Tuesday, October 16, 2018

The household sector accounts make sense again

It’s a well-worn path that Ireland’s national accounts are so heavily distorted by the impact of MNCs that getting any reliable signal from some of the most commonly-used aggregate measures is close to impossible.  The work of the CSO has led to the publication of some bespoke measures from the Irish accounts such as GNI* and CA* that strip away some of the distortions.  These have been welcome additions to the accounts.

Within the accounts themselves the household sector may be a good place to look for underlying trends.  The outcomes for the household sector should reflect many of the underlying trends in economy for incomes, spending, saving, investment and borrowing.

About 18 months ago we did a deep dive and pulled together a coherent narrative from the accounts. In summary, household current spending (consumption) and capital spending (capital formation) was below household income so that the household sector was an aggregate net lender and was using these funds to repay loan liabilities. 

But then, this time last year, the apparent coherence was revised away and the figures at that time reported the household sector to have been a net borrower since 2014.  We returned to this a few times (here, here, here and here). 

At the time we were still waiting to get a clear view of CA* so the net lending/borrowing position of the household sector would have been an important indicator when looking for signs of pressures in the economy.  Except, after last year’s revisions, it didn’t make sense.  But this has now been restored.

If we go all the way to the bottom line we can see the result of the latest revisions.

Household Sector Net Lending Revised Oct 2018

There has been a massive upward revision in the accounts to the net lending position of the household sector.  For the period 2014-2017 in cumulative terms, the household sector has switched from being a net borrower of €1 billion to being a net lender of €16 billion. 

This is much closer to what we would expect given the scale of debt reduction untaken by the household sector in recent years with loan liabilities reducing from over €200 billion in 2008 to under €140 billion now. 

Household Sector Loan Liabilities

It never made sense that the funds for these repayments were coming from the sale of unlisted shares.  That the accounts now show that a large part is coming from unspent income eases any concerns about the build-up of financial pressures in the household sector: the “deleveraging hypothesis” trumps the “overheating hypothesis”, for now at least.  The deleveraging will not continue for ever.

Although not of central concern there may be some interest in looking at where the revisions were entered into the accounts.  Some of it happened in the current account.  There has been some upward revision to the gross savings rate from what was shown this time last year but not massively so.

Household Sector Savings Rate Revised Oct 2018

This has largely been because of an upward revision to household income.  For example, gross disposable income for 2016 has been revised from €95 billion to €97 billion with the result that the gross savings rate is now 1.5 percentage points higher.  The output produced and wages paid by the household sector itself were revised up.

But some of the more significant changes happened in the capital account.  Here are the previous and revised figures for gross capital formation of the household sector.

Household Gross Capital Formation Revised Oct 2018

The 2016 figure for household capital formation has been revised from €8.0 billion down to €5.2 billion.  The main item in the capital formation of households is housing; both the improvement of existing units and the acquisition of new units.  There is even less of this going on then previously thought which is a major reason for the revisions in the net lending shown at the top.

Whatever the reason we now have a set of household accounts that make sense.  The household sector is not spending all its income and is a significant net lender which is what we would expect given the scale of the reduction in household loan liabilities in recent years.  As hinted above this points to wondering what will happen when the deleveraging stops.

Friday, October 12, 2018

The Irish Hare is set to complete its second lap

Here is a chart from Honohan and Walsh (2002) showing Ireland going through a 25-year imbalance cycle from 1975 to 2000.  Internal imbalances are shown through the unemployment rate with external imbalances shown through the balance of payments current account deficit (these are shown using the reverse sign so positive numbers indicate deficits).

Celtic Hare Lap 1

Back in 2009, Honohan pondered whether the hare was heading off on another lap.  He was right (and first raised the possibility with co-author Walsh as early as 2007). 

Anyway, here is an update of the imbalance chart using the modified current account rather than the headline one.  Outturn data from the CSO is used for 2004 to 2017 with figures for 2018 to 2020 coming from the latest Department of Finance forecasts included with Budget 2019.

Celtic Hare Lap 2

The latest lap began with the current account deterioration from 2004 (though it should be noted that the range of the horizontal axis in the second chart is about half that of the first).  The current account did begin to improve after 2008 but this was coincident with the explosion in unemployment (same axis range in both charts) as consumption and, most notably, investment fell. 

Since 2012, we have been closing the loop through rapid falls in unemployment and improvement in the current account.  The current account did deteriorate in 2017 though this may have been an MNC effect related to the acquisition of stocks.  The latest forecasts from the Department of Finance show a continued erosion of the current account surplus from that point as a result of consumption and investment rises.  The forecasts have us getting us back to where we were in 2004 sometime next year or the year after so the final closing of the loop as shown above is still a forecast rather than an outturn.

If it does happen the hare will set a new PB: cutting the the lap time 25 years to 15 years (albeit, as noted by Honohan, the course was shorter this time). What’s in store for the celtic hare? Hard to know.  But let’s hope it takes a breather before heading off on its third lap.