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ESCAPING THE DEBT ADDICTION: Monetary and macro-prudential policy in the post-crisis world

Adair Turner Senior Fellow, Institute of New Economic Thinking Center for Financial Studies

Center for Financial Studies Frankfurt, 10 February 2014

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Escaping Debt Addiction |1

Banks create credit, money and purchasing power

Loan to entrepreneur

Bank

100 Credit to entrepreneurs deposit account

100



Dynamics of real GDP and credit (Year on year % change)

Source: Monthly Bulletin, European Central Bank, January 2014

Real GDP Real credit to households Real credit to NFCs

United States United Kingdom



Household deposits and loans: UK 1964 – 2009

Source: Bank of England, Tables A4.3, A4.1

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

% o

f GDP

Securitisations and loan transfers

Deposits

Loans



Private and public leverage cycles: US

Source: McCulley and Pozsar

1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 0

50

100

150

200

250

Financial Repression

Hou

sing

bur

sts

WW

II en

ds

Private debt as a % of NGDP Public and



Private domestic credit as a % of GDP: 1950 – 2011

Advanced

Emerging

Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013



China: total social finance to GDP

100

120

140

160

180

200

220

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

% o

f GD

P



Non-financial private sector* credit outstanding: % of GDP

0 50 100 150 200

Brazil

China

India

Hungary

Indonesia

Korea

Mexico

Russia

South Africa

Turkey

2002

2007

2012

Source: BIS, Citi Research *Households + corporates



4.9%

7.1% 6.5%

13.9%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Real GDP Growth Real Domestic Private Credit Growth

1996-2003 2004-2011

Source: IMF, Haver Analytics, Citi Research

Real annual credit and GDP growth in emerging markets: 1996-2011



Total German private sector leverage: 1991 - 2010

0

20

40

60

80

100

120

140

16019

91-Q

119

91-Q

419

92-Q

319

93-Q

219

94-Q

119

94-Q

419

95-Q

319

96-Q

219

97-Q

119

97-Q

419

98-Q

319

99-Q

220

00-Q

120

00-Q

420

01-Q

320

02-Q

220

03-Q

120

03-Q

420

04-Q

320

05-Q

220

06-Q

120

06-Q

420

07-Q

320

08-Q

220

09-Q

120

09-Q

420

10-Q

3

Private sector debt as % of GDP



Private credit to GDP and growth

Source:"Reassessing the impact of finance and growth“, S. Cecchetti and E. Kharroubi, BIS Working Paper No. 381



Credit and asset price cycles

Expectation of future asset price increases

Increased credit extended

Low credit losses: high bank profits • Confidence reinforced • Increased capital base

Increased asset prices

Increased lender supply of credit

Favourable assessments of

credit risk

Increased borrower demand for credit



The Dilemma

Pre-crisis path of nominal GDP growth

Pre-crisis path of credit growth

4% - 5%

10% - 15%

If central banks had raised interest rates to slow credit growth …. this would presumably mean slower nominal GDP growth?

We seem to need Ċ ˃ NGḊP to ensure adequate NGḊP … but this produces financial instability and post-crisis recession

2% real growth

2% inflation



Categories of debt: UK, 2009

227

1235

243

232 Primarily productive investment

Some productive investment and some leveraged asset play

Mainly purchase of existing assets

Pure life-cycle consumption smoothing

Other corporate

Commercial real estate

Residential mortgage (including securitizations

and loan transfers)

Unsecured personal

£bn



Corporate loans by broad sector: 1987 – 2008

Source: ONS, Finstats

Note: Part of the increase in real estate lending may be due to re-categorisation of corporate lending following sale and lease-back of properties and PFI (public finance initiative) lending, but we do not think these elements are large enough to change the overall picture. Break in series from Q1 2008 due to inclusion of building society data. Sterling borrowing only.

