage a key indicator
But no precise threshold for ‘too high’ leverage can be defined
Tax on credit intermediation – or at least removal of tax biases in favour of debt
• Recognises the adverse externality of debt creation
• Major political difficulties given winners and losers
• Dangers of arbitrage via shadow banking
Preemptive interest rate rises to lean against credit/asset price cycles
But insufficient due to heterogeneous interest rate elasticity of credit demand
Much higher bank capital ratios Would require parallel action to prevent shadow bank based arbitrage
Encourage equity and hybrid contracts Unlikely to occur spontaneously without government support
Manage the mix of credit by category
Escaping Debt Addiction |33
Managing the mix of credit by category: possible policies
Increase capital risk weights for real estate finance above those indicated by private assessment of risk
Addresses the externality of lending against real estate
Loan-to-value or loan-to-income limits on real estate lending
Borrower constraint since lender constraints imperfect
Underwriting mortgage standards to prevent reliance on price rise assumptions
Introduced by UK FCA
Constraints on high interest consumer lending
• Danger of illegal alternatives• Constraints on marketing preferable to
prohibition
Banks with dedicated focus on non-real estate business finance
To avoid crowding out of investment or trade finance
Escaping Debt Addiction |34
Real yields to maturity on UK indexed linked gilts
Source: Bank of England Statistics, Zero coupon real yields
10-year Yield 20-year Yield
-2
-1
0
1
2
3
4
5
Escaping Debt Addiction |35
Velocity of money circulation
Source: BoE, BoJ, Datastream
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Q4
1980
Q2
1982
Q4
1983
Q2
1985
Q4
1986
Q2
1988
Q4
1989
Q2
1991
Q4
1992
Q2
1994
Q4
1995
Q2
1997
Q4
1998
Q2
2000
Q4
2001
Q2
2003
Q4
2004
Q2
2006
Q4
2007
Q2
2009
Q4
2010
UK (M2) Japan (M2)
Velocity of Money (Nominal GDP/M4)
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Q4
1980
Q2
1982
Q4
1983
Q2
1985
Q4
1986
Q2
1988
Q4
1989
Q2
1991
Q4
1992
Q2
1994
Q4
1995
Q2
1997
Q4
1998
Q2
2000
Q4
2001
Q2
2003
Q4
2004
Q2
2006
Q4
2007
Q2
2009
Q4
2010
Japan (M4) UK (M4)
Velocity of Money (Nominal GDP/M2)