Sunday, May 24, 2020

Where stands the crisis of 2020? Some insights from a century of leading and lagging indicators

The Irish economy is no stranger to crisis.  Since the 1950s, the most severe of these have occurred in roughly 25-year intervals.  The current crisis has brought about the sharpest downturn, at least in employment terms, that the economy has ever experienced.  As the duration remains uncertain it is cannot be definitively classed as severe so it may be that comparisons to previous crises aren’t wholly appropriate but it may be instructive to look at what preceded and coincided with previous episodes.

Regardless of whether  COVID19 has ended the sequence of 25-year intervals between severe economic crises hopefully we have not returned to the rhythm of the early years of the State when no decade passed without a severe crisis, or more, of some form or another.

The chart below shows a time series for the real growth of the Irish economy since just after Independence. The series is smoothed by taking a three-year, centred average.

Real Growth 1924-2019

The shaded periods are when this three-year average growth rate was negative, and this will also be used in the charts that follow.  Five such negative growth episodes can be identified:

  • 1930s: Great Depression and Economic War
  • 1940s: The Emergency (WWII)
  • 1950s: Balance of Payments Crises
  • 1980s: Procyclical Fiscal Policy
  • 2000s: Bursting of the Credit Bubble

The Gerlach and Stuart (2015) estimates are based on GDP and provide the most plausible annual estimates up to the late 1940s.  A series based on GNI* from Fitzgerald and Kenny (2017) is shown from then but it differs little from the Gerlach and Stuart series right through to the end of the 20th century. 

The Fitzgerald and Kenny series is chosen because it better fits with the constant price GNI* for 2013 on as published by the CSO.  A chart showing unsmoothed versions of both historical series, and illustrating the strong overlap between the two, is here.

The negative growth episodes of the nineteen thirties, forties, fifties, eighties and a decade ago could be joined by a similar outturn for the start of the twenty twenties.  Given that we have gone through periodic economic crises it may be instructive to look for some “then and now” comparisons for some key indicators.

The most severe of Ireland’s economic crises have typically being preceded by a deterioration in the current account of the balance of payments.  From Fitzgerald and Kenny (2017) we have annual estimates of the current account balance as a share of gross national income beginning in 1938 which here is combined with the modified current account of a share of GNI* from 1995 on.

BoP Current Account 1938-2019

As stated, a deterioration in the current account has been a leading indicator for major negative growth episodes, with the deteriorations in the late-1970s and mid-2000s in particular due to economic mismanagement and pro-cyclical fiscal policy.  The presence of a large balance of payments deficit before these crises hit severely restricted the policy options available to respond to the downturn with “restoring order” taking precedence of over supporting incomes and economic activity. 

But in a case of “this time it’s different” we can see that in the past few years there has been a balance of payments surplus that is unmatched since the years of The Emergency (World War II to the rest of the world).  Indeed the 6.3 per cent of GNI* figure for the 2019 current account surplus taken from the Stability Programme Update may be an underestimate.  This strongly suggests we do not have structural imbalances that need to be corrected first before responding to the crisis.

When the slowdown took hold in 2008 one of the first fiscal responses was to announce a package of spending cuts in July 2008.  This time around one of the response was to announce a multi-billion package of increased spending.  A year ago, we said that the economy had savings that could have been spent but suggested it maybe should be a sector other than the government sector that did so. 

We can look at how the sectoral balances contribute to that six per cent of national income surplus we have been running on the current account (with all adjustments to make the sectoral balances consistent with the modified current account applied to the non-financial corporate sector which is where the MNC distortions occur).

Sectoral Balances and the Modified Current Account 2001-2019

A chart showing the domestic sectors for recent years stripping out the impact of foreign-owned companies is here.  Previously, we thought it might be the household sector that could cut loose a bit, but needs must, and it is the government sector that is doing the spending.  Indeed, it could be that the household sector, which has been deleveraging for a decade actually increases its savings during the crisis which is something we will come back to. These savings can be used to fund the government’s spending.

Of course, flows are only part of the story. Stocks matter too.  From Fitzgerald and Kenny (2017) we also have a long-run series of government debt as a share of national income.  The path of the ratio of public debt to national income before each crisis has not been the same.

General Government Debt to GNI 1924-2019

The debt ratio was already rising in advance of the crises of the 1950s and the 1980s.  The ratio was declining in advance of the 2008 crash but that still saw the largest run-up of public debt of any crisis (to date).  In recent years the debt ratio was on a declining path, however the level is still elevated and at around 100 per cent of national income is the highest it has been as the country potentially enters a severe crisis.

For private debt we can get a measure of personal, i.e. household, debt from Stuart (2017) and this shows that increasing household debt was really only a factor in advance of the crash of 2008.

Household Debt to GDI 1949-2019

And in the decade since, the Irish household sector has undertaken a remarkable level of deleveraging – reducing debt was what a large share of the household sector surplus shown with the breakdown of the current account was used for.  Household loan liabilities have fallen from €205 billion at their peak to around €130 billion now.  As the chart shows, the household debt to income ratio peaked at around 215 per cent in 2009; at the end of 2019 it was 115 per cent and is approaching ‘normal’ levels faster than anyone could have imagined.