0%

5%

10%

15%

20%

25%

30%

35%

Q1 1987

Q1 1989

Q1 1991

Q1 1993

Q1 1995

Q1 1997

Q1 1999

Q1 2001

Q1 2003

Q1 2005

Q1 2007

Q1 2009

% o

f G

DP

Non-commmercial real estate PNFC lending Commercial real estate lending



The dominance of real estate in bank lending

Total bank credit to domestic

private sector

Mortgage

credit

Mortgage credit

as % of total

129% 74% 57%

206% 131% 64%

155% 78% 50%

175% 101% 57%

122% 78% 64%

130% 91% 70%

+ Commercial real estate at

typically around 20% - 25% of total

lending

Source: Jordá, Schularick and Taylor, “Betting the Home”, forthcoming 2014

(*Bank and non-bank combined)

*



Three conceptually distinct functions of lending

Finance of new capital investment

• Enabling inter-temporal shift of consumption within life time income

Finance of purchase of existing assets

Finance of increased consumption

• Non-real estate • Commercial real estate • Residential real estate • Human capital

• Real estate • Collectibles • Existing business assets – e.g. Leveraged Buy Outs



National non-financial assets as a % of GDP

Source: Blue Book 2013 Source: Vermoegensbilanzen 1991-2012 Destatis



UK household net worth £trillion: 2012

4.5 1.5 1.3 4.3

3.2 0.1 7.6

Houses, other buildings and land

Loans Deposits & currency

Real estate + net monetary assets

Other financial assets – claims against business debt and equity

Other - mainly cars

TOTAL

Source: ONS National Banking Sheets



Variation in land value per hectare: UK 1983 – 2010

UK

Source: Blue Book 2013

10

9

8

7

6 5

4

3 2

1

£ million



Credit extension and house prices

House prices 2000 – 2007 Household debt as a % of GDP 2000 – 2007

Source: BEA; ONS; ECB

0

20

40

60

80

100

120

Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 %

GD

P

US UK Spain Ireland

0

50

100

150

200

250

Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007

Inde

x: 2

000

= 10

0

Spain US UK Ireland

Source: Ministry of Housing (Spain), S&P (US), DCLG



Interactions between credit categories and effects

Increased apparent

wealth

Reduced saving:

increased consumption

Increased price of

existing real estate

Increasing credit supply

/ demand

Equity withdrawal mortgage supply & demand

Boom in new real estate

construction

Increased prices for new real

estate

Borrower and lender net worth, confidence

and expectational effects



Inequality, demand and credit

Rich have higher

marginal propensity to

have than poor

Rising inequality

Deflationary impetus – growth on NGDP falls

Deflationary impetus offset:

• NGDP growth maintained

• Growth in credit intensity

•Rich lend to poor

•Central banks facilitates

Savings not matched

by ______

investment

+



Changes in housing wealth: UK 2003 – 2013

Households with no mortgage debt

Buy-to-let landlords

Households with mortgages

£bn

556

434

-59

Source: Savills, Private landlords gain the most from rising property market, Financial Times, 18 January 2014



Global current account balances as a % of world GDP

-2

-1,5

-1

-0,5

0

0,5

1

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

United States Germany+Japan Developed RestOPEC Developing Rest China

Source: IMF BOPS



Eurozone current account deficits: 2000 – 2008

% o

f GD

P 20

00 –

200

8

Source: International Monetary Fund, World Economic Outlook Database, October 2012

-16

-14

-12

-10

-8

-6

-4

-2

0

2000 2001 2002 2003 2004 2005 2006 2007 2008

%

Year

Greee

Ireland

Portugal

Spain

Greece Ireland Portugal Spain

% o

f GD

P



Decomposition of cumulative capital inflows: Spain (% of 2007 GDP)

