Wednesday, May 16, 2012

National Bank of Belgium: Liquidity Doesn't Always Cause Asset Bubbles

A 2007 empirical study by the National Bank of Belgium on the effects of excess liquidity finds that only under certain conditions does excess liquidity actually lead to an asset bubble. The idea that most high-cost booms are preceded by high money growth has been well elaborated by economic theory. However, this does not necessarily imply that all periods of excess liquidity signal an imminent asset price boom. In fact only 1/3 of all periods of excess liquidity analyzed by this empirical study lead to an asset bubble. It is a warning against naive monetary analysis.

The findings of this paper are that an asset price boom arises only under a combination of events. The conditions under which excess liquidity might lead to an asset price boom (a bubble), are when the period of excess liquidity is prolonged and is accompanied by strong real GDP growth, low inflation, and credit growth.

In looking at what this means for monetary policy, it means simply that central banks can afford to act without fearing the automatic rise of inflation or asset bubbles in reaction to any effort to improve sluggish economic growth. The threat of bubbles looms large when excess liquidity persists on the market for long periods, during episodes of strong economic growth. In looking at what it means for financial regulation, it means that asset price bubbles can also be prevented or possibly even dismantled by better regulating the credit markets.

Essentially, the results of this study confirm the conclusions outlined by the Quantity Theory of Money and by the Phillips Curve, albeit on a micro scale. That is, increases in liquidity might influence prices, but only after other avenues have been exhausted. Looking at the graph above, we can say that while at point B, we should feel confident in the usefulness of monetary action, without immediately worrying about price levels. We should not pretend that we are at point A when it simply isn't the case.  

This paper analyses the relationship between the prevailing liquidity conditions (such as measures of money, credit and interest rates) and developments in asset prices from a monetary analysis perspective. After having identified periods of sustained excess liquidity, we analyse under which conditions they are more likely to be followed by an asset price boom. The results from a descriptive analysis of the developments in a number of macroeconomic and financial variables suggest that periods of sustained excess liquidity that are accompanied by strong economic activity, low interest rates, high real credit growth and low inflation have a higher likelihood of being followed by an asset price boom. This conclusion is also confirmed by a logit analysis.
The National Bank of Belgium is Belgium's central bank and lender of last resort. It is part of the European System of Central Banks 

Friday, May 11, 2012

Hollande Wins French Elections
On Sunday May 6th, 2012, French voters chose François Hollande as their president for the coming five years. Voters responded strongly to campaign promises made on transparency, proportional representation, and competence-related issues.

French Economist Francois Cocquemas comments: 
Both the left-wing favorite, François Hollande, and the right-wing incumbent, Nicolas Sarkozy, promised higher taxes and controlled public spending. Both candidates aim to bring the public deficit back to equilibrium, disagreeing only on the time-frame. Both mostly refrained from costly, last-minute promises to rally the undecided. According to the pro-business think-tank Institut de l’entreprise, both programs are underfunded by a similar amount, €11bn to €12bn.

Their difference on economic matters seems largely limited to their plans for Europe: Mr Hollande wants to renegotiate the European Fiscal Stability Treaty, so it also promotes growth and not just government austerity, which is enough to make him “rather dangerous” in the eyes of the Economist. As the Financial Times’ Chief political commentator Philip Stephens rightly puts it, there’s no reason to fret:  
The influential Economist has declared on its front cover that Mr Hollande is “dangerous” – though, being British, it did add a qualifying “rather” to this disobliging epithet. The would-be president, the magazine observed, “genuinely believes in the need to create a fairer society”. Well, what could be more dangerous than that?
The influential Economist has declared on its front cover that Mr Hollande is “dangerous” – though, being British, it did add a qualifying “rather” to this disobliging epithet. The would-be president, the magazine observed, “genuinely believes in the need to create a fairer society”. Well, what could be more dangerous than that?

Be that as it may, Mr Hollande’s campaign has been soft-spoken in therms of social and economic justice rhetoric. Mr Sarkozy, on his side, has argued about the impossibility to renegotiate a signed treaty – shortly before threatening to suspend the Schengen agreement if nothing was done to fix “leaky Europe”. Mr Hollande, on the other hand, claims that other leaders in Europe are looking forward to his election, and that lines are already moving after ECB president Mario Draghi called for a growth compact alongside the fiscal compact.

