5/2/19: The Myth of the Euro: Economic Convergence

The last eight years of Euro's 20 years in existence have been a disaster for the thesis of economic convergence - the idea that the common currency is a necessary condition for delivering economic growth to the 'peripheral' euro area economies in the need of 'convergence' with the more advanced economies levels of economic development.

The chart below plots annual rates of GDP growth for the original Eurozone 12 economies, broken into two groups: the more advanced EA8 economies and the so-called Club Med or the 'peripheral' economies.

It is clear from the chart that in  growth terms, using annual rates or the averages over each decade, the Euro creation did not sustain significant enough convergence of the 'peripheral' economies of Greece, Italy, Portugal and Spain with the EA8 more advanced economies of the original euro 12 states. Worse, since the Global Financial Crisis onset, we are witnessing a massive divergence in economic activity.

To highlight the compounding effects of these annual growth rates dynamics, consider an index of real GDP levels set at 100 for 1990 levels for both the EA8 and the 'peripheral' states:

Not only the divergence is dramatic, but the euro area 'peripheral' economies have not fully recovered from the 2008-2013 crisis, with their total real GDP sitting still 3.2 percentage points below the pre-crisis peak (attained in 2007), marking 2018 as the eleventh year of the crisis for these economies.  With Italy now in a technical recession - posting two consecutive quarters of negative growth in 3Q and 4Q 2018 based on preliminary data, and that recession accelerating (from -0.1% contraction in 3Q to -0.2% drop in 4Q) we are unlikely to see any fabled 'Euro-induced convergence' between the lower income states of the so-called Euro 'periphery' and the Euro area 8 states.

17/1/19: 2019 Outlook

My post on economic outlook for 2019 is now available from the Focus Economics: https://www.focus-economics.com/blog/constantin-gurdgiev-thoughts-on-the-global-economy-for-2019

17/1/19: Eurocoin December 2018 Reading Indicates a Structural Problem in the Euro Area Economy

December 2018 reading for Eurocoin, a lead growth indicator for euro area posted a second consecutive monthly decline, falling from 0.47 in November to 0.42 in December. December reading now puts Eurocoin at its lowest levels since October 2016.

Charts below show dynamics of Eurocoin, set against actual and forecast growth rates in the euro area GDP and  inflation:

Per last chart above, the pick up in inflation, measured by the ECB’s target rate of HICP, from 1.4% at the end of 3Q 2017 to 1.7% in 3Q 2018 has been associated with decreasing growth momentum (Eurocoin falling from 0.67 q/q to 0.48, and growth falling from the recorded 0.7% q/q in 3Q 2017 to 0.2% q/q in 3Q 2018).

With this significant downward pressure on growth happening even before any material monetary tightening by the ECB, Which suggests that euro area growth problem is structural, rather than policy-induced. While QE did boost growth from the crisis period-lows, it failed to provide a sustainable momentum for significantly expanding potential growth. Thus, even a gradual slowdown in monetary easing has been associated with a combination of subdued, but accelerating inflation and falling growth.

19/10/18: IMF's Woeful Record in Forecasting: Denying Secular Stagnation Hypothesis

A recent MarketWatch post by Ashoka Mody, @AshokaMody, detailing the absurdities of the IMF growth forecasts is a great read (see https://www.marketwatch.com/story/the-imf-is-still-too-optimistic-about-global-growth-and-thats-bad-news-for-investors-2018-10-15?mod=mw_share_twitter).  Mody's explanation for the IMF forecasters' failures is also spot on, linking these errors to the Fund's staunch desire not to see the declining productivity growth rates (aka, supply side secular stagnation).

So, to add to Mody's analysis, here are two charts showing the IMF's persistent forecasting errors over the last four years (first chart), set against the trend and the cumulative over-estimate of global economic activity by the Fund since mid-2008 (second chart):

While the first chart simply plots IMF forecasting errors, the second chart paints the picture fully consistent with Mody's analysis: the IMF forecasts have missed global economic activity by a whooping cumulative USD10 trillion or full 1/8th of the size of the global economy, between 2008 and 2018. These errors did not occur because of the Global Financial Crisis and the high degree of uncertainty associated with it. Firstly, the forecasting errors relating to the GFC have occurred during the period when the crisis extent was becoming more visible. Secondly, post GFC, the hit rates of IMF forecasts have deteriorated even more than during the GFC. As Mody correctly points out, Fund's forecasts got progressively more and more detached from reality.

At this stage, looking at April and October 2018 forecasts from the Fund's WEO updates implies virtually zero credibility in the core IMF's thesis of a 'soft landing' for the global economy over 2019-2021 time horizon.

23/5/17: Eurocoin: Growth Momentum Slips Marginally in April

A quick update to the old-running series: Eurocoin, the leading economic growth indicator for the euro area, published by CEPR and Banca d'Italia posted another (second in a row) moderation, falling from 0.7 in March 2017 to 0.67 in April. The indicator remains at the upper range of growth for the current upside cycle, and within lower range of growth compared to previous upside cycle:

On the drivers side, stock markets valuations helped to push growth forecast higher, while a slowdown in industrial activity pushed growth expectations lower. In other words, absent the financial assets impact, growth indicator would be much lower.

While euro area overall HICP was at 1.9% in April (bang at the upper range of ECB's target), 12mo trailing average inflation rose to 0.8% from 0.7% in March. Which means the ECB has moved out of the 'policy corner' and is now positioned to start unwinding assets purchasing programs. It will proceed gradually and at a later date, due to political, not monetary reasons.

Meanwhile, although Eurocoin averaged 0.72 in 1Q 2017, actual growth came in at (first estimate) 0.5%. This marks the largest gap between Eurocoin and actual growth since 2Q 2014. This is hardly surprising. In general, the gap between leading indicator-implied growth forecast and actual growth outrun is usually wider during periods of elevated uncertainty about the economy, and especially when financial economy takes over as a major contributor to overall economic growth outlook.

27/1/17: Eurocoin Signals Accelerating Growth in January

Eurocoin, leading growth indicator for euro area growth published by Banca d'Italia and CEPR has risen to 0.69 in January 2017 from 0.59 in December 2016, signalling stronger growth conditions in the common currency block. This is the strongest reading for the indicator since March 2010 and comes on foot of some firming up in inflation.

Two charts to illustrate the trends:

Eurocoin has been signalling statistically positive growth since March 2015 and has been exhibiting strong upward trend since the start of 2Q 2016. The latest rise in the indicator was down to improved consumer and business confidence, as well as higher inflationary pressures. Although un-mentioned by CEPR, higher stock markets valuations also helped.