0%

10%

20%

30%

40%

50%

60%

Jan-

02Ju

n-02

Nov

-02

Apr-

03Se

p-03

Feb-

04Ju

l-04

Dec-

04M

ay-0

5O

ct-0

5M

ar-0

6Au

g-06

Jan-

07Ju

n-07

Nov

-07

Apr-

08Se

p-08

Feb-

09Ju

l-09

Dec-

09M

ay-1

0O

ct-1

0M

ar-1

1Au

g-11

Jan-

12Ju

n-12

PRIVATE INFLOWS TARGET Liab. TOTAL INFLOWSTARGET 2 Liabilities to ESCB



Sectoral financial surpluses/deficits as % of GDP: Japan 1990 – 2012

Source: IMF, Bank of Japan Flow of Funds Accounts

-15

-10

-5

0

5

10

PNFCs Government

%



Japanese government and corporate debt: 1990 – 2010

Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations

% G

DP

0

50

100

150

200

250

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20010

Bank lending to non-financial corporates General Government debt



35

50

65

80

95

110

125

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: OECD National Accounts

Household PNFCs Public

Shifting leverage: private and public debt-to-GDP

Spain

50

60

70

80

90

100

110

120

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: OECD National Accounts

US

Household PNFCs

%GDP %GDP

20

45

70

95

120

145

170

195

220

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

% G

DP

Household PNFCs Public



Policies required to achieve more stable growth

Reduction in inequality or at least reduced pace of increase in inequality Reduction in global current imbalances between surplus and deficit nations

Remove biases to credit creation in deficit countries Remove biases to excessive savings in surplus countries

Integrated set of monetary, macro-prudential and fiscal policies to lean against ‘too much of the wrong sort of debt’.



Monetary, macro-prudential and fiscal policies to combat excessive debt creation

Level as well as rate of growth of leverage a key indicator

But no precise threshold for ‘too high’ leverage can be defined

Tax on credit intermediation – or at least removal of tax biases in favour of debt

• Recognises the adverse externality of debt creation

• Major political difficulties given winners and losers

• Dangers of arbitrage via shadow banking

Preemptive interest rate rises to lean against credit/asset price cycles

But insufficient due to heterogeneous interest rate elasticity of credit demand

Much higher bank capital ratios Would require parallel action to prevent shadow bank based arbitrage

Encourage equity and hybrid contracts Unlikely to occur spontaneously without government support

Manage the mix of credit by category



Managing the mix of credit by category: possible policies

Increase capital risk weights for real estate finance above those indicated by private assessment of risk

Addresses the externality of lending against real estate

Loan-to-value or loan-to-income limits on real estate lending

Borrower constraint since lender constraints imperfect

Underwriting mortgage standards to prevent reliance on price rise assumptions

Introduced by UK FCA

Constraints on high interest consumer lending

• Danger of illegal alternatives • Constraints on marketing preferable to

prohibition

Banks with dedicated focus on non-real estate business finance

To avoid crowding out of investment or trade finance



Real yields to maturity on UK indexed linked gilts

Source: Bank of England Statistics, Zero coupon real yields

10-year Yield 20-year Yield

-2

-1

0

1

2

3

4

5

01. M

rz 8

501

. Mrz

86

01. M

rz 8

701

. Mrz

88

01. M

rz 8

901

. Mrz

90

01. M

rz 9

101

. Mrz

92

01. M

rz 9

301

. Mrz

94

01. M

rz 9

501

. Mrz

96

01. M

rz 9

701

. Mrz

98

01. M

rz 9

901

. Mrz

00

01. M

rz 0

101

. Mrz

02

01. M

rz 0

301

. Mrz

04

01. M

rz 0

501

. Mrz

06

01. M

rz 0

701

. Mrz

08

01. M

rz 0

901

. Mrz

10

01. M

rz 1

101

. Mrz

12

01. M

rz 1

3



Velocity of money circulation

Source: BoE, BoJ, Datastream

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Q4

1980

Q2

1982

Q4

1983

Q2

1985

Q4

1986

Q2

1988

Q4

1989

Q2

1991

Q4

1992

Q2

1994

Q4

1995

Q2

1997

Q4

1998

Q2

2000

Q4

2001

Q2

2003

Q4

2004

Q2

2006

Q4

2007

Q2

2009

Q4

2010

UK (M2) Japan (M2)

Velocity of Money (Nominal GDP/M4)

00.20.40.60.8

11.21.41.61.8

2

Q4

1980

Q2

1982

Q4

1983

Q2

1985

Q4

1986

Q2

1988

Q4

1989

Q2

1991

Q4

1992

Q2

1994

Q4

1995

Q2

1997

Q4

1998

Q2

2000

Q4

2001

Q2

2003

Q4

2004

Q2

2006

Q4

2007

Q2

2009

Q4

2010

Japan (M4) UK (M4)

Velocity of Money (Nominal GDP/M2)


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