As stated earlier, it could be that the household sector actually increases its savings in response to the crisis – this may show through an increase in deposits.  This would not be unusual.  The household savings rate is something that tends to react to a crisis rather than something that foretells it. 

Household Savings Rate to GDI 1945-2019

Using Stuart (2017) we have estimates going back to 1945 and it can be seen that the savings ratio does increase at the start of each negative growth event meaning the reduction in household consumption is greater than the reduction in household income.  Remarkably, the Stability Programme Update estimates that the household savings rate will jump from 10 per cent in 2019 to close to 20 per cent this year, which would be the highest for the series by some distance.  In nominal terms this would be an increase of around €10 billion.

The savings rate only reflects the difference between income and consumption; one would need to add the impact of investment spending to get the final non-financial position of the household sector. Such a sectoral breakdown of investment is only available back to 1995 and is what is shown in the chart of sectoral composition of the current account.  The large borrowing position of the households sector in the decade before 2008 is clearly evident, as is the net lending the sector has done in the decade since.

Another response variable or lagging indicator can be the real growth in household disposable income.  Using Stuart (2015) we can see that this followed the same pattern as each of the last three major negative growth crises took hold: it too turned negative.

Household Disposable Income Real Growth 1945-2018

We do not yet know what will happen to aggregate household income in this crisis.  Yes, earnings will fall very significantly for a period but there will be an offsetting effect from government transfers.  As already pointed to, additional social welfare spending of almost €7 billion has been allowed for (thus far).  This is countercyclical policy and is maybe another reason why comparisons to previous crises are not be appropriate.  We still don’t have enough information but if there is a shaded area for the early-2020s added to future versions of these charts it could be the first time the real growth of household disposable income does not also turn negative (on a three-year average basis).

Fiscal policy was a contributory factor to the reduction in household income seen in the 1950s, 1980s and a decade ago.  Some automatic stabilisers would have played a role in mitigating income losses but steps taken to address imbalances, perceived or otherwise, which included tax increases and real expenditures cuts, meant that the impact of the downturns on incomes was exacerbated by fiscal contractions.  Fiscal policy was procyclical.

From Fitzgerald and Kenny we have a long-run series of the balance of the government sector right back to the earliest years of the State.  It can be seen that there was a wide range of levels and trends in the government balance prior to the previous three negative growth events.  There was a deficit that was reducing in the mid-1950s; the late-1970s saw a large government deficit that was increasing and during the mid-2000s budget surpluses were recorded. 

General Government Balance to GNI 1924-2019

But what is as significant is what happened to the government balance not long after economic growth turned negative in the 1980s and 2000s: it improved.  And this was a forced improvement brought about through tax increases and real expenditure cuts which started almost as soon as those crises hit which is the opposite of what is required to support incomes and economic activity in a downturn.

The past few years have seen the headline government balance improve and move to a (small) surplus.  If the government had stuck to its own spending plans maybe the surplus would have been a bit bigger and fiscal policy was probably acyclical, at best.  But there is capacity now for policy to be countercyclical and in large part it is down to what is shown below.

General Government Interest to GNI 1924-2019

At the end of 2019, government debt was equivalent to almost 100 per cent of national income.  In the 96 years since 1924, according to the estimates from Fitzgerald and Kenny there have been only been 13 years when the debt ratio was higher.  But if we look at the interest chart we see that the interest to national income ratio does not reflect this.  In fact, since 1924 there have only only be 35 years when the interest ratio was lower than the 2.2 per cent recorded in 2019. 

As some of this interest is paid to the central bank it is recycled back to the government.  And as long as the ECB keeps the taps opened the massive additional borrowing that will happen will not significantly increase the interest ratio – in the short term at least.

And to conclude, here another lagging indicator that illustrates why this crises will be different to previous ones: the escape valve of emigration is unlikely to be available to alleviate unemployment.

Net Migration per Thousand 1926-2019

This is yet another series where the response to the 25-year crises is clearly evident.  In fact, it has been pointed out that the crisis of 2020 may be the first since that linked to The Great Depression in the early 1930s when net outward migration does not increase.  Emigration did increase in the mid-1930s but by then the international economy was pulling out of The Great Depression. 

Taking the unemployment series from Gerlach, Lydon and Stuart (2016) it is probably safe to predict that the record unemployment from 1935 of 18 per cent will be exceeded in 2020 (at least for part of it).

Unemployment Rate 1923-2019

So where stands the crisis of 2020? The short-term shock is likely to be the most severe the economy has ever experienced.  But relative to what has gone before we have identified a number of key differences. 

The most significant of these is probably the large balance of payments surplus.  The government might not have a rainy-day fund but the household sector has been saving for a decade.  And as the government cuts back on its emergency measures there will be capacity, and hopefully the confidence necessary, for households to increase their spending. 

A second difference arises from the fact that this is a global crisis. If a country using a common currency experiences an asymmetric shock there is a risk of interest rates exacerbating the problem.  Ireland has a high level of government debt but the medium-term risk of adverse interest rate moves is low so we can expect the interest burden of public debt will remain low.

