Where inflations expectation is not nonsense
In a recent post where I detailed why I thought the "inflation expectations" model used by orthodox macro was nonsense, I promised to outline the one exception. Well, here it is.
The reason I reject the inflation expectations model is because it handles savings as an inter-temporal consumption decision. This fails to capture the essence of the actual savings dynamic, leading to comical predictions as proffered by Nick Rowe. While economists take a year's vacation and buy luxury items on the eve of their life savings evaporating, the rest of the species merely shift into other savings vehicles -- forex, gold, and real assets, particularly land.
That last category, however, is an exception to the rule, and here I believe inflations expectations really do alter consumption decisions on the margin. Someone who has decided to buy a house may very well decide to take on more leverage, and buy more house than they otherwise would, if they expected inflation. Real estate is about the only highly leveraged position a household can take, and I can see it being very interest rate sensitive. Our friend in Sao Paolo may very well take his cruz while he has them, and plow it into as much real estate as he can leverage himself into.
This may be part of the dynamic in an old paper I've currently mislaid that looked at historic data and concluded that real estate is the business cycle. I'll poke around for it, but if anyone know what I'm referring to, please do post it in the comments.
While ultimately, real estate may be the trigger for private sector credit expansion again, signaling the true end to this recession, it may take a while to get there. House prices are still higher than historic norms on average, although in practice this means some areas are fairly priced (or cheap) while other areas remain at bubble levels. I also think the recent bubble has taken some of the gloss of real estate, although I don't think this factor is particularly strong. I think continued labor market weakness is discouraging household formation, and there is still an overhang of homes, all of which will keep prices down. And of course there is the big backlog of shadow inventory which banks will keep dribbling into the market whenever prices start to show material appreciation.
Japan is now about 30 years into their post-bubble economy, and have yet to recover. I don't think the US will take as long, but if the Government gets serious about deficit reduction I may be proved wrong.
The reason I reject the inflation expectations model is because it handles savings as an inter-temporal consumption decision. This fails to capture the essence of the actual savings dynamic, leading to comical predictions as proffered by Nick Rowe. While economists take a year's vacation and buy luxury items on the eve of their life savings evaporating, the rest of the species merely shift into other savings vehicles -- forex, gold, and real assets, particularly land.
That last category, however, is an exception to the rule, and here I believe inflations expectations really do alter consumption decisions on the margin. Someone who has decided to buy a house may very well decide to take on more leverage, and buy more house than they otherwise would, if they expected inflation. Real estate is about the only highly leveraged position a household can take, and I can see it being very interest rate sensitive. Our friend in Sao Paolo may very well take his cruz while he has them, and plow it into as much real estate as he can leverage himself into.
This may be part of the dynamic in an old paper I've currently mislaid that looked at historic data and concluded that real estate is the business cycle. I'll poke around for it, but if anyone know what I'm referring to, please do post it in the comments.
While ultimately, real estate may be the trigger for private sector credit expansion again, signaling the true end to this recession, it may take a while to get there. House prices are still higher than historic norms on average, although in practice this means some areas are fairly priced (or cheap) while other areas remain at bubble levels. I also think the recent bubble has taken some of the gloss of real estate, although I don't think this factor is particularly strong. I think continued labor market weakness is discouraging household formation, and there is still an overhang of homes, all of which will keep prices down. And of course there is the big backlog of shadow inventory which banks will keep dribbling into the market whenever prices start to show material appreciation.
Japan is now about 30 years into their post-bubble economy, and have yet to recover. I don't think the US will take as long, but if the Government gets serious about deficit reduction I may be proved wrong.
posted by winterspeak at
3:56 PM
5 Comments:
To some extent equity markets have the same dynamic. If interest rates are low and inflation expectations high, I am likely to move my funds from dollars and bonds to the stock market. As more people do this, the stock market rises, and that can create wealth effect consumer spending.
Also, corporations are themselves borrowing to buy back their own stock and to invest. I work for a software startup, but we're actually thinking of doing a debt round instead of taking more venture capital money, because the interest rates are so low.
That said, the overall impact from the above effects are not that large and they are slow to act. Furthermore, it creates more leverage and contributes to making the economy cyclical. A tax holiday or mailing everyone a check for ten grand is a much faster way to stimulate the economy, and will result in reducing debt and leverage.
BTW, I recently posted my own thoughts on the economy and economic policy on my blog. See my posts Assorted Thoughts on the Economy and How to Reform the Banking System. I'd love to hear what you think. You may recognize some MMT ideas, but there should be some unique ideas for you to noodle on. If any other commenters that area reading this are interested, I'd love to hear your thoughts too.
I think the paper you have in mind is "Housing IS the Business Cycle" by Ed Leamer:
www.nber.org/papers/w13428
Rajiv: Excellent -- thank you! I kept googling "Lerner" and didn't find anything.
Devin: Welcome! Didn't I read you over a unqualified reservations once upon a time?
Hey Winterspeak,
I have commented on UR at various points. I've also commented here, and we had an email thread a while ago under my real name (Devin Finbarr is my internet pen name).
"Someone who has decided to buy a house may very well decide to take on more leverage, and buy more house than they otherwise would, if they expected inflation. Real estate is about the only highly leveraged position a household can take, and I can see it being very interest rate sensitive."
THAT is precisely the trap of Real Estate, you leverage yourself to buy it to the point you wld not if you thought it was as depreciable an item as a car is, or an asset that can also lose value like a stock or ETF can. All hell breaks lose when the "inflation expectation" turns out to be wrong and it was the basis on which the private economy expanded itself. "Real Estate IS the Business Cycle" IMO is a true yet misleading diction. The more appropriate shld be "Real Estate has been the Business Cycle" to take out any implication of naturalness or inevitability from it. Economic expansion Doesn't HAVE TO be built on Real Estate speculation.
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