To what extent does history repeat itself? Minsky’s Financial Instability Hypothesis infers that credit cycles are fairly inevitable. We have seem them in the past and we will see them in the future. Human beings are subject to emotion, to irrational exuberance and to a large dose of forgetfulness! To what extent do the latest UK credit numbers suggest that we might be embarking on another credit binge? Are the credit data consistent with evidence of another credit cycle?
Chart 1 shows the stocks of debt acquired by households and private non-financial corporations from MFIs (Monetary Financial Institutions). The scale of debt accumulation in the late 1980s and again from the mid 1990s up to the financial crisis of the late 2000s is stark. At the start of 1985 the UK household sector had debts to MFIs of around £140 billion. By the start of 2009 this had hit £1.29 trillion. Meanwhile, private non-financial corporations saw their debts to MFIs rise from around £45 billion to over £500 billion. (Click here to download a PowerPoint of the chart.)
The path of debt at the start of the 2010s is consistent with a story of consolidation. Financially-distressed households, private non-financial corporations and, of course, MFIs themselves meant that corrective action was needed to repair their balance sheets. The demand for and supply of additional credit waned. Debt accumulation largely ceased and, in fact, debt numbers fell. This trend continues today for private non-financial corporations. But, for households debt accumulation resumed in the middle of 2013. At the end of the third quarter of 2015 the household sector had debt obligations to MFIs of £1.246 trillion.
Chart 2 focuses on flows rather stocks. It allows us to see the accumulation of new credit (i.e. less repayments of debt). What is even more apparent from this chart is the evidence of cycles in credit. The growth in new credit during the 2000s is stark as is the subsequent squeeze on credit that followed.
The question that follows is what path are we now on? Clearly flows of credit to households are again on the rise. In part, this is driven by the rebound in the UK housing market. But, in fact there is a more rapid increase in consumer credit, i.e. unsecured debt. (Click here to download a PowerPoint of the chart.)
Chart 3 shows the flows of consumer credit from MFIs and other credit providers. Again, we see the marked evidence of cycles. In the year to the end of Q1 of 2015 net consumer credit flows amounted to £22.8 billion, the highest figure since the 12-month period up to the end of Q3 of 2005. Click here to download a PowerPoint of the chart.)
While it might be a little early to say that another Minsky cycle is well under way, policymakers will be keeping a keen eye on credit patterns. Is history repeating itself?
Articles
Average UK mortgage debt rises to £85,000 The Guardian, Phillip Inman (15/12/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Recovery ‘too reliant on consumer debt’ as BCC downgrades forecast The Guardian, Heather Stewart (9/12/15)
BCC: UK Growth Too Reliant On Consumer Debt Sky News (9/12/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
IMF: UK’s economic performance ‘very strong’, but risks remain BBC News (11/12/15)
Data
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England
Questions
- How can the financial system affect the economy’s business cycle?
- What does it mean if households or firms are financially distressed? What responses might they take to this distress and what might the economic consequences be?
- How would you measure the net worth (or wealth) of an individual or a firm? What factors might affect their net worth?
- How might uncertainty affect spending and saving by households and businesses?
- What does it mean if bank lending is pro-cyclical?
- Why might lending be pro-cyclical?
- Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?
As we saw in the blog post Down down deeper and down, or a new Status Quo?, for many countries there is now a negative rate of interest on bank deposits in the central bank. In other words, banks are being charged to keep liquidity in central banks. Indeed, in some countries the central bank even provides liquidity to banks at negative rates. In other words, banks are paid to borrow!
But, by definition, holding cash (in a safe or under the mattress) pays a zero interest rate. So why would people save in a bank at negative interest rates if they could get a zero rate simply by holding cash? And why would banks not borrow money from the central bank, if borrowing rates are negative, hold it as cash and earn the interest from the central bank?
These questions are addressed in the article below from The Economist. It argues that to swap reserves for cash is costly to banks and that this cost is likely to exceed the interest they have to pay. In other words, there is not a zero bound to central bank interest rates, either for deposits or for the provision of liquidity; and this reflects rational behaviour.
But does the same apply to individuals? Would it not be rational for banks to charge customers to deposit money (a negative interest rate)? Indeed, there is already a form of negative interest rate on many current accounts; i.e. the monthly or annual charge to keep the account open. But would it also make sense for banks to offer negative interest rates on loans? In other words, would it ever make sense for banks to pay people to borrow?
Read the folowing article and then try answering the questions.
Article
Bankers v mattresses The Economist (28/11.15)
Central bank repo rates/base rates
Central banks – summary of current interest rates global-rates.com
Worldwide Central Bank Rates CentralBankRates
Questions
- What is a central bank’s ‘repo rate’. Is it the same as (a) its overnight lending rate; (b) its discount rate?
- Why are the Swedish and Swiss central banks charging negative interest rates when lending money to banks?
- What effect are such negative rates likely to have on (a) banks’ cash holdings; (b) banks’ lending to customers?