30/12/16: In IMF's Forecasts, Happiness is Always Around the Corner

Remember the promises of the imminent global growth recovery 'next year'? IMF, the leading light of exuberant growth expectations has been at this game for some years now. And every time, turning the calendar resets the fabled 'growth recovery' out another 12 months.

Well, here's a simple view of the extent to which the IMF has missed the boat called Realism and jumped onboard the boat called Hope

Table above posts cumulative 2010-2016 real GDP growth that was forecast by the IMF back in September 2011, against what the Fund now anticipates / estimates as of October 2016. The sea of red marks all the countries for which IMF's forecasts have been wildly on an optimistic side. Green marks the lonely four cases, including tax arbitrage-driven GDPs of Ireland and Luxembourg, where IMF forecasts turned out to be too conservative. German gap is minor in size - in fact, it is not even statistically different from zero. But Maltese one is a bit of an issue. Maltese economy has been growing fast in recent years, prompting the IMF to warn the Government this year that its banking sector is starting to get overexposed to construction sector, and its construction sector is becoming a bit of a bubble, and that all of this is too closely linked to Government spending and investment boom that cannot be sustained. Oh, and then there are inflows of labour from abroad to sustain all of this growth. Remember Ireland ca 2005-2006? Yep, Malta is a slightly milder version.

Notice the large negative gaps: Greece at -21 percentage points, Cyprus at -18 percentage points, Finland at -15 percentage points and so on... the bird-eye's view of the IMF's horrific errors is:

• Two 'programme' countries - where the IMF is one of the economic policy 'masters', so at the very least it should have known what was happening on the ground; and 
• IMF's sheer incomprehension of economic drivers for growth in the case of Finland, which, until the recession hit it, was the darling of IMF's 'competitiveness leaders board'.  

Median-average miss is between 4.33 and 4.97 percentage points in cumulative growth undershoot over 7 years, compared to IMF end-of-2011 projections.

So next time the Fund starts issuing 'happiness is just around the corner' updates, and anchoring them to the 'convincing' view of 'competitiveness' and 'structural drivers' stuff, take them with a grain of salt.

11/10/15: Tax Code Simplification and Deadweight Loss of Taxation

In a recent speech (see notes here), I discussed the need for tax reforms in Ireland and, specifically, for flattening of the income tax system.

Here is an interesting, albeit dated, paper on the subject of tax codes simplification as the tool for reducing the Deadweight Loss of compliance and improving tax compliance and enforcement: http://www.columbia.edu/~wk2110/bin/epi.pdf.

H/T to @brianmlucey for the link.

4/10/2015: Budget 2016 and beyond: some priorities...

This is a summary of my speech at the local constituency meeting in Sandymount organised by Renua Ireland (October 1, 2015). Please note: I was invited to speak in a personal capacity as an independent, politically non-affiliated speaker, so all thoughts, arguments, errors and omissions in the below are mine.


Where we are?

1) Recovery in official figures:

• GDP is up 6.9% y/y in 1H 2015.
• GNP is up 6.6%
• Some 60% of GDP growth in 1H 2015 was accounted for by Fixed Capital Formation - much of which is driven by assets sales to and by vulture funds, plus by reclassified R&D spending booked by MNCs into Ireland via our ‘knowledge development box’. 
• But the aggregate data is dodgy. Our GDP is 19 percent ahead of our GNP and it is 25% over Domestic Demand, over 2000-2007 the latter gap averaged ‘only’ 10 percent.

2) Recovery in somewhat more real figures:

• Personal expenditure is up 3.27% y/y in 1H 2015. 2Q 2015 was sixth consecutive quarter of positive y/y growth. But it is still down 9.9% on pre-crisis peak. Nonetheless, the numbers coming out on this side of National Accounts are positive.
• Government expenditure on current goods and services was up 3.54% y/y in 1H 2015. But down 10.6% on pre-crisis peak. There is timing issue involved here, but for now, Government spending is rising faster than personal consumption.
• Fixed Capital Formation rose 22% y/y in 1H 2015, but is still down 12.3% on peak.

By all measures of domestic economy, we are in an official recovery since 3Q 2013. And the rate of growth is relatively robust

• Final Domestic Demand is up 7.7% in 1H 2015 on a yearly basis, although overall activity as measured by Domestic Demand is down 7.9% on pre-crisis peak. 
• But, crucially, over the last 4 quarters, personal expenditure per capita was up only 1.62% on average (y/y per quarter) against total domestic demand rising 4.3%. Which shows the role played by Fixed Capital Formation (including Nama, vulture funds, R&D reclassifications and MNCs activities) in driving up domestic demand. 

Ditto for Unemployment figures:

• Official unemployment rate (QNHS-based) has fallen from 16.3% in Q3 2011 to 10.3% in 2Q 2015. Which is a robust decline and undoubtedly good news. Other good news is that much of new jobs creation was in stronger quality category of full time employment. 
• Still, current rate of unemployment is close to 1Q 2009 and is almost double 5.9% rate recorded in 2Q 2008, more than double 4.9% rate in 2Q 2007.

However, these figures mask several sub-trends that are worrying.

• Per CSO own report: % of unemployed persons plus  others who want a job, plus part-time underemployed persons, plus those who want a job, who are not available and not seeking for reasons other than being in education or training stands at 18.3%.
• Factoring in those in State Training Programmes (e.g. JobBridge) raises actual unemployment rate to 21.9%, comparable to 2Q 2009.
• Adding in net emigration as reported through 1Q 2015 raises broadest measure of potential unemployment to 29.5 percent - a figure that puts our relative labour market performance back to 1Q 2011 levels. In other words, it took us twice longer to go from cyclical unemployment high back to 1Q 2011 levels than to go from 1Q 2011 to cyclical unemployment high. Road to recovery is, for now, twice longer than the road travelled through the collapse.
• Worse: labour force participation rate has been averaging 59.8% in 1H 2015 down from 59.9% in 1H 2014. Both are still well below pre-crisis (2000-2007) average of 61.2%.

Top line: 

• Our GDP - at the aggregate - is now above the pre-crisis peak levels. 
• But our GDP per capita is still 0.8% below pre-crisis levels and our domestic demand per capita is 13.3% down on pre-crisis peak. Our personal consumption per capita is down 8% on pre-crisis peak. 
• Much has been achieved, the Government deserves quite a bit of credit for facilitating these achievements, if only in a 'safe pair of hands' way, yet more remains to be delivered, still and this requires more than just a 'safe pair of hands'.

