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There is Still No Housing Bubble

Articles about Housing Bubbles are ten a penny at the moment, so I thought it was about time for another salvo in my lonely war against the Bubble Obsessed. When I was lying awake last night, it occurred to me that there is not really enough thought about what constitutes “expensive” or “cheap” when it comes to housing. When talking about an item like bread, we can see that over time the price tends to fall slowly as technology and farming improves, but with occasional spikes when there is some type of supply shock which lowers supply. So it makes sense to talk about when bread is expensive by comparing it to recent history. Fashion items, on the other hand, derive part of their value from their exclusivity, so their price relative to wages stays fairly constant to target a given type of consumer.

Then there are financial assets like the stock market, which make new highs most years, because they are a claim on a fraction of a pie which is growing. Since the housing market also a claim on future earnings, via rent, it too should logically make new highs most years.

It is my contention that housing is more of a luxury good than a commodity, and thus I would expect people to have a reasonably stable preference about what fraction of their income they are prepared to spend on housing. Thus, house prices are expensive, only in so far as they grow more than the total spending (perhaps per capita) in an economy. This makes sense, if my wages grow over time, I would expect to try to move to a better house, and pay more rent. Since, on average, everyone’s wages grow over time, so must house prices. Running to stand still as it were.

The following shows the change in the house price index relative first to NGDP (=total spending), and secondly to the median wage.

Look how stable house prices/median wages have been!!!

Look how stable house prices/median wages have been!!!


The first thing to note is how amazingly stable both these measures are over time. Particularly house prices/median wages. It was basically flat for decades. On the housing/nominal spending measure, US housing has never been cheaper! The difference in trajectory is a measure of the fact that median wages have not risen in line with total spending due to declining labour share over the period. It is interesting that prices relative to median wages really did show a marked increase in the 2000s, but that is all but fully unwound, and I look forward to watching house prices going flat relative to median wages for many more decades.

I tried to recreate the same graph for the UK, but FRED seems to only have rental income. However, that is interesting in its own right, so lets look at rental prices vs NGDP and vs the median wage in the UK:


Where is that house price bubble again?

Where is that house price bubble again?

This data goes over a much shorter period than the US data above. However, its pretty clear that the cost of renting has been in a reasonably long term decline throughout the nineties. I look forward to watching the cost of renting resume its decade long decline.

Its also interesting that the crash has actually made housing more expensive since it caused wages to fall much faster than house prices. A salutory warning to the Bundesbank and Swedish who seem determined to make the case that you should try to put a lid on house prices by raising rates.

Anyway, the main point is clear – forget the media’s obsession. Housing is cheap by the most important measure – its cost relative to median wages.

Also, if you are a BOE Hawk determined to raise rates to put the break on the housing market, then have another look at the evidence. And then don’t.

PS:If someone can find the data for UK house prices in a handy format somewhere, I will redo the US graph for the UK.

Thomas Piketty and Inequality

I haven’t read this book, but judging from the blog reviews, it seems that is central point is that if the return on capital is higher than economic growth, then the owners of capital should become richer over time.

However, it seems that there are certain problems with this thesis. Firstly, an economy has an optimal capital stock, and thus can carry only a finite amount of wealth into the future. Attempts to save beyond this simply drive the return on capital negative. In the long run then, the capital stock approaches the optimal, and the return on savings should approach zero. Given the epic lack of capital in EM, we are still some 50-100 years from that, at least. On the other hand, we can comfort ourselves with the thought that even if Piketty is correct now, he won’t be correct forever.

If we think that the inequality in capital ownership is a problem, there is a simple solution. Simply have world governments buy up large quantities of the capital stock, say half of the stock and bond markets over a few decades. By reducing the supply of capital, savers, and by extension the wealthy, would have to compete for a smaller and smaller share of the optimal capital stock.

In the short term, this will drive up the price, but in the long run it limits the supply of available savings vehicles, and exposes the wealthy to inflation by giving them the choice between holding cash, or buying capital at such prices that returns are bound to be negative.

Of course, it seems that this would not be a politically acceptable move. For one thing, people seem to believe in the divine right of savers to reasonable returns. Of course, no one seems to equate the very wealthy with `hard working’ savers, but economically they are largely identical. To make it politically acceptable, the government would have to provide bonds at a reasonable rate of return. This could be managed, simply start selling bonds directly to savers at some limit such that no one person can own more than, say $500,000.  This is not very different from the UK’s pensioner bonds.