- Why are many central banks (including the ECB) charging banks to deposit money with them? Why do banks continue to make such deposits when interest rates are negative?
- Would banks ever lend to customers at negative rates of interest? Explain why or why not.
- Would banks ever offer negative rates of interest on savings accounts? Explain why or why not.
- How do expectations about exchange rate movements affect banks willingness to hold deposits with the central bank?
- What are the arguments for and against abolishing cash altogether?
The Federal Reserve chair, Janet Yellen, has been giving strong signals recently that the US central bank will probably raise interest rates at its December 16 meeting or, if not then, early in 2016. ‘Ongoing gains in the labor market’ she said, ‘coupled with my judgement that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2%.’ This, as for many other central banks, is the target rate of inflation.
In anticipation of a rise in US interest rates, the dollar has been appreciating. Its (nominal) exchange rate index has risen by 24% since April 2014 (see chart below).
In the light of the sluggish eurozone economy, the ECB president, Mario Draghi, has been taking a very different stance. He has indicated that he stands ready to cut interest rates further and increase quantitative easing.
At the meeting on 3 December, the ECB did just that. It announced a further cut in the deposit rate, from –0.2 to –0.3 and an extension of the €60 billion per month QE programme from September 2016 to March 2017 (bringing the total by that time to €1.5 trillion – up from €1.1 trillion by September 2016).
Stock market investors had been expecting more, including an increase in the level of monthly asset purchases above €60 billion. Consequently stock markets fell. Both the German DAX and the French CAC 40 stock market indices fell by 3.6%. The euro also appreciated against the dollar by 2.7% on the day of the announcement. Nevertheless, since April 2014, the euro exchange rate index has fallen by 13%. Against the US dollar, the euro has depreciated by a massive 31%.
So what will be the consequences of the very different monetary policies being pursued by the Fed and the ECB? Are they simply the desirable responses to a lack of convergence of the economic performance of the US and eurozone economies? In other words, will they help to bring greater convergence between the two economies?
Or will the desirable effects of convergence be offset by other undesirable effects for the USA and the eurozone and also for the rest of the world?
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Will huge amounts of dollar-denominated debt held by many emerging economies make it harder to service these debts with an appreciating dollar? |
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How much will US exporters suffer from the dollar’s rise and what will the US authorities do about it? |
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Will currency volatility lead to currency wars and, if so, what will be their economic effects? |
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Will the time lags involved in the effects of the continuing programme of QE in the eurozone eventually lead to overheating? Already euro money supply is rising, on both narrow and broad measures. |
The following articles address these issues.
Articles
The Fed and the ECB: when monetary policy diverges The Guardian, Mohamed El-Erian (2/12/15)
European stocks slide after ECB dashes hopes of major QE expansion The Guardian, Heather Stewart and Graeme Wearden (3/12/15)
Mario Draghi riles Germany with QE overkill The Telegraph, Ambrose Evans-Pritchard (3/12/15)
How the eurozone missed its shot at a recovery The Telegraph, Peter Spence (3/12/15)
Yellen Signals Economy Nearly Ready for First Interest-Rate Hike Bloomberg, Christopher Condon (3/12/15)
Exchange rate data
Effective exchange rate indices Bank for International Settlements
Exchange rates Bank of England
Questions
- What would be the beneficial effects to the US and eurozone economies of their respective monetary policies?
- Explain the exchange rate movements that have taken place between the euro and the dollar over the past 19 months. How do these relate to the various parts of the balance of payments accounts of the two economies?
- Is it possible for the USA to halt the rise in the dollar while at the same time raising interest rates? Explain.
- Why are some members of the ECB (e.g. the German and Dutch) against expanding QE? Assess their arguments.
- What will be the impact of US and eurozone monetary policies on emerging economies?
- What will be the impact of US and eurozone monetary policies on the UK?
- Why did the euro appreciate after the Mario Draghi’s press statement on 3 December? What has happened to the dollar/euro exchange rate since and why?
George Osborne in his recent Autumn Statement, once again stressed that ‘the government is committed to strong, sustainable and balanced growth’. But while he plans to reduce government debt as a percentage of GDP, consumer debt is rising, both absolutely and as a percentage of household disposable income. The rise in household borrowing, and the resulting rise in consumer expenditure, has been the main factor driving economic growth. It has not been exports nor, until recently, investment, as the Chancellor had hoped. Indeed, investment in new housing is falling.
The Office for Budget Responsibility in its latest Economic and Fiscal Outlook forecasts that gross household debt will reach 163 per cent of household disposable income by 2021, up from 146% at the end of 2015.
Consumer gross debt includes both secured debt and unsecured debt. Secured debt is essentially debt secured on property (i.e. mortgages), while unsecured debt is largely in the form of credit card debt, overdrafts and personal loans.
The chart shows that from 2008 to 2013, gross debt fell as a percentage of personal disposable income. Following the financial crisis, banks were more cautious about lending as they sought to increase their capital and liquidity ratios. And consumers were more cautious about borrowing as the uncertainty made many people keen to reduce their debts. This decline in credit reversed the massive growth in household debt from 2000 to 2008: one of the contributing factors to the financial crisis. (Click here for a PowerPoint of the chart.)