We enter the crisis from a position of structural strength.  And the response so far, at a macro level at least, can be considered to have been appropriate.  Duration remains the key unknown.  But if the phased re-opening of the economy is successful, and microeconomic policy can keep viable businesses alive, it may that this shock, sharp and all as it will be, does not break the 25-year cycle between severe, multi-year negative growth events of the Irish economy.  Here’s hoping.

Friday, May 15, 2020

International travel restrictions and the location of consumption spending

With COVID19 all countries are going through the same crisis but not all countries will experience the crisis in the same way.  International travel is likely to be curtailed for a significant period of time.  Some countries are more dependent on tourism than others.

One way to look at this is to compare consumption expenditure by residents of a country outside of that country to spending by non-residents in that country.  Here are 2018 figures for the then EU28.  These figures exclude expenditure linked to business or commercial activity.

HFCE by Location

For Household Final Consumption Expenditure (HFCE), the “national concept” is that amount undertaken by residents of the country (both at home and abroad) while the “domestic concept” is that amount undertaken within the jurisdiction (both by residents and non-residents).  For measures like GDP it is the “national concept” of HFCE that is included. 

This means that consumption spending abroad by Irish residents is counted in Irish GDP (though it does not increase GDP as there is obviously an offsetting import included for the goods and services consumed, which of course then results in an export for the country where the spending happened).  The purpose is to make the Consumption figure in GDP better reflect the actual use of goods and services by a country’s residents.  In the circular flow framework, this is a leakage from the country where the people live and an injection to the country where the spending occurs.

Anyway, for Ireland, we can see that residents spent about €6 billion abroad while non-residents spent about €4.5 billion here, such that non-residents spending here was 76% of Irish residents spending abroad.  As shown by the second column from the left by which the countries are ranked, this ratio is one of the lowest in the EU – only the UK, Belgium, Germany and Romania are lower.

This means that a lot of the spending that non-residents would typically do in Ireland could be replaced by the spending that Irish residents would typically spend abroad – if and when businesses premises are opened and people have the confidence to go and visit them.

At the top end of the table we can see countries where the spending by non-residents is multiple times greater than the spending their residents do abroad, notably Greece, Croatia, Portugal, Malta and Spain.  The final column gives the spending of non-residents as a share of Gross National Income.  And again, the countries that are most dependent on spending by non-residents are those at the top.

It can be seen there is what could be considered a north-south or even a core-periphery split to the table.  The countries at the top (most dependent on spending by non-residents) include Portugal, Italy, Greece and Spain while towards the bottom are The Netherlands, Sweden, Finland, Germany and Belgium.

Of the bottom five countries, the spending by non-residents in Ireland is the largest as a share of Gross National Income (with modified GNI, or GNI* used in the case of Ireland).  While we are in a position to replace much of the spending by non-residents by the spending we would typically do abroad this is only in an aggregate sense. 

But just like the restrictions on international travel will have unequal impacts on countries, the location and composition of any additional spending in Ireland that might typically happen abroad will be significantly different than that which it might replace which will result in winners and losers.

Thursday, May 14, 2020

The strong position of the household sector (and the poor case for helicopters)

A couple of weeks ago the CSO published the Q4 2019 update of the Institutional Sector Accounts.  This is one of the most useful from the suite of macroeconomic datasets produced by the CSO but also one of the least used.  Here we will look at what it tells us about the household sector. 

THE CURRENT ACCOUNT

We will start with the current account which shows the generation of income

Household Sector Current Account 2015-2019

THE CURRENT ACCOUNT

The end point of the current account is that the household sector had a gross savings rate of 11 per cent.  This arises from the finding that of a gross disposable income of €117 billion, €106 billion was used for household final consumption expenditure (HFCE).  While the changes for 2019 are far removed from where the economy is now they can be helpful in telling us where we were before the crisis hit.

Household gross disposable income increased by €7.5 billion in 2019.  The largest contribution to this came from employee compensation which grew by €7 billion (though some of this would have been paid to the government sector through income taxes and social contributions).  As pointed out before the boom was in labour income rather than non-labour income.

Gross Operating Surplus/Mixed Income

The gross operating surplus/mixed income of the household sector rose €2.5 billion in 2019.  Preliminary figures provided by the CSO to Eurostat show that the mixed income component of this (essentially the earnings of the self-employed) rose by €1 billion to €13.5 billion.

The gross operating surplus component rose €1.5 billion to €17.5 billion.  The gross operating surplus of the household sector is derived from the provision of housing services, i.e. rental income less costs for maintenance, repairs, utilities and property taxes. 

Around 80 per cent of this arises through imputed rents – estimated rents of owner-occupiers for the housing services that they provide to themselves (and this income exits the above table as part of final consumption expenditure so has no impact on the bottom line). 

The remaining 20 per cent is actual rentals for housing which landlords receive for providing housing services to others.  When the NIE and annual sector accounts are published later in the year it is probable that these will show an increase of €1.2 billion in imputed rents and €0.3 billion in actual rents.