What are the risks to a sustained recovery and how do we deal with these?  We should focus not short-term risks, but on bigger themes:

1. Global secular stagnation and demographic challenges
2. Global interest rates (cost of debt) normalisation
3. Our legacy debt problems and related issues of longer-term savings and investments
4. Domestic imbalances on production side: MNCs v domestic economic activity
5. Domestic imbalances on wealth distribution side (inequality, poverty, persistent and concentrated underinvestment in human capital, homelessness, debt distress, and cultural/systemic/institutional barriers to deployment of human capital).

• All of these factors are cross-linked. The realisation of which at the top of Irish political elite is lacking.
• All require a joined-up thinking to deal with.  A practice of which at the top of Irish political elite is lacking too.
• Addressing them requires a new longer-term agenda or strategy for growth and development of the Irish economy. Which we have no institutional framework for preparing, let alone enacting.

In this environment, lacking big ideas, Budget 2016 or indeed any budgetary framework won’t be enough, no matter how good the intentions and execution can be. Neither will be piece-meal approach to development of public investment, as exemplified by what we know from the bits and pieces of the Capital Investment programme for 2016-2021 announced this week.

So what needs to be done to begin addressing these bottlenecks in leadership?

Let’s start from the big picture - policy formation and implementation mechanism. We need deep reforms of how we do business when it comes to policy formation.

Key principles here should be:

1. Cross-party engagement
2. Bringing in divergent voices from the outside (given lack of political culture to do so, this should be mandated for all public boards, agencies and policy formation bodies).
3. Bringing in robust measures to stress-test all and any proposals.
4. Doing away with token talking shops of policy formation: all the Diaspora Meet-ups, all National Forums and Working Groups that are dominated by vested interests, the Fiscal Council (which has neither teeth, nor independence in its composition), etc etc.
5. Replacing the above fora with a functional National Task Force composed of both independent and vested interests-linked people with requisite expertise divided by key sectors of the economy: Domestic Economy, Internationally Trading Economy, Public Sector & Government, Households and Quality of Life. Each sectoral group should be tasked with generating & collating ideas for development of the broader sectors on the basis of counterbalancing measures applied to one sub-sector against other sub-sectors. Each group uses seconded public service assistance to cost/price proposals. All group proposals are to be published, publicly vetted and reviewed subsequently by the umbrella body based on the same principles of transparency, professionalism, factual analysis and contrarian view stress-testing. 

At the deployment level, we need to reform public sector systems and local authorities. This should at the very least involve:

1. Dramatically reducing the number of local authorities, to eliminate extreme levels of non-coordination and empire-building in individual decisions;
2. Empowering local authorities to create meaningful institutions for developing economic and social policies at a local level by providing them with full control over taxation in property sector and giving them a right to impose local prices for water delivery as well as supply water (Irish Water should be changed to a state-wide entity in charge / ownership of water infrastructure, while actual water provision should be decentralised to local authorities who can supply water into the distribution network on a competitive basis. Such system already works in electricity and gas distribution and can provide better services to consumers at lower cost, while giving local authorities more independent revenues to undertake provision of their own supports and services).
3. Bringing in functional mechanisms to promote and reward managed risk-taking and informed decision-making in the public sector, as well as to support those who reach above the mean in terms of effort and output. Merit, not tenure, should guide public sector careers progressions. Whilst this objective is not easy to achieve, I am certain that a combination of best practices and good policy thinking can result in a significant (though probably imperfect) improvement on status quo.
4. Bringing in functional measures to create a climate and culture of accountability. Not for mistakes made (and properly managed) in attempting leadership, but for lack of initiative, failure to carry out required work, any harm done by negligence and inaction.
5. We need to reform the system of ministerial advisors and oversight over departments, state boards and bodies. Again, here, the key is to bring in professionalism and remove cronyism, instill culture of debate, independence and entrepreneurialism (measured and managed taking of risks).

Let’s go on to specifics of policy objectives.

Ireland is a demographically young country trading in global markets in higher value-added goods and services. This means we are a country based on human capital. And this also means we face global competition for human capital.

What is human capital? A sum total of skills, formal and informal education, aptitude to work, attitudes to risk, ability to manage risks and uncertainty, creativity, capacity to innovate and to adapt to innovation. It also includes health, emotional and psychological well-being, cultural capital, and so on.

So what do we need to do to shift our economic model firmly in the direction of relying on human capital?

The core principles of human capital-intensive economy are:

• The need to attract human capital from outside
• The need to retain human capital that is already present in the economy
• The need to create new human capital within the economy, and
• The need to enable human capital to add value in the economy.

I have a catchy name for this system: CARE.

Primarily, in the short term, we have to rebalance our tax system. This is something that can be started with the budget, but will require more effort than just altering tax rates.

We need to shift burden of taxation away from taxing individual returns on human capital - in other words, we need to cut tax burden on income from skilled labour and entrepreneurship, but also from other forms of human capital. Incidentally, because human capital is a very broad concept, human capital-intensive value added is being created across the entire economy: public and private, lower income and higher income and so on activities. Human capital economy is not about rich v poor, and it is not about unemployed v employed. Every person in any occupation should be encouraged to invest in their own human capital in whatever form suits them, and every person in every occupation should benefit from reaping the returns on such investments.

To do so, we have to shift some of the current taxation burden away from income tax arising from investing own effort and talents into work, and onto something else.

Best target for such a shifting of burden is to shift it onto those assets that have the least productive use (in terms of value added) in the economy and that, simultaneously, cannot be moved offshore. Such assets are land and fixed capital - buildings and distribution networks.

It is worth noting that in sectors where land plays significant role in overall production, such as agriculture, human capital matters too, and land occupies still lower importance in production chain than we tend to think. Agriculture producing commoditized goods (e.g. generic grains or milk) still accrues value added via types of production, quality of supply, etc. Which are non-land outputs. Beyond that, agriculture also involves increasingly higher value added production – e.g. specialist grains, processing of milk, production of organic and/or artisan and/or specialist types of dairy products, etc. A land tax does not mean a tax on agriculture, but a tax on those activities in all sectors, including agriculture, that use land less efficiently.

Budget 2016 can start on this path by eliminating two or three upper marginal rates under the USC. Or better yet, eliminating USC altogether. And introducing a land or site value tax.

We also need to eliminate all penalties on taxation of self-employed and, unless we bring in symmetric access to benefits, we need to stop charging self-employed for services they have no access to.