Draghi, of course, is thinking of structural reforms promoting flexibility and mobility in the labour market, where Mr Hollande’s growth plans mostly entail increased investment, financed by eurobonds.
In fact, BBC has reported that far from the being economically "rather dangerous", Hollande's policies will not make have the negative effect on growth that many in the media are trumpeting.

What the Real Story is:
What is perhaps bigger news is the ideological shift across Europe as European voters reject austerity and pro-financial sector economic agendas in favor of parties backing pro-growth  economic policies. Almost simultaneously, there have been electoral shifts in Greece, France, and Germany, while the Dutch government fell over the austerity issue.
Francois Cocquemas holds a Master degree in finance from Sciences Po Paris and a joint Master degree in economics and public policy from Ecole Polytechnique, ENSAE and Sciences Po. He is currently doing  a PhD in finance at EDHEC Business School (École des Hautes Etudes Commerciales du Nord).

Sunday, May 6, 2012

We Need to Address Student Loans & Student Debt
Today, we have reinvented debt-bondage via the university system. In the US, the OECD country where tuition rates are the highest relative to median income, the cost of decent tertiary education often exceeds $100,000 for a bachelor's degree and $150,000 for a master's. Given actual income and salary figures for Americans with a bachelor-level education, this constitutes an unsustainably high price level for education. 

Even in the best of economic times when jobs are plentiful, young people with considerable debt burdens end up delaying life-cycle events such as buying a car, purchasing a home, getting married and having children.  

The Effect on our Society
The amount of student borrowing crossed the $100 billion threshold for the first time in 2010 and total outstanding loans and exceeded $1 trillion for the first time in 2011.   Essentially, students and workers are borrowing extraordinary amounts to cover the rising cost of university education.  In fact, Americans now owe more on student loans than on credit cards. Furthermore, the National Association of Consumer Bankruptcy Attorneys reports that 25% of student loan recipients who graduated in 2005 have gone delinquent on the loans at some point, while 15% have defaulted. With rising debt comes increased risk, both to borrowers and to the economy in general. 

For the economy, higher private indebtedness levels mean less consumer confidence  (and indeed, less consumption), increased dependence on the economic cycle, and increased vulnerability to economic crises, unemployment, or anything else troublesome. It also means that people will be doing less investing in both themselves (such as by seeking more education), and in the market (which might have generated more employment).

On the personal side, high indebtedness amounts to serfdom. Ever-increasing tuition costs relative to other costs will not only lead to fewer Americans graduating from university, but also to increased mortgaging of the future for those who do. Just as the housing bubble created a mortgage debt-burden that absorbed the income of consumers and rendered them unable to afford to engage in the consumer spending that sustains a growing economy, student loans are beginning to have the same effect, which will be a drag on the economy for the foreseeable future. What’s worse, Bush-era bankruptcy law reforms make student debt completely undischargeable under bankruptcy proceedings.

Accumulating student debt in middle age is even more problematic because there is less time to earn back the money. It may also mean facing retirement years still deeply in debt.  Furthermore, parents who take out loans for children or co-sign loans will find those loans more difficult to pay as they stop working and their incomes decline.



How we Should Treat the Issue?
We need to invest properly in the productivity and competitiveness of our nation. Investing in human capital secures dividends for our nation, our economy, and our society. Like most OECD countries, the US has an economy that depends on the knowledge-base of its human capital-driven service industry in order to be competitive on an international level. OECD and US research indicate that this trend will only get deeper in the future. The more we drag our feet on this issue, the further behind the US will get compared to countries like Japan, Korea, and Germany.

In order to address the situation, a two-pronged approach is best. On one hand, tuition costs should be mostly paid by taxpayers. The argument for this can be justified by the simple fact that most of the benefits of higher education actually accrue to society at large, rather than the student. This comes in the form of increased employment levels and international competitiveness, as well as lower incarceration rates and improved health. On the other hand, currently outstanding student debt should be drawn down as efficiently and quickly as possible. This should take place by means of statutory pro-debtor statutory changes, as well as interest rate caps, and stricter application of anti-predatory-lending principles.

A 2012 study by the US National Association of Consumer Bankruptcy Attorneys found that aside from the proportions of the student debt problem and its productivity-draining effects on our economy, the stability of US student-loan debt may become the next trouble spot on the financial markets. The study recommends statutory reforms including re-instating the dischargablilty of student debt, and improved oversight of private student lenders.

About the Author:
Max Berre is a financial sector regulatory economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.