Summary of Income Changes

So a summary of the change in resources for the household sector in 2019 would be:

  • Employee compensation +€7.2 billion
  • Self-employed earnings +€1.0 billion
  • Imputed rentals for housing +€1.2 billion
  • Actuals rentals for housing +€0.3 billion
  • Property income –€0.1 billion
  • Social benefits in cash +€0.7 billion

All-in-all, gross disposable income for the household sector rose seven per cent in 2019, which in the absence of widespread inflation will have translated into significant real income gains.  Households used most of this increase for additional consumption.  As noted above imputed rentals of owner-occupiers will have risen by more than €1 billion and households will have used other parts of the increase in resources for purchases of goods and services.

Increased Savings

But household final consumption expenditure ‘only’ rose by five per cent. This means there was an increase in the gross savings of the household sector of €1.5 billion t0 €13 billion, giving a gross savings rate of 11 per cent.  The only time the household savings rate was higher than this in the past 25 years was in 2009 and 2010 and, of course, that was after a crisis had hit not before it.

THE CAPITAL ACCOUNT

We can turn to the capital account to see what the household sector does with these savings.

Household Sector Capital Accounts 2015-2019

In summary, the household sector undertook €9 billion of gross capital formation in 2019(mainly purchases and upgrades of housing assets).  In recent years, household investment spending has been growing rapidly albeit from a low base.  It doubled from 2015 to 2019.

Net Lending of the Household Sector

The bottom line is that the household sector was a net lender to the tune of €4 billion in 2019, with this going on the financial balance sheet – either through an increase in deposits or a reduction in loans.  This is actually a reduction on the net lending levels seen in recent years as a result of the increase in investment by the household sector but is far removed from the huge net borrowing (and fundamentally weak position) of the household sector in the run up to the crisis of a decade ago.

Household Sector Net Lending-Borrowing 2001-2019

This persistent net lending has seen the financial position of the household sector improve considerably in recent years.  In 2009, household loan liabilities stood at nearly 220 per cent of gross disposable income.  The latest figures indicate that this was down to 115 per cent in 2019 which is a remarkable reduction in a decade and brings it back pretty much to where it was before the credit-fueled excesses of the mid-2000s (it was 115 per cent at the start of 2003).

Additions to deposits also means that the household sector has more currency and deposits which again is something that brings things back to a position last seen in 2003.

Household Sector Loans and Deposits 2002-2019 CB Data

COVID19

What impact will COVID19 have on all this?  We know it is having a huge negative impact on the economy but when looking in aggregate terms at the sector accounts, the impact on the household sector will not be as large.  There will be significant income losses as self-employed and employee earnings will fall but these will be offset to some extent by transfers from the government sector. 

At this stage it looks like that between the government and household sector it will be the balance sheet of the government sector which carries most of the burden.  It may seem paradoxical but we could actually see the balance sheet of the household sector improve while we are the teeth of the crisis.  This is because household income will have held up reasonably well (again we are talking in an aggregate sense) but the opportunities to spend money have evaporated. 

Separate figures from the CSO show that, even for retailers that are open, 26 per cent of the population aged over 15 are “afraid to go shopping” (see Table 4(b)). That is one million people.

Looking at Table 11.1 of the Money and Banking Statistics published by the Central Bank shows that the deposits of Irish households in banks regulated by the Central Bank rose by almost €1 billion in March.  This was by no means an exceptional increase but the average monthly increase in household deposits in the banks since January 2018 has been €0.5 billion.

Ireland doesn’t need “helicopter money”. The reason people aren’t spending is because business premises are closed or because they are fearful; not because they don’t have money.  Helicopter money is only really appropriate, if ever, for countries that don’t have efficient social welfare systems. 

The fact that hundreds of thousands of applications, and crucially payments, for the Pandemic Unemployment Payment were processed in a very short period of time shows that Ireland does have an efficient system for delivering supports rapidly and effectively.  The money is been delivered and it’s going to people who need it.  We can stand down the helicopters.  Now if businesses could be reopened and fear reduced…

Tuesday, April 28, 2020

Why does Ireland have some of the highest relative price indices in the EU?

Comparisons are hard.  Whether it is through time or across countries making comparison is hard because things are different.  It is hard to compare like with like. 

One of the key objectives of economic policy is to raise living standards.  And we would like to see whether that objective is being reached. How do living standards now compare to what they were in the past? How do living standards here compare to what they are over there?

We don’t have a direct aggregate measure of living standards but do have some reasonable proxies.  From the national accounts, we can use per capita national income such as GDP, GNI (or its bespoke Irish equivalent GNI*) or per capita consumption such as Household Final Consumption Expenditure or Actual Individual Consumption. 

Changes in these from one year to the next can provide information about the changes in living standards. However, to fully see the true impact on living standards we need to make an adjustment for prices.  If the GDP per capita number has gone up but only because of an increase in prices then people aren’t better off at all – in volume or real terms they are still using the same amount of goods and services but the current prices and incomes for which these are bought and sold have gone up.

So we want to deflate this year’s GDP per capita number (nominal GDP) by the increase in prices since last year (the GDP deflator) to be able to make a like-for-like comparison of living standards based on the quantity of goods and services we get to use (real GDP).  By adjusting the per capita national income figures for inflation we can make comparisons of living standards in the same country for different time periods.  The comparisons can be made using this year’s or last year’s prices what matters is that they use the same, or constant, prices.

