September 22, 2014
A few weeks ago this column stated that the economy was growing at 4 per cent plus and would grow much faster than most economists thought. The contention was partly based on the array of figures that were coming in more positive than before. However, the main factor was the “feel” that could be sensed out in the economy. When you are self-employed, this feel or what I termed a few weeks ago the “buzz” is perceptible. You know when it’s not there and, if the buzz returns, you can sense it too.
This isn’t the most scientific approach to the economy but economics isn’t too scientific. In fact, I’d go so far as saying that in economics what is important is rarely complicated and what is complicated is rarely important. We are irrepressible social animals, prone to bouts of optimism and pessimism. We are deeply irrational and emotional. We are the polar opposite of what economists contend we are, beings driven by rationality and calculation.
This “invented” rational human being was “made up” by mainstream economists because this rational character’s reactions could be measured and then these perfect numbers could be fed into an elegant mathematical model that delivered a definitive, quasi-scientific answer. But this search for measurement, science and accuracy falls foul of the trap that Einstein highlighted when he warned that “not everything that is important can be measured and not everything that can be measured is important”.
As a result many economists don’t get the “confidence” thing. The confidence thing is the collective feeling that only the deeply irrational get. And this giddiness is infectious on the up and the downside. It’s the same giddiness that prompts us to fall in love, follow ridiculous football teams and be enormously influenced by each other’s moods, attitudes and notions.
It is what Keynes referred to as the “animal spirits” which dictate the ebb and flow of the economy.
However, the fact that the confidence thing is nebulous doesn’t mean it can’t be influenced by policy. It can be, and in Ireland the primary influencer of confidence is the property market. This is because property prices are the means by which macro-economic policy works in Ireland.
At the moment with real wages static, bank lending negligible and income taxes extremely high, the only new money in the economy comes from savings that are now being drawn down after six years of zero consumption. Sure there are exports, but as they are primarily multinational-driven, the extra income coming into the economy is from wages in the multinational sector and that is only 6 per cent of the workforce.
So why are savings being drawn down? What is the trigger?
House price increases are the trigger.
This is because the recession in Ireland was a balance sheet recession. The balance sheet of the middle class was broken because on the asset side, property collapsed in value. But in contrast, on the liability side, the debts that were incurred to buy these assets didn’t fall but remained the same or rose because interest rates were positive. People with broken balance sheets don’t spend, they save what they can or pay back what they can.
In order for the balance sheet – on paper at least – to improve, the value of assets has to go up, or the debt has to be forgiven. Since debt forgiveness has not been contemplated, the only way the conditions for a take-off in local economic confidence can be engineered is for a rise in house prices to be encouraged. This changes the “paper” value of assets in the economy and triggers confidence.
This process is highly controversial because higher house prices encourage banks to lend against property – which, added to the savings that are being drawn down, leads to house prices rising. The very increase in house prices coaxes the banks to lend yet more and we begin again. This is how the process of deleveraging leads to re-leveraging.
In short, the only way monetary policy can work in Ireland is through the medium of house prices. The only way near zero interest rates can affect the confidence thing is via rising house prices. This is the game, not just here but all over the world.
I am writing this article on the plane back from the US and the soundtrack is the same there. In fact we are copying it.
So where does this leave us?
Far from depending on monetary policy in Ireland to stop house price rises, as some people seem to believe, the opposite is the case. Successful monetary policy in Ireland (and by success, I mean generating the conditions for the “confidence thing” to take off) is dependent on monetary policy which will push house prices up, not down. I wish I could say it wasn’t, but it is the case.
The State – the Central Bank and the Department of Finance – in Ireland is implicitly targeting upward house price movements. This is the recovery policy.
Now long-term readers of this column will know that I believe this land obsession is a disaster for the country in social terms, in efficiency terms and in terms of our ability to compete with countries where accommodation isn’t used and abused to manipulate the economic cycle. But we are back to square one.
The “confidence thing” drives animal spirits and these spirits are infectious. One of the most crucial conditions for confidence is repairing the middle classes’ balance sheet so that deleveraging can lead to re-leveraging.
As a result the success of monetary policy and the ability of monetary policy to work and support the broad economy means that it works through the property market.
Over the course of the next few weeks, the column will look at other ways to run an economy and look around the world at places that do it differently, but for now it is important to acknowledge that seven years after the peak of the bubble, we are back to square one.
Growth will continue apace for a while, maybe a few years, and it will feel better. But a sugar rush is a sugar rush.