We also need to create a system of taxation that recognises that self-employed face high volatility of income year-on-year. A system of 3 year average minimum taxation can be developed to address this, providing self-employed with a limited, but meaningful temporary credit for taxes paid in the case their income dips below, say, 75% threshold for previous 3 year average. These credits can be recouped in subsequent years when their income exceeds, say 110 percent threshold. Numbers here are illustrative and can be estimated more precisely, but it is the principle that matters. As economy becomes more and more linked to the ‘Gig Economy’ principles of work, the volatility of incomes and asynchronicity of tax liabilities will wreck more and more havoc in the households’ ability to fund basic purchases and investments, savings and debt repayments.

But, real reforms will require simultaneously bringing in some sort of income transfer system that guarantees high quality of life for those in needs of social transfers, while not relying on excessively penalising those who invest in their own skills and labour. So longer term reforms should involve introduction  of basic income. This will, accidentally, retain progressivity of taxation under flat rate income tax. And it will assure that those who are well-off can not benefit from social transfers.

Parallel with this, we need to close all targeted incentive schemes within our tax codes. The state should get out of business of picking and choosing future ‘winners’ or ‘champions’ of Irish economy and get into business of administering payment for & provision of core public services.


We also need to stimulate enterprise formation and entrepreneurship. These are two different but adjoining concepts.

• So we need to reform tax codes to allow entrepreneurs who exit their recent ventures to reinvest in new ventures. In other words, we need to recognise the reality of modern entrepreneurship: it takes more than one or two years to find and develop a suitable target for new investment, so tax exemption for reinvested proceeds of business sale should be stretched out to cover 3 years. A reduced rate of CGT for reinvestment over 3 years window can help here.
• We need to empower entrepreneurs to incentivise their employees and key partners/advisers. Which means we should switch taxation of equity shares granted to employees and key contributors to new business from immediate tax liability on shares issuance to taxation at the point of shares disposal. When income arises, tax should arise. Until no income accrues, no tax should be levied.
• We need to steer more funding toward risk capital or equity, away from preferentially-treated debt. Which means we should have symmetric tax applying to both capital gains on equity and gains realised from holding debt instruments (bonds), including Government bonds. There is no financial or ethical justification for exempting Government bonds from taxation net.
• VAT threshold in Ireland is imposing too high of a burden on sole traders and self-employed. We should move this threshold to the levels found in the UK. Instead of EUR37,500, VAT should be levied from around EUR90,000. 

We also need to significantly reform our corporation tax policies. 

The headline rate is fine. But the loopholes are glaring and are damaging to our competitiveness through several channels:

1. Tax loopholes are costing us in international markets by creating a perception that Ireland is a corporate tax haven
2. Tax loopholes are funding the creation of a labour market that is severely skewed in favour of MNCs, inducing higher costs on SMEs and indigenous enterprise
3. Tax loopholes are steering economic activity into non-productive areas where we have little chances to capture international comparative advantage (STEM areas of R&D, whilst our human capital base is better suited to develop sales, marketing, copyright and soft-innovation expertise).

One key loophole that has been introduced recently is the so-called ‘Knowledge Development Box’ that suits primarily (and almost exclusively) a narrow segment of MNCs, while providing no benefit for domestic enterprises. Another key loophole is treatment of foreign revenues domiciled into Ireland.

Shut them down.

The issue of reforming taxation system also goes to the heart of the ongoing debate about wealth inequality.

Except, contrary to what many (especially in the media) think, this debate is a bit more complex than our papers’ and TV programmes allow.

Economists Bill Gale, Peter R. Orszag and Melissa Kearney at the Brookings Institution recently showed that even a big increase in the marginal tax rate for top earners would have shockingly little effect on after-tax inequality in the U.S.

This covered such scenarios as raising the top individual income tax rate to 50 percent from its current level of 39.6 percent. Take the Gini coefficient is an index that ranges from 0, if everyone has the same earnings, to 1, if a single person has all the earnings and everyone else has none. When the authors calculated the Gini coefficient for after-tax income before and after the simulated tax change, they found that under the current tax schedule, the after-tax Gini coefficient is 0.574; raising the top marginal tax rate to 50 percent would reduce that only to 0.571. This difference is smaller than the effect of enlarging the share of the population with a college degree. Income inequality doesn’t change materially even if the revenue raised from a high-income tax increase is redistributed to households in the bottom income quintile, or if high earners are assumed to respond to the higher tax rate by reducing their work effort and taxable income.

For Ireland, the same measure would probably be even less productive in reducing income inequality. Why?  Because of our residency basis of taxation as opposed to the American citizenship-based system. And because our top earners (excluding public sector employed ones) are more mobile internationally than their U.S. counterparts.

Instead, in my view, reducing wealth inequality requires increasing wealth (not spending) of households that are currently below the top 20 percent of earners. This can only be done by simultaneously:

• Increasing their after-tax incomes (to create savings surplus) by having lower tax burden at the upper margin of earnings, and
• Increasing their investments in productive capital (not property) - e.g. business equity and entrepreneurship via incentives and behavioural nudging (for example, auto enrolment into pensions etc).

Now, let’s talk about capital investment side. 

I have some signifcant reservations about the new proposed capital investment 2016-2021 framework. Here they are.

1) ‘Something for everyone’ spatial development plan is an investment model followed by Irish banks in pre-2008 period: hosing cash wide in hope of striking a random pot of gold. Instead, what is needed is an in-depth, costed and scrutinised assessment of potential returns on investment. Project by project. And a tie-in of investment plans to a broader regional development scheme.

2) To give you an example: is our public capital priority to provide yet another link to Dublin airport? Or should it be to provide direct, quality train access to Ireland’s third largest city - Limerick?.. I don’t know. But I see nothing in the new framework analysing this. Should new priority development involve improving infrastructure links in parts of Ireland - e.g. Kerry to Limerick-Galway-Shannon links - or to sustaining & expanding public subsidies for transport provision? The point of investment is not to ‘give something to everyone’ but to prioritise areas where ROI is highest (social, economic, financial).

3) Prioritising investment must be based on factual analysis & scrutiny - both of which are lacking in the proposed framework. Examples of the contrary approach are Poolbeg Incinerator & Irish Water. Again, I see no change in the new plan on past modus operandi.

4) Any investment plan, based on prior experiences, should explicitly commit to capping a maximum percentage of total allocated expenditure going to auxiliary activities, such as consultancy fees, planning etc. Given the horrific track record of our public sector in securing value for money in capital investment structuring, eliminating waste should be a priority.