We would also like to make comparisons across different countries at the same time.  Again, we could use measures like GDP per capita or Actual Individual Consumption (AIC) per capita.  Each country will have its own per capita number and typically its own currency so to make a volume, or real, comparison we need to first convert to a common currency and then adjust for the different price levels in each country.  The quantity of goods and services you can get for a given level of spending will vary by country because the prices vary by country.

So we want to adjust the national figures by a measure of purchasing power to reflect the amount of goods and services that can actually be purchased and consumed with a given amount of income or spending.  By adjusting income and consumption figures for national price levels we can make comparisons of living standard across different countries in the same time period. 

This currency and price level adjustment can be considered putting income or spending figures from different countries into purchasing power standards – a common reference unit that reflects equal purchasing power in all countries.  Although they arise from estimates in the national accounts these purchasing power standard (PPS) units can be used across a variety of income and living standards measures.

Indeed, the EU’s own set of Statistics on Income and Living Conditions (EU-SILC) uses purchasing power standards to help us make cross-country comparisons of the income figures derived from the national surveys.  One of the headline measures in the SILC is equivalised disposable income.  This table shows the 2018 outcomes for the EU15.

Median Equivalised Disposable Income in the EU15 in 2018

The table is relatively straightforward. It starts with the nominal figures in national currencies as determined from the national surveys and other sources.  This are then converted into the same currency using the exchange rate (here the average annual exchange rate with the euro which for 12 of the 15 countries is 1.00 as they use the euro to begin with).  Once, converted into euro, a price level index is applied to get a comparable figure in what we could call purchasing power standards or PPS units. 

To see how significant this adjustment can be, here are the € and PPS columns of the above table in ranked order with the change in Ireland’s relative position highlighted.

Median Equivalised Disposable Income in the EU15 in 2018 Ranked

In nominal euro terms, at €24,900, Ireland had the fifth-highest median equivalised net income in the EU15 in 2018.  But when we adjust for national price levels to reflect the living standards that can be achieved with that income Ireland falls to tenth.  That is a very significant ranking change due to a price adjustment. 

Trajectories and growth rates mean that it would not be unreasonable to expect that Ireland will have the third-highest median equivalised net income in nominal € terms when the 2019 figures are released towards the end of this year.  But even that might not be enough to raise the PPS ranking which could stay at tenth. 

So, for the same income measure you could have Ireland in top three in the EU15 or in the bottom half of the EU15 depending on whether you adjust it for prices or not.  But this raises the question are prices in Ireland really so different to the rest of the Eu15?

The first table shows that the price index used by Eurostat for the purposes of the SILC puts Irish prices at 128 per cent of the level of the EU28.  The arithmetic mean for the rest of the EU15 is 110 per cent.  On average, this suggests prices in Ireland are around 15 per cent higher than the rest of the EU15.  We may think things are expensive in Ireland but that is a large difference with other well-developed countries, most of whom we share the same currency with.

If we take Germany as an example. In nominal terms, Ireland’s median equivalised income is estimated to be around 10 per cent greater.  When the price level is applied, Ireland changes to be 10 per cent lower than Germany.  Ireland’s price level of 128 per cent of the level of the EU28 compares unfavourably to Germany’s which is put at 103 per cent of the level of the EU28.  Indeed, Germany has the highest gain between the € and PPS rankings above, rising six positions from ninth to third.

So, lets look a little closer at these relative price indices.  There are lots of them we can use but we will focus on the one derived for Household Final Consumption Expenditure (HFCE).  Here it is for a selection of years since 1998.

HFCE Price Indices for the EU15

It can be seen that the 2018 figures closely correspond to the price indices applied by Eurostat to the SILC data.  It is noticeable that for most of the countries, the comparative price level indices in 2018 are little changed from what they were in 2008.  This doesn’t mean that they haven’t had inflation; just that there price changes have been in line with the average.

For Germany, its HFCE price level index stayed around 103, France went from 109 to 110, Italy stayed at 100 with Finland also unchanged at 122.  For Ireland we see that it rose slightly from 127 in 2008 to 129 in 2018.

In and of itself, this raises an eyebrow. Why? Well, relative to the rest of the EU, Ireland has had below average consumer price inflation for more than decade yet our relative price index is unchanged from what it was in 2008 and is actually up on what it was in 2013/14.

Here are figures for the Harmonised Index of Consumer Prices for the EU15.  In this instance we are looking at a comparison through time in the same country and all countries are set equal to 100 in 2008.

HICP for the EU15

Look at the column for 2018.  Ireland is by far the lowest.  Compared to 2008, Ireland’s HICP was just 1.3 per cent higher in 2018.  No other country in the EU15 comes close to that level of non-inflation.  Greece is next at nine per cent but then we can go through Germany (14 per cent), France (12 per cent), Italy (13 per cent) and Finland (17 per cent).  And for the EU28 as a whole, HICP inflation is measured at 16 per cent between 2008 and 2018.

So now we have a disconnect.  When measured through time, consumer prices for the EU28 have risen significantly faster than consumer prices in Ireland since 2008 (16 per cent versus one per cent).  If this was to be translated into a relative price index we might expect Ireland’s price index relative to the EU28 to have fallen by 15 per cent.  But when we look at the relative price indices, Ireland has gone from a price level that was 127 per cent of the EU28 in 2008 to 129 per cent in 2018.  Something doesn’t seem to add up.