Driving down inequality by having the government buy up the capital stock. Its just the modern repackaging of Marxist ideas, but the difference is that we could do it now, without the terrible side effects. Just buy ETF’s and the government can be a silent partner in the world’s stock and bond markets. No interference in workings of capitalism, just lots more capital.

The Importance of Charity in a Market Economy.

Ever since I first read “I pencil”, I have been somewhat in awe of market economies. The ability of price signals to transmit demand along supply chains containing millions of individuals is akin to magic. The market appears almost limitless in its ability to reshape the contours of labour and capital in order to produce goods that we never even knew that we wanted. It is the ultimate democracy: every £ of spending is one vote, directing research and development, production, and marketing.

Just as, in the case of a pencil, it is impossible to derive precise causal links between buying a pencil and the production forecasts of saw-makers, so it is not possible to see how our consumption drives the research and development which produces new products. Nevertheless, the link is real.

Thus, when you buy clothes, you are voting for the development of new clothes. When you buy clothes based on how they look rather than how they last, you are driving research into sartorial elegance over the production of hard wearing fabrics. As consumers, we hold ultimate responsibility for the make up of the market. If we stopped demanding the latest fashions, we could instead direct that energy and talent into Medical research, or ending poverty.  I, for one, have every faith that the market can make huge strides towards improving some of our most intractable social problems. All it takes is demand. Sadly, often those most affected are those with no voice. If you are poor, your problems are invisible to the Market. So who will speak on their behalf?

Thus we come at last to the point. When you make a charitable donation, you are voting for a solution to that problem. So vote for an End to Cancer, or an End to Homelessness, or for the Elimination of Poverty. Vote to end Child Trafficking, or the Sexual Exploitation of Vulnerable Women. Together, we can reshape our economy, and build a better world. All it takes is a little charity.


Charitable giving in the UK by adults is currently less than 0.5% of GDP.

An update on Abenomics

Via FTAlphaville, I found a graph from this paper:


Abenomics is having a huge effect on output compared, which is somewhat masked by demographic decline in the working population.

So when will the ECB realise that QE is an effective policy tool which increases output during a depression, and get on with saving the EZ?

Update to Wage Growth Does Not Necessitate Inflation

Marcus Nunes left a link to a Cleveland Fed Paper which has some interesting remarks about wage inflation and price inflation:

…since labor costs are a large fraction of a firm’s total costs of production, rising wages and compensation should put pressure on firms to pass these higher costs on as higher prices. We have several reasons to doubt the accuracy of this view. First, if a wage increase is brought about by increased labor productivity, it will not create inflationary pressure.3 Second, a wage increase will not create inflationary pressure if it leads to a squeeze in profits because a firm cannot pass along cost increases. No firm inherits the right to simply “mark-up” the prices of its output as a constant proportion above its costs; competitive market pressures strongly influence the pricing decisions of firms. Finally, causation could work in the opposite direction: An increase in aggregate demand may permit firms to raise the price of their products, and the resulting increase in profits would lead workers to demand higher wages in future negotiations.

And just in case you missed their meaning…

It turns out that the vast majority of the published evidence suggests that there is little reason to believe that wage inflation causes price inflation. In fact, it is more often found that price inflation causes wage inflation. Our recent research, which updates and expands on the current literature, also provides little support for the view that wage gains cause inflation. Moreover, wage inflation does a very poor job of predicting price inflation throughout the 1990s, while money growth and productivity growth sometimes do a better job. The policy conclusion to be drawn is that wage inflation, whether measured using labor compensation, wages, or unit-labor-costs growth, is not a reliable predictor of inflationary pressures.

So if the hawks could all stop clamouring that a tighter labour market means the start of a wage-price spiral of death, that would be great, and dare I say it, rational.

Wage Growth Does Not Necessitate Inflation

There seems to be a certain segment of the economic commentariat who believe that whatever the reason, tightening is the answer. The latest reason to tighten is that there is evidence that the labour market is tightening. Wage growth in the US is staging a modest recovery.

However, this does not imply that the CPI is going to rise. Lets have a quick look at average hourly compensation vs inflation since 2000.

Compensation and Inflation

We can see that inflation and wage growth typically track each other fairly closely. This correlation is likely spurious, an artefact of the fact that productivity growth and population growth have similar magnitudes. I am more interested in the effect of total compensation on inflation. Since the argument goes that wage growth leads to inflation, lets note first that wage growth is still far below historical norms.