5) Why are new PPP rules going to be announced in 2017 when investment plan covers 2016-2021? Much of the projects will be allocated in 2016-2017, with expenditures happening later, but committed to under the old rules. If current PPP frameworks is not fit for purpose, how can we commit multi-annual programme to run under it. If current PPP framework does fit its purpose, why is it necessary to revise it in 2017?

6) Current cap spend is ~E3.5-3.7bn/pa. New plan E4.5bn/pa. So over 6 years the entire net new funding is just about enough to cover Dublin Airport link.

Truth is, Ireland needs to stop talking about State investments and State-run investment funds as a panacea for our economic problems. We need more productive, better managed private investment, more productive, better managed, better funded and more empowered public services, and more productive and better managed domestic private sectors.

There is much more that can and needs to be done within the context of structural reforms in Ireland, and within the context of the Budget 2016. My presentation today was neither designed to address all important aspects of both, nor has achieved a comprehensive coverage of all issues we face. This is not to say that the omitted considerations (for example relating to improving access for those in need to basic public services, improving the quality of all public services and so on) are less important than considerations I discussed above. No speech or presentation can aim to be comprehensive or perfectly complete.

The key point, therefore, of what I was focusing on today, is the need for dramatic, deep reforms of our policy formation and deployment systems and the need for new policies aimed to put Ireland onto the track toward human capital-intensive growth. So far, sadly, both of these objectives are missing from the Government and the main parties’ analysis.

7/6/15: Secular Stagnation: A Double-Threat

Recent evidence on long term growth dynamics and drivers decomposition across the advanced economies presents a striking paradox relating to the post-recessionary experience around the world. In a traditional business cycle, recovery period growth exhibits certain historical regularities, that are no longer present in the current cycle. These regularities involve the following stylised facts:

1) Following a recessionary contraction in aggregate output, advanced economies enter a stage of recovery associated with strong growth in investment and domestic demand;

2) Gains in factors' productivity, especially in labour productivity, are amplified in the early stages of post-recessionary recovery compared to their pre-crisis trend levels; and

3) Rates of growth in the recovery cycle are in excess of pre-recessionary growth.

These facts are patently absent from the data for the major advanced economies today, some four to five years into the recovery. This realization has prompted some economic and financial analysts to speculate about the potential structural decline in long term growth rates, the thesis commonly termed "secular stagnation".

Currently, there are two prevailing theses of secular stagnation, linked to two long-term cycles gaining prominence in the global economy: the demand side and the supply side theses.

Investment-Savings Mismatch

The first theory suggests that secular stagnation is linked to a structural decline in aggregate demand, manifesting itself though a decades-long mismatch between aggregate savings and investment and more broadly related to the demographic effects of ageing.

This theory traces back to the 1930s suggestion by Alvin Hansen that the U.S. Great Depression aftermath was coinciding with decreasing birth rates, resulting in oversupply of savings and a fall off in demand for investment. The thesis was salient throughout the 1930s and the first half of the 1940s, but was overrun by the war and subsequently forgotten in the years of the post-WW2 baby boom and investment uplift. Large scale increase in public investment, linked to rebuilding destroyed (in Europe and Japan) or neglected (in the war years in the U.S.) public infrastructure, helped to push Hansen's forecasts of a structural growth slowdown aside.

The thesis of demand-driven secular stagnation made its first return to the forefront of macroeconomic thinking back in the 1990s, in the context of Japan. As in Hansen's 1930s U.S., by the early 1990s, Japan was suffering from a demographics-linked glut of savings, and a structural drop off in investment. Suppressed domestic demand has led to a massive contraction in labour productivity. During the 1980-1989 period, Japan's real GDP per worker averaged 3.2 percent per annum. In the following decade, the rate of growth was just over 0.82 percent and over the period of 2000-2009 it fell below 0.81 percent. Meanwhile, Japan's investment as a percentage of GDP fell from approximately 29-30 percent in the 1980s and the 1990s to under 23 percent in the 2000s and to just over 20 percent in 2010-2015.

Following Japan's experience and the shock of the Great Recession, the theory that the entire developed world is set for a structural growth slowdown has gained traction. Between 1980 and 2014, the gap between savings and investment as percentage of GDP has widened in Canada, Japan, and the Euro area. Controlling for debt accumulation in the real economy, the widening of savings surplus over investment over each decade since the 1980s is now present in all major advanced economies, including the U.S.

In line with this, labour productivity also fell precipitously across all major advanced economies. As shown in the chart below, even a period of unprecedented rise in unemployment in the U.S. and the euro area over the recent Great Recession did not shift the trend for declining labour productivity growth.

CHART: Five-year Cumulated Growth in Real GDP per Employee

Percentage Points

Source: Author own calculations based on data from the IMF

Worse, current zero rates monetary policy environment is reinforcing the savings-investment mismatch, rendering the monetary policy impotent, if not damaging, in stimulating the return to higher long term growth.

Traditionally, low interest rates create incentives for investment and reduced saving by lowering the cost of the former and increasing the opportunity cost of the latter.

However, today's ageing demographics and rising dependency ratios offset these 'normal' effects. This means that for the older generations, retirement pressures work through both insufficient reserves built in pensions portfolios, and also through lower yields on retirement portfolios, incentivising more aggressive savings.

For the working age population, the pressures are more complex. On the one hand, middle age workers today face severe pressures to deleverage their balance sheets, aggressively reducing liabilities accumulated before the crisis. On the other hand, growing proportions of middle-age adults are facing twin financial pressures from the rising demand for support for ageing parents and, simultaneously, for increasing number of satay-at-home younger adults who continue to rely on family networks for financial and housing subsidies. A recent Pew Research study found that 64 percent of Italian middle-aged generations find themselves sandwiched between ageing parents and children. In the U.S. this proportion is 47 percent and in Germany 41 percent. All along, the same households are under pressure to build up their pensions, as retirement security and social provision of pensions are now highly uncertain.

In his speech to the NABE Policy Conference in February 2014, Lawrence H. Summers (http://larrysummers.com/wp-content/uploads/2014/06/NABEspeech-

Lawrence-H.-Summers1.pdf) outlined six  core sources of this demand side-driven slowdown:

1) Existent legacy of the private debt overhang;

2) Demographics of ageing;

3) Rising income inequality that induces greater financial insecurity today and into the future, thus creating incentives for increased ordinary and precautionary savings;

4) Access to low cost capital;

5) Positive real interest rates that continue to prevail despite historically low policy rates; and

6) Large scale holdings of banks' reserves on central banks balance sheets.

All of these factors are currently at play in the U.S., UK and the euro area, as well as Japan. With a lag of about 3-5 years, they are also starting to manifest themselves in other advanced economies.