We want to measure purchasing power.  On aggregate, consumer prices in Ireland have been flat for more than a decade.  They have risen everywhere else.  Yet, the price levels indices say the bang for a buck (or a euro) in Ireland has actually decreased. 

So, lets look at the price index for Household Final Consumption Expenditure (HFCE) in a bit more detail.

HFCE Ireland 2018

In 2018, aggregate HFCE in nominal terms was a little under €100 billion or around €20,000 per inhabitant.  We can see comparative price indices by component relative to the level of the EU28.  There are a number of categories where the price in Ireland is put well above the average level of the EU28. Alcohol and tobacco (178), health (160), communications (140) and restaurants and hotels (including pubs) (121) are all significantly higher than the level of the EU28.  But the share of most of these in HFCE is relatively modest.

In PPS terms, HFCE on housing and fuels (excluding motor fuels) was 20 per cent of consumption expenditure.  It is 24 per cent of nominal HFCE.  The price level for housing is put at 158 per cent of the level of the EU28 in 2018.  By looking at share and level this is the price index that seems to have the biggest impact on the overall price index for HFCE.

Here are the relative price indices for each component for selected years.

HFCE Price Indices by Component

Given what we have seen for inflation, the relative price indices for most of the categories correspond to what we would expect since 2008: they have fallen.  Relative to the rest of the EU28, in the last ten years in Ireland all of food, clothing and footwear, furniture and household equipment, transport, recreation, education, and pubs and restaurants have become cheaper.  But this still hasn’t been enough to bring down our overall relative price index. 

In total, there have been relative price drops for categories that make up 70 per cent of real per capita HFCE.  Of the categories that have risen the only one that is of any significant size is housing and fuels (excluding motor fuels).  Within Household Final Consumption Expenditure this category has driven much of the recent increase in Ireland’s price index relative to the rest of the EU28.

So let’s see the outlandish prices increases in Ireland for this category…

Housing in the HICP for the EU15

Again, these are comparisons through time in the same country with all countries set equal to 100 in 2008.  Unsurprisingly, the price of housing and fuels (excluding motor fuels) rose in Ireland in the ten years to 2018.  Per the HICP these prices rose by 26,5 per cent.  But it also rose in all the countries of the EU15. 

No country had a price increase in housing from 2008 to 2018 of less than 12.5 per cent and three had consumer price inflation in housing that was greater than Ireland (Portugal, Finland and the UK).  Indeed for the EU28 as a whole consumer prices for housing were 21 per cent higher than the were in 2008, which is not much different to the 26 per cent increase recorded in Ireland.

Now this disconnect is becoming bizarre.  At a time when the price of housing in household consumption in Ireland went from 132 per cent of the level of the EU28 to 158 per cent, the HICP recorded 21 per cent consumer price inflation for housing in the EU28 and 26 per cent for Ireland.  Where is this relative price increase in the HFCE price level index coming from that is not showing in the HICP which is based on the money that people actually spend?

So let’s look at housing in the HICP in a bit more detail.

Housing in the HICP for Ireland

There doesn’t seem to be a whole lot here that is surprising.  We have already seen that between 2008 and 2018 the price of housing services in the HICP for Ireland rose 26.5 per cent.  Looking at the weights to find the important categories we can see that this was driven by rents (+26 per cent) and fuels (+18 per cent).

But as we also saw, in the same period that housing in the Irish HICP rose 26.5 per cent, it rose 21 per cent in the HICP for the EU28 as a whole.  So why did Ireland’s relative price index for housing in HFCE go from 128 per cent of the level of the EU28 in 2008 to 158 per cent in 2018?

A clue is in the weights in the above table.  The category for housing services is about 11.5 per cent of the All Items HICP, with rents making up over half of this.  But when we looked at Household Final Consumption Expenditure we saw that the consumption of housing services was 24 per cent of Ireland’s nominal total in 2018. 

So the share of housing services is nearly two and half times greater in household consumption (HFCE) than it is in consumer prices (HICP).  What is in consumption of housing that is not in consumer prices for it?  Here is a breakdown of the housing services category in HFCE.

Housing in HFCE for Ireland

The key figure is “imputed rentals for housing”.  If we exclude this item housing would be 10.5 per cent of the remaining HFCE, pretty much in line with the weight for housing services in the HICP.

Household Final Consumption Expenditure is a measure of household use of goods and services.  In the main this is measured by household spending: the goods and services that households use are the goods and services that they buy.  This means it excludes most domestic production: cleaning, cooking, child rearing etc.

If it was only based on the purchases of goods and services, housing is another service which would be excluded from HFCE for a large share of households.  Most households don’t buy housing services; they own a housing asset.  In Ireland, around 70 per cent of households are owner-occupiers.  They provide their own housing services (with the house purchase and any associated mortgage or loan showing on the household balance sheet).