Inflation is generated when demand outstrips supply. Labour market tightening means that workers have better bargaining positions, and then can bargain for better wages. Wage growth is coming, and wage growth means rising AD, but inflation comes only when AD outstrips AS. There are two reasons that that this might not happen at once:

(1) Productivity growth. It is a feature of recessions generally that Capex falls because companies do not invest in productivity enhancements in an environment of weak demand. Technological progress marches on regardless, and the result is that there is a steady stream of available but unbuilt productivity enhancements that a company could invest in. Thus we should expect that productivity growth could stage a catch up. This is supported by the general observation that RGDP has grown on the same trendline for decades, and it would be a remarkable coincidence if trend growth had a secular change exactly at a time that happened to have a financial crises.

(2) Corporate Profit Margins. CPI measures consumer prices, which is not quite the same thing as monetary inflation. This is punishing on the way down, when consumer prices do not fall in line with the changing money demand, but can be beneficial on the way up. For example, a decline in corporate profit margins as a tighter labour market allows workers to capture more of their marginal product can give you rising demand without rising consumer prices.

The economy is complicated, and no one can predict what will happen with perfect certainty, but you should not give undue credence to those who tell you that rising wage growth is certain to generate inflationary pressure. As in the late nineties, wage growth can be large while inflation is low for years at a time. We have two plausible stories that can support the hypothesis that this is a likely outcome, it is certainly where I would place my chips.

Low Interest Rates, Excess Saving, and Bubbles

It seems like the belief that low interest rates cause bubbles is all the rage. Its superficially such an obvious relation “low rates” means “easy money” which means people “bid up” assets and hey presto instant bubble.

Unfortunately, its all wrong. What really causes bubbles is too much saving. For a given level of technical progress, an economy has an optimal capital stock. We define the the optimal capital stock through its equilibrium condition: there is no productive investment (which can be made by the private sector) which has a risk adjusted return which is better than zero.

Now of course, in the real world there is always new innovation, and replacing deprecated capital, so we would really expect the optimal (real) rate to be slightly above zero. Nevertheless, zero real return on capital is where an economy wants to be, where it strives to be. However, the optimal stock is not fixed, it is in fact rapidly changing. New technology can create new possibilities for investment, or it can render old capital irrelevant. The new tech industries are much less intensive than the old “heavy” industries that they are largely replacing. Nevertheless, this capital stock represents the maximum stock of savings  that can be carried into the future. If people want to save more than this, they have no choice but to invest in assets with a negative real rate of return.

Real capital investments are funded by foregoing consumption in the present in order to get more later. This is what the interest rate asks, it says, how much extra consumption do you need in the future to persuade you to forgo consumption now, so that we can build this useful investment. The more people want to save compared tot he optimal stock of assets, the more negative the real rate of return must become. The more the real rate or return becomes negative  the more “bubbles” people will see.

There is really only one possible strategy for this, and it amounts to aligning the stock of capital investments with peoples desire to save. This is possible because:

(1) Often capital investments are inhibited by real world factors like unstable government, poor human capital, poor infrastructure. Stabilising Africa and parts of the IndoChina region would offer plenty of investment opportunities.

(2) Government funded spending. There are plenty of productive investments that only a government can make, and through either higher taxes (on those who over-save – the rich) or higher deficits (providing more safe assets). These include: Education – the state of UK and US public education is a joke, and severely inhibits future productivity; Infrastructure – some projects are simply too large for the private sector to undertake; Regulation – the UK house market is a typical example, where poor government regulation prevents housing stock being built at the required pace; Free trade – this is a little less obvious, but take for example, US energy protectionism (preventing the export of shale gas), this prevents the optimal level of investment in shale technology, by keeping the price artificially low. On the other hand, it raises the risk premium for investing in oil and gas outside the US (as it could be made unprofitable through an arbitrary regulatory announcement), which reduces investment outside the US aswell. Essentially, people aren’t stupid – they will not invest in a product which depends purely on regulatory trade barriers unless they are convinced that they are here to say.

(3) Transfer payments. By transferring income from those with a high propensity to save (rich people/middle class) to poorer people, you lower the overall savings rate.However, this is not likely to be too effective in a UK/US centric view, as most of the excess savings appear to be coming from Japan, Germany and China as a response to their coming demographic disasters. UK particularly does not suffer from excess savings 🙂

Any time the total quantity of saving is in excess of the total stock of capital, a bubble is guaranteed, by draining savings out the system through government investment, we get higher total productivity, higher interest rates for savers, and fewer bubbles. Win Win Win?