Tech Investment: Value-Added  Miss

The supply side of secular stagnation thesis is a relatively new idea coming from the cyclical view of historical development of physical and ICT-linked technologies. First formulated by Robert Gordon some years ago it is summarised in his August 2012 NBER paper, titled "Is the US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds" (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2133145).

Gordon looks at long-term - very long-term - trends in growth from the point of challenging the traditional view of macroeconomists that perpetual economic progress is subject to no time constraints. In Gordon's view, U.S. economy over the period through the 2050s is likely to face an uphill battle. Per Gordon, "The frontier established by the U.S. for output per capita, and the U. K. before it, gradually began to grow more rapidly after 1750, reached its fastest growth rate in the middle of the 20th century, and has slowed down since.  It is in the process of slowing down further."

The reason for this, according to the author, is the exhaustion of economic returns to the most recent technological / industrial 'revolution'.  "A useful organizing principle to understand the pace of growth since 1750 is the sequence of three industrial revolutions. The first with its main inventions between 1750 and 1830 created steam engines, cotton spinning, and railroads. The second was the most important, with its three central inventions of electricity, the internal combustion engine, and running water with indoor plumbing, in the relatively short interval of 1870 to 1900.  Both the first two revolutions required about 100 years for their full effects to percolate through the economy. …After 1970 productivity growth slowed markedly, most plausibly because the main ideas of [the second revolution] had by and large been implemented by then. The computer and Internet revolution began around 1960 and reached its climax in the dot.com era of the late 1990s, but its main impact on productivity has withered away in the past eight years. …Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it."

Gordon’s argument is not about the levels of activity generated by the new technologies, but about the rate of growth in value added arising form them. In basic terms, ongoing slowdown in the U.S. (and global) economy is a function of six headwinds, including the end of the baby boom generation-linked demographic dividend; rising income and wealth inequality; factor price equalisation; lower net of cost returns to higher education; the impact of environmental regulations and taxes; and real economic debt overhangs across public and non-financial private sectors.

Gordon estimates that future growth in consumption per capita for the bottom 99 percent of the income distribution is likely to fall below 0.5 percent per annum over the period of some five decades.

The supply-side thesis, implying persistently falling returns to technological innovation and resulting reduced rates of productive investment in technological capital, is supported by some top thinkers in the tech sector, notably the U.S. entrepreneur and investor Peter Thiel (see http://www.ft.com/intl/cms/s/0/8adeca00-2996-11e2-a5ca-00144feabdc0.html).

A recent study from IBM, titled "Insatiable Innovation: From sporadic to systemic", attempted to debate the thesis, but ended up confirming Gordon’s assertion that incremental and atomistic innovation is the driver for today's technological progress. In other words, the third technological revolution is delivering marginal returns on investment: significant and non-negligible from the point of individual enterprises, but hardly capable of sustaining rapid rates of growth in economic value added over time.

Disruptive Change Required

The problem is that both theses of secular stagnation are finding support not only in the past historical data, but also in the more recent trends. Even the most recent World Economic Outlook update by the IMF (April 2015) shows that the ongoing economic slowdown is structural in nature and traces back to the period prior to the onset of the Great Recession.

As both, the demand and supply side theses of secular stagnation allege, the core drivers identified by the IMF as the force behind this trend are adverse demographics, decline in investment, a pronounced fall off in total factor productivity growth (the tech factor), as well as the associated decline in labour and human capital contributions to productivity. IMF evidence strongly suggests that during the pre-crisis spike in global growth, much of new economic activity was driven not by expansion on intensive margin (technological progress and labour productivity expansion), but by extensive margin (increased supply of physical capital and emergence of asset bubbles).

Like it or not, to deliver the growth momentum necessary for sustaining the quality of life and improvements in social and economic environment expected by the ageing and currently productive generations will require some serious and radical solutions. The thrust of these changes will need to focus on attempting to reverse the decline in returns to human capital investment and on generating radically higher economic value added growth from technological innovation. The former implies dramatic restructuring of modern systems of taxation and public services provision to increase incentives for human capital investments. The latter implies an equally disruptive reform of the traditional institutions of entrepreneurship and enterprise formation and development.

Absent these highly disruptive policy reforms, we will find ourselves at the tail end of technological growth frontier, with low rates of return to technology and innovation and, as the result, permanently lower growth in the advanced economies.

28/4/15: There is a Spring... There was a Statement...

This Spring Statement was a lengthy and over-manned delivery of the vintage "A Lot Done. More to Do." 2002 FF slogan. As such, it is inevitable that the Statement ended up sounding like a self-congratulatory pre-electioneering platform announcement with some promises for the future. And you can read the Department document here: http://budget.gov.ie/Budgets/2015/Documents/SPU%20for%20Web.pdf in its full glory.

'Entrepreneur' or 'Entrepreneurship' are words not mentioned in the document. Self-employed are cited only once, in reference to timing of tax receipts the Government expects from them. Part-time workers - the crucial category that can drive up ranks of early stage entrepreneurs and can be a source for huge gains in productivity if their skills are increased forward - deserves only two mentions, both relating to the unemployment reductions trends to-date. Quality of jobs creation is un-addressed. And so on...

In his speech, Mr Noonan said the government is in a position to implement another expansionary Budget this year and every year out to 2020 “if this is deemed prudent and appropriate.” The "if" part - crucial as it may be - is hardly enforceable, once the train of spending rolls out into the station.

The Government deserves credit. The national deficit was reduced from €15 billion to €4.5 billion over 2011-2015. This was achieved with less tax increases and expenditure cuts than forecast at the onset of 2011. Minister Noonan is correct. But much of this was down to good fortunes from abroad. And still is. And, based on the Department of Finance projections still will be, if one to trust their outlook for the exchange rates, exports growth and jobs growth.

Per Minister Noonan, the state has, this year “fiscal space of the order of € 1.2 billion and up to € 1.5 billion… for tax reductions and investment in public services." So, “the partners in Government have agreed that [this] will be split 50:50 between tax cuts and expenditure increases …in Budget 2016.”

Does that make much sense? Well, no. 2014-2015 cumulated decrease in deficit can be broken down into:
- 50% from increased tax revenues,
- 14% to GDP growth,
- 9% to reduction in net Government expenditure and
- 27% other factors.
Jobs creation and wealth creation both require reducing burden of State and taxation on self-employed and early stage entrepreneurs. Who, both, went totally unmentioned in the Spring Statement. Domestic demand growth - that supposed to contribute 2/3rds of 2015 growth and more than 3/4 of 2016 growth - requires reducing household and corporate debt and stimulating domestic investment - preferably not in property sector. These too went un-mentioned in the Spring Statement.