These housing services could be ignored for the purposes of household final consumption expenditure much as they are with domestic cleaning, cooking and child rearing.  But that would create distortions.  Countries where more households rent (pay third-parties for housing services) would show higher levels of consumption than countries where more households are owner-occupiers (provide their own housing services) where there is no rent spending to include. Other domestic services can be left out on the assumption that they are produced and used relatively equally across countries.

So for housing services to get a more consistent picture of the use of goods and services an “imputed rent” is added to household consumption.  Essentially, this is an estimate of the rent owner-occupiers would pay for the housing services they use.  As they are both the owner and the occupant the imputed rent is paid to themselves so we have an equal amount on the income and expenditure side of the household sector accounts.  The amounts net out but we get a more consistent measure of living standards – household use of goods and services – by including the housing services used by all households, not just those who pay actual rent.

The previous table gave nominal, or current price, figures for imputed rent.  We can see that this has risen by around 50 per cent in recent years.  And now we are back to something we set out right at the start. When making this comparison through time does this 50 per cent increase in imputed rents represent more owner-occupier use of housing services or has the price increased causing the nominal figure to rise? 

Well, we should know the answer to this.  The price-level for imputed rents is based on the price level for actual rents.  So as the price of actual rents has risen in recent years so too has the price of imputed rents.  There isn’t a constant price series for imputed rents in Eurostat’s data but the CSO do provide one.

Imputed Rents Real and Nominal

Just look at the changes from 2010 to 2018.  In nominal terms, imputed rents rose by over 50 per cent.  But this was almost entirely a price effect as in real, or constant price, terms imputed rents rose by less than two per cent in those eight years.

This is obviously correct. It would have been hard for the household sector to increase the amount of housing services consumed when very few new houses were being built.  Owner occupiers continued to live in the houses they owned but the imputed rent of the housing services they provided to themselves rose in line with market rents.  [Aside: there could be some concerns with the volume levels of imputed rents in Ireland’s national accounts but that is a related, but somewhat separate, matter. Here our concern is with prices.]

So, within household final consumption expenditure (HFCE) we have an item which:

  • now makes up over 15 per cent of total nominal HCFE
  • is based on imputed rather than actual expenditure
  • rose significantly in price over the past decade

The rise in the price of imputed rents is correct.  Here are actual rentals for housing in the HICPs of the EU15.

Rents in the HICP of the EU15

We can see that from 2010 to 2018 actual rents in Ireland rose 55 per cent, by far the highest in the EU15.  This corresponds to the price deflator the CSO used between their current price and constant prices series for imputed rents.

The increases in actual rents are rightly reflected in the consumer price indices of the countries shown above – but using a weight relative to the amount of money households actually spend (around seven per cent of the HICP in the case of Ireland).  This is a price increase which reduces purchasing power and affects living standards.

The issue is with the inclusion of the price of imputed rents in the estimation of price level indices used for income and spending measures that do not include imputed rents.  Is an increase in the rise of an imputed rent something that reduces the purchasing power of households?

Let’s go back to something we started with: median equivalised net income from the SILC.  Here is a comparison of the outcomes for Ireland relative to a population-weighted average of the EU15 from 2010 to 2018 in both nominal (euro) terms and price-level-adjusted (PPS) terms.

Equivalised Net Income Nominal v Price Level Adjusted

The path of the nominal line corresponds to what we would expect: falling relative to the EU15 until 2012, then flat for a couple of years before returning to positive growth in 2015. 

Since 2014, nominal income in Ireland has had an annual growth rate that has been around two and half percentage points higher than the average for the EU15 (4.6 per cent versus 2.2 per cent).  Ireland’s median nominal income in the SILC has gone from 108 per cent of the estimated EU15 level in 2014, to 123 per cent in 2018 – a rise of 15 percentage points.  This is what has us pushing into the top three in this ranking.

But if we look at the price-level adjusted series Ireland has made little or no improvement and has remained close to the average of the EU15 (and tenth overall); the rapid nominal improvement has apparently been eroded by relative-price increases.  Ireland’s median equivalised income was 96 per cent of the EU15 in 2014.  In 2018, after four years of very strong nominal income growth, it was 103 per cent, an increase, yes, but at just seven percentage points is not as much as the nominal growth might imply.

And, as we have seen a further disconnect is that consumer price inflation has actually been lower in Ireland (averaging 0.2 per cent per annum in Ireland versus 0.9 per cent for the EU28 for the past five years).

Annual Inflation Rates HICP EU15 2010-2018

So where do the nominal income gains go when we do the cross-country comparison?  In recent years, Ireland has had nominal household income growth that has been two and half percentage points higher and consumer price inflation that has been three-quarters of a percentage point lower.  As this has been maintained over a five-year period it should have translated into much larger real income gains than is showing in the cross-country income comparisons.

So how does three become one? Or in aggregate terms over the five years how does 15 become seven?  What wiped out what should have been eight percentage points of additional real income gains for Ireland versus the rest of the EU15.

As we have seen, the price-level adjustment means some of the nominal income gains have been eroded by increases in imputed rent in the relative price indices.  This is a price increase that no one pays – it is imputed.

Here is an attempt to estimate the contribution of prices changes for imputed rent to the HFCE price level index of each country in the EU15 to the overall price level of the EU28.  It applies the inflation rate of actual rentals in each country to the share of HFCE that arises due to imputed rents.