But since late 2013, household debt – both secured and unsecured – has been rising. In absolute (nominal) terms, individuals’ debt is now £1.43 trillion, slightly above the previous high in 2008. And as the chart shows, the OBR forecasts that it will continue rising. This makes consumers more vulnerable to adverse economic shocks, such as a downturn in emerging markets, another crisis in the eurozone or financial crises in other parts of the world.
And as consumer debt has been rising, the personal saving ratio (the ratio of saving to personal disposable incomes) has been falling and is now lower than before the financial crisis.
The rise in consumer borrowing has been of some concern to the Bank of England. Andy Haldane, the Bank’s Chief Economist, appearing before the Treasury Select Committee, warned that consumer credit, and in particular personal loans, had been ‘picking up at a rate of knots. That ultimately might be an issue that the Financial Policy Committee might want to look at fairly carefully.’
Articles
The UK economy may be growing, but in a highly unbalanced way The Guardian, Phillip Inman (27/11/15)
UK growth hit by biggest drag from net trade on record The Telegraph, Szu Ping Chan (27/11/15)
Surge in consumer lending could prompt Bank of England intervention The Guardian, Patrick Collinson and Jill Treanor (30/11/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Between Debt and the Devil by Adair Turner review – should the government start printing money? The Guardian, Tom Clark (25/11/15)
Lending rises as Bank of England ponders new curbs Financial Times, Ferdinando Giugliano (30/11/15)
Carney indicates BoE’s willingness to rein in credit Financial TImes, Chris Giles (5/11/15)
FCA sounds alarm at rising credit card debt Financial Times, Emma Dunkley (3/11/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
Seven years after the crisis, Britain is still addicted to the drug of debt Independent, James Moore (1/12/15)
Vince Cable: Former Business Secretary warns that ‘severe economic storms’ are on the way Independent, Ben Chu (14/11/15)
The risks stalking the UK economy BBC News, Kamal Ahmed (1/12/15)
OBR publications
Economic and fiscal outlook Office for Budget Responsibility (25/11/15)
Economic and fiscal outlook charts and tables (Excel file) Office for Budget Responsibility (25/11/15)
Questions
- Does it matter if economic growth is driven by a rise in consumer demand, in turn driven by a risen in consumer credit?
- Is there an inflation risk from growth being driven by a rise in consumer credit?
- What is the precise relationship between the household saving ratio and the household debt ratio? (Which of these ratios is a stock and which is a flow?)
- What might cause a fall in consumer borrowing? Would this be a good thing?
- Why did consumer borrowing fall following the financial crisis of 2007–8?
- What could the Bank of England’s Financial Policy Committee do to curb consumer borrowing?
- If banks were forced to hold more reserves, how could aggregate demand be maintained? Would ‘helicopter money’ be a good idea?
- What are ‘countercyclical buffers for banks’? What are the arguments for raising them at the current time?
Jim Slater, who has just died at the age of 86, was a tycoon of the 1970s, probably unknown to most reader of this blog. But his legacy lives on and many will question whether the actions of the banking sector and big business today is a reflection of the lessons that were not learnt 40 years ago.
Slater was a businessman: perhaps the businessman in the 1970s, building up a company that in today’s money and the height of its success, would have been worth billions. Buying and selling companies, asset stripping and investing created Slater Walker, which shot to success and then crumbled to failure, taking with it a bailout from the Bank of England of £110 million. You might look at that figure and compare it with the bail outs of more recent times and think – peanuts. But think about how prices have changed and convert £110 million into today’s money and that’s a hefty bail out. A key question is whether the willingness of the government and Bank of England to bail out key banks and financial sector businesses has encouraged the irresponsible lending that led to the credit crunch. Was there a moral hazard? Had Slater Walker been left to fail, would the world look a slightly different place?
Perhaps a little extreme, but I wonder, if we were to look back over the past 50 to 60 years, whether we would find other cases of key businesses being bailed out, which set a precedent for other companies to grow, without necessarily taking full responsibility for it. Jim Slater will certainly leave a legacy behind him .
Jim Slater and the warning from the 1970s that we ignored BBC News, Jonty Bloom (20/11/15)
Questions
- What is meant by asset stripping?
- If a company like Slater Walker had not been bailed out, do you think the economy would have suffered?
- If Slater Walker had been left to fail, would that have changed the business model of some of our largest banks and reduced the chance of a financial crisis 40 years later?
- Do you think the concept of moral hazard is relevant here?
To what extent does history repeat itself? Minsky’s Financial Instability Hypothesis infers that credit cycles are fairly inevitable. We have seem them in the past and we will see them in the future. Human beings are subject to emotion, to irrational exuberance and to a large dose of forgetfulness! To what extent do the latest UK credit numbers suggest that we might be embarking on another credit binge? Are the credit data consistent with evidence of another credit cycle?