Instead, we got Minister Howlin watershed discovery that the Government creates wealth.

Which is scary and even scarier in the context of missing real wealth creators in the Statement: the Government's role in wealth creation should be to remove itself from managing it as much as possible. But see more on this below.

Minister Noonan warned that returning to the days of “if I have it I’ll spend it” or the “even if I don’t have it I’ll spend it” policy stance taken by the opposition over the past four years, was by far the biggest risk to economic growth and job creation. He might be right, but his plan for expansionary Budgets into 2020 is more of a policy stance consistent with "I might have it, so I'll spend it".

“We must never again repeat the boom and bust economic model. Over the remainder of this decade we expect all sectors of the economy to contribute to growth and employment.”

He is right on this and the Government said much the same over and over again. But it is hard to see any coherent strategy emerging from the Government's numerous reiterations of Jobs and Growth plans and white papers on how broad growth can be delivered. To-date, the Government projected the same policy approach to growth as its predecessor - targeted supports and tax incentives. Not levelling the playing field, getting rid of state inefficiencies, political interference and tax-and-spend redistribution of resources. Note: this is not about redistribution of income. It is about allowing the economy to grow without political meddling and favouritism.

The Spring Statement was not much of a departure from the same. In the statement, the Minister mentions just one 'red line' policy item - the 12.5% corporation tax. Everything else is more of an IOU based on "if - then". Which suggests that this Government has little in terms of new economic growth ideas beyond corporate tax measures.

Mr Noonan said the mistakes that left the country on the verge of bankruptcy in 2010 must never again be repeated. Which begs a question: does Minister Noonan recognise the mistakes, linked to 2010, that this Government also participated in - willingly or not? Banks recapitalisations were carried out in 2011 on foot of 2010 policy decisions. Troika MOU - shaped in 2010 - was implemented by this Government. Bondholders bailouts were completed by the present Government on foot of mistakes made by the previous one.

Minister Noonan also referenced a promise to "give people security around their income and their pensions". But it is very hard to see how this can be achieved, given lack of any serious progress on dealing with legacy debts and the 50:50 split between tax reductions and expenditure increases in Government budgets forward. And on the point of debt, we do have a massive Government debt, now being augmented by the quasi-Government non-Government debt of the likes of Irish Water et al. Remember, expenditure increases do not improve people's incomes and pensions, except for the select few in State employment and contracting. Nor do they improve Government ability to deleverage its own debt.

And on that note, the Department of Finance says little about actual interest rates, but does project relatively benign debt-related costs through 2020. Which might be tad optimistic, given we are currently scraping the bottom of the historical rates barrel. The Department says that "While unlikely in the short term, higher policy-induced interest rates would have a dampening impact on Ireland’s economic activity. Simulations suggest that a 1 percentage point increase in policy interest rates could reduce the level of GDP by almost 2½ percentage points by 2020. This effect is especially pronounced given the large debt overhang. Such a deterioration in the economy would add almost 1 percentage point to the budget deficit by 2020". I know we all 9ok, not 'we' but almost 'all') expect the current interest rates to stay here forever, because, obviously the ECB is not going to raise them any time in the future under the 'new normal' of complete oblivion to the reality. But here's a bad news: current ECB rates are some 300bps below the pre-crisis average. And if we are moving out of crisis, that average is moving closer and closer in time. So for testing that 100 bps rate rise that the DofF did in the Spring Statement: try 300 bps next. And see the whole promise of the golden future go puff in a cloud of smoke.

Moving on through the Statement: it is also hard to spot any serious momentum for pensions reforms that can really be productive in restoring some capability of the private sector workers to secure pensions. The Government has all but abandoned the idea of pensions reforms in the public sector - the biggest drain on pensions resources in the country.


In summary, the Spring Statement is a call to the voters to support the status quo based on the idea that 'our continuity is less painful than opposition's change'. Which, of course, is an equivalent to giving a granny a choice of being mugged by the "Thank you, Mam" lads with school ties or by the rude villains in clowns' wigs. It is a choice. Just not the one many would order on their elections' menu after six years of economic and social bloodletting. 

Irish Times summed this up as "The spring statement can be seen as a political exercise in which Fine Gael and Labour adopt a common fiscal plan for the election campaign to come." (see http://www.irishtimes.com/business/economy/spring-statement-analysis-assumption-nothing-goes-askew-1.2191971?utm_content=sf-man) and my favourite political analyst in this country, summed it up much better: http://thejacktrack.blogspot.ie/2015/04/michael-noonans-2-billion-return-to.html?spref=fb who says: "there was a haunting echo of Bertie Ahern and Charlie McCreevy resonating through the halls of his Department, and with it the emergence of a disturbing - if hardly, at this stage, surprising - sense that in Ireland there is no such thing as a lesson learned, only a lesson observed."

23/4/15: Why is Investment Weak?

Despite all the QE and accommodative monetary policies, despite all the state funding directed toward new lending supports, and despite unorthodox measures aimed at inducing the banks to lend into the economy, the following took place in the advanced economies over the course of the Great Recession:
1) financing conditions globally have first tightened (during the Global Financial Crisis) and then eased, in majority of the advanced economies reaching the levels of stringency comparable to pr-crisis peak;
2) cost of borrowing fell on pre-crisis levels across all advanced economies with exception of a handful of countries; and
3) investment remains weak.

Want to see the problem illustrated?

Banerjee, Ryan and Kearns, Jonathan and Lombardi, Marco J., (Why) is Investment Weak? (March 2015, BIS Quarterly Review March 2015: http://ssrn.com/abstract=2580278) ask: What explains this apparent disconnect?

Per authors, "The evidence suggests that, historically, uncertainty about the future state of the economy and expected profits play a key role in driving investment, and financing conditions less so. As a result,
investment after the Great Recession appears to have been broadly in line with what could have been expected based on past relationships. A stronger recovery of investment would seem to depend on a reduction in economic uncertainty and expectations of stronger future growth."

As I argued in the paper on the European Capital Markets Union (CMU) proposal here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918 - you might think that lack of investment is because markets for credit supply are dysfunctional. But you can also think of the demand side: if there is no growth prospect ahead, why invest in new capacity? And taking the second view, the prescription for solving the problem is: growth. Which requires improved prospects for investors, entrepreneurs, SMEs and, above all else - households.