Contribution of Imputed Rents to Price Level Index

The final column shows the sum total for 2014 to 2018.  Over this period, Ireland’s HFCE price level went from 123 per cent of the EU level to 129 per cent of the EU level.  As shown above, imputed rents contributed an increase of nearly five percentage points to increase in Ireland’s price-level index relative to the EU28. 

Without imputed rents Ireland’s price-level index would essentially have been flat for that period and the nominal income gains that have been recorded in the SILC would have translated into much more plausible gains in real income when doing cross-country comparisons.

So instead, of Ireland’s median equivalised net income being 103 per cent of the level of the EU15 once adjusted for prices, a more appropriate measure might put it five percentage points higher.  In the relative-ranking table this could see Ireland move from 10th in the EU15 to seventh.  That is quite an impact for a number that is essentially made up (though it is a bit more formal than that to be fair).

How can this be fixed?  There are two possible solutions:

  1. Use a relative-price index to adjust the incomes derived from the SILC that excludes imputed rents, or
  2. Include imputed rents in the income measures of the SILC.

Either of these would solve the problem.  And it applies in many areas where price-level adjustments are made using PPSs.  It should be possible for Eurostat to produce a set of price indices that omit imputed rents. 

And consideration has been given for some to including imputed rents in the SILC.  Doing so would improve measures of income inequality as the ability to command resources from a given income can be very different for owner-occupier versus renting households (particularly if the owner-occupiers have no outstanding mortgage or loan).

The easiest solution would probably be for Eurostat to produce a price-level index that excludes imputed rent.  Then we could make price-level adjustments across countries for the goods and services that households actually spend their income on.  We have reasonable measures of household income from the SILC and employee earnings from the SES but maybe not for price measures for the goods and services that these incomes and earnings are spent on.

For now, caution is warranted when Ireland is ranked in cross-country comparisons using Purchasing Power Standards.  Most households can actually buy a greater volume of goods and services, that is, enjoy a higher standard of living, than these comparisons might imply.

Monday, November 18, 2019

The exploding balance sheet of the Irish-owned non-financial corporate sector

The previous post looked at the current and capital accounts of the domestic non-financial corporate (NFC) sector and painted a positive picture of rising output, employee compensation, profits, corporation tax, investment and savings. 

Here we look at the financial balance sheet of the Irish-owned NFCs (excluding redomiciled PLCs) from table 2.9 of the release.  Before getting to the detail here is a summary chart.

Domestic NFC ISA Financial Balance Sheet 2012-2018 Chart

The data go back to 2012, and though there has been some volatility in between, the bottom line, financial net worth, is pretty much the same in 2018 as it was in 2012.  The financial net worth of the sector was –€108 billion in 2012 and was –€104 billion in 2018.  To get overall net worth we would need the value of non-financial assets such as fixed capital and land which is not provided but there is value in looking just at the financial balance sheet.

Although, the bottom line is essentially unchanged the size of the balance sheet of the Irish-0wned NFC sector has exploded in the last six years – and particularly in 2015 and 2016.  For example, total financial assets increased from €167 billion in 2012 to €428 billion in 2018.  This is equivalent to increase from 132 per cent of GNI* in 2012 to 217 per cent of GNI* in 2018.

So, lets see what the detail shows (click to enlarge):

Domestic NFC ISA Financial Balance Sheet 2012-2018

Unfortunately, there are some categories where suppressed values means we can’t complete the above table.  All values are included in the balance sheet for the overall NFC sector so we can see roughly where the residual amounts would show.

For financial assets, we can see actually where most of the increase arose: loans and equity.  Loan assets rose from €54 billion to €121 billion and equity assets rose from €56 billion to €177 billion.  There was also an increase in ‘other accounts receivable’ from €39 billion to €99 billion.  These increases account for almost all of the €260 billion increase and again it should be noted that they took place in just six years, with €170 billion of the increase accounted for by 2015 and 2016 alone.

On the liability side the increase is from €275 billion in 2012 to €532 billion last year.  The available figures show some increase in loan liabilities but most of the increase is accounted or by equity liabilities.  There was also about a €60 billion increase in financial liabilities accounted for by the suppressed categories with most of this due to ‘other accounts payable’. 

For this, note that for overall NFC sector (Irish-owned, foreign-owned and redomiciled PLCs), the amount of debt securities rose from €10 billion to €18 billion while there are relatively minor overall amounts in the other suppressed category above: financial derivatives and employee stock options.

It’s well and good going through the increases by category but the overall increase is immense.  Usually, we can point to the activities of US MNCs when trying to pick through the distortions in Ireland’s national accounts but the above shows that Irish-owned firms might be throwing a distortion or two of their own into the mix.

The Irish economy has been performing well in recent years but nothing that would seem to justify a quarter of a trillion expansion in the financial balance sheet of the Irish-owned non-financial corporate sector.  The concurrent rise in financial assets and liabilities could point to circular transactions of some kind. 

However, at this stage, it is hard to tell what impact this expansion of the financial balance sheet has had on output, income and other flows in the national accounts.  That is likely where the real story lies.

Printfriendly