19/4/15: The costs of deflations: a historical perspective

An interesting article from the BIS on the impact of deflation risks on growth and post-crises recovery. Authored by Borio, Claudio E. V. and Erdem, Magdalena and Filardo, Andrew J. and Hofmann, Boris, and titled "The Costs of Deflations: A Historical Perspective" (BIS Quarterly Review March 2015: http://ssrn.com/abstract=2580289), the paper looks at the common concern amongst the policymakers that falling prices of goods and services are very costly in terms of economic growth.

The authors "test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt."

But there is much more than this to the paper. So some more colour on the above.

"Concerns about deflation [are] …shaped by the deep-seated view that deflation, regardless of context, is an economic pathology that stands in the way of any sustainable and strong expansion."

Do note that I have been challenging this thesis for some time now, precisely on the grounds of: 1) causality (deflation being caused by weak growth, not the other way around) and 2) link between corporate and household debt and deflation via monetary policy / interest rates channel.

Per authors, "The almost reflexive association of deflation with economic weakness is easily explained. It is rooted in the view that deflation signals an aggregate demand shortfall, which simultaneously pushes down prices, incomes and output. But deflation may also result from increased supply. Examples include improvements in productivity, greater competition in the goods market, or cheaper and more abundant inputs, such as labour or intermediate goods like oil. Supply-driven deflations depress prices while raising incomes and output."

Besides the supply side argument, there is more: "…even if deflation is seen as a cause, rather than a symptom, of economic conditions, its effects are not obvious. On the one hand, deflation can indeed reduce output. Rigid nominal wages may aggravate unemployment. Falling prices raise the real value of debt, undermining borrowers’ balance sheets, both public and private – a prominent concern at present given historically high debt levels. Consumers might delay spending, in anticipation of lower prices. And if interest rates hit the zero lower bound, monetary policy will struggle to encourage spending. On the other hand, deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive."

Note: the authors completely ignore the interest cost channel for debt.

Meanwhile, "…while the impact of goods and services price deflations is ambiguous a priori, that of asset price deflations is not. As is widely recognised, asset price deflations erode wealth and collateral values and so undercut demand and output. Yet the strength of that effect is an empirical matter. One problem in assessing the cost of goods and services price deflations is that they often coincide with asset price deflations. It is possible, therefore, to mistakenly attribute to the former the costs induced by the latter."

The BIS paper analysis is "based on a newly constructed data set that spans more than 140 years, from 1870 to 2013, and covers up to 38 economies. In particular, the data include information on both equity and property prices as well as on debt."

The study reaches three broad conclusions:

• "First, before accounting for the behaviour of asset prices, we find only a weak association between goods and services price deflations and growth; the Great Depression is the main exception."
• "Second, the link with asset price deflations is stronger and, once these are taken into account, it further weakens the association between goods and services price deflations and growth."
• "Finally, we find some evidence that high private debt levels have amplified the impact of property price deflations but we detect no similar link with goods and services price deflations." Note: this means that the ECB-targeted deflation (goods and services deflation) is a completely wrong target to aim for in the presence of private debt overhang. Just as I have been arguing for ages now.

Let's give some more focus to the paper findings on debt-deflation links: "Against the background of record high levels of both public and private debt (Graph 7 below), a key concern about the output costs of goods and services price deflation in the current debate is “debt deflation”, ie the interaction of deflation with debt."

"The idea is that, as prices fall, the real debt burden of borrowers increases, inducing spending cutbacks and possibly defaults. This harks back to Fisher (1933), who coined the term.16 Fisher’s concern was with businesses; today the focus is as strong, if not stronger, on households and the public sector. This type of debt deflation should be distinguished from the strains on balance sheets induced by asset price deflations. This interaction has an even longer intellectual tradition and has been prominent in the public debate ever since the re-emergence of financial instability in the 1980s."

Yep, you got it - the entire monetary policy today is based on the ideas tracing back to the 1930s and anchored in the experience that is only partially replicated today. In effect, we are fighting a new disease with false ancient prescriptions for an entirely different disease.

To assess the link between debt and deflation effects on growth, the authors take two measures into account:

• "One is simply its corresponding debt ratio to GDP." 
• "The other is a measure of “excess debt”, which should, in principle, be more relevant. We use the deviation of credit from its long-term trend, or the “credit gap” – a variable that in previous work has proved quite useful in signalling future financial distress."

Per authors, "The results point to little evidence in support of the debt deflation hypothesis, and suggest a more damaging interaction of debt with asset prices, especially property prices. Focusing on the cumulative growth performance over five year horizons for simplicity, there is no case where the interaction between the goods and services price peaks and debt is significantly negative. By contrast, we find signs that debt makes property price deflations more costly, at least when interacted with the credit gap measure."

So deflation in asset prices (property bust) is bad when household debt is high. Why?

Per study: "…these results suggest that high debt or a period of excessive debt growth has so far not increased in a visible way the costs of goods and services price deflations. Instead, it seems to have added to the strains that property price deflations in particular impose on balance sheets. …Why could the interaction of debt with asset prices matter and that with goods and services prices not matter, or at least less so? A possible explanation has to do with the size and nature of the corresponding wealth effects. For realistic scenarios, the size of the net wealth losses from asset price deflations can be much larger. Consider, for instance, the 2008 crisis in the United States,... the corresponding losses amounted to roughly $9.1 trillion and $11.3 trillion, respectively. By contrast, a hypothetical deflation of, say, 1% per year over three years would imply an increase in the real value of public and private debt of roughly $1.1 trillion (about $0.4 trillion for households and roughly $0.35 trillion each for the non-financial corporate and public sector). Moreover, the nature of the losses is quite different in the two cases. Asset price deflations represent declines in (at least perceived) aggregate net wealth; by contrast, declines in goods and services prices are mainly re-distributional. For instance, in the case of the public sector, the higher debt burden reflects the increase in the real purchasing power of debt holders."

And herein rests a major omission in the study: following asset (property) busts, accommodative monetary policy leads to a reduced cost of debt servicing for households that suffer simultaneous collapse in their nominal incomes and in their net wealth. This accommodation is deflating the cost of debt being carried. If it is accompanied by goods and services price deflation, such deflation is also boosting purchasing power of reduced nominal incomes. In simple terms, there is virtuous cycle emerging: debt servicing deflation reinforces real incomes support from goods and services deflation.

Now, reverse the two: raise rates and simultaneously hike consumer prices. what do you get?

1. Debt servicing costs rise, disposable income left for consumption and investment falls;
2. Inflation in goods and services reduces purchasing power of the already diminished income.

Any idea how this scenario (being pursued by the likes of the ECB) going to help the economy? I have none.