Wednesday, November 4, 2020

The position of the household sector as we entered the crisis

Last week, the CSO published the 2019 Financial and Non-Financial Institutional Sector Accounts.  Obviously, with the emergence of COVID-19 this is a world away from where we find ourselves now but it is instructive to see where we were with the onset of the crisis.  We previously looked at some of the COVID-generated chaos in the household sector with the Q2 2020 sector accounts here.

The non-financial accounts of last week’s publication give the incomes and expenditures of each sector and then how they translate through the positions for items like loans and deposits is shown in the financial accounts. 

Here we will look at the household sector.  First, an extended version of the current account for the household sector. Click to enlarge.

Household Sector Current Account 2015-2019 Full

OK, lots more detail there then we need to go through.  The headline results are that Gross Disposable Income rose 7.3 per cent in 2019 to reach €114.2 billion.  Household Final Consumption Expenditure rose 5.6 per cent and was €102.0 billion.  Income rising faster than consumption meant savings rose and the Savings Rate was 12.2 per cent in 2019.

The most significant change for the household sector in recent years has been the rise in employee compensation received.  In 2015, this was €77 billion.  By 2019 it exceeded €100 billion.  The was driven by an expansion of employment and an increase in earnings.

Household Sector COE Paid 2003-2019

By far, the largest source of the increase were non-financial corporations, and COE from this sector was €15 billion higher than it was at the previous local maximum in 2007 and 2008.  For more recent years, we have a breakdown of this between domestic and foreign NFCs, noting that foreign NFCs include traditional FDI as well as foreign-owned companies with a presence to serve the domestic market.

Household Sector COE Domestic and Foreign NFCs 2013-2019

In recent years, COE growth from domestic firms has outstripped that from foreign firms.  In 2015, were responsible for 35.5 per cent of the COE that arose in NFCs, €16.8 billion out of €47.4 billion.  By 2019, the foreign share was down to 32.6 per cent, €21.4 billion out of €65.7 billion.

Further up the table it can be seen that that the mixed income of the self-employed was much less buoyant than employee compensation. Self employed income, which includes agriculture, went from €11.6 billion in 2015 to €12.3 billion in 2019. 

There was a substantial increase in the Gross Operating Surplus of the household sector from €12.2 billion in 2015 to €18.9 billion in 2019.  The GOS of the household sector is derived from the provision of housing services.  Most of this is income from “imputed rents” said to be paid by owner-occupiers to themselves (this nets out further down the table via “imputed rent” expenditure in consumption). Household GOS also includes the surplus generated from actual rents for housing earned by households who own buy-to-let properties.

Household Sector GOS and MIxed Income 2003-2019

In the allocation of primary income account there isn’t a whole lot going on.  We will consider interest flows – though before the adjustment is made for Financial Intermediary Services Indirectly Measured (FISIM). No, let’s not go there. 

Here are the gross interest flows for the household sector from Eurostat.

Household Sector Interest 2003-2019

Interest received is down to less than €300 million while interest paid has been €4 billion or slightly under for the past six years or so.  As stated, most else in this part of the current account has been relatively stable.  There has been a bit of a bounce in dividends received by the household sector which exceeded €2 billion for the first time in 2019.

The next part of the table works through income taxes and social contributions paid, social benefits received and other transfers paid and received.  The net outcome here gives us the difference between Gross National and Gross Disposable Income. 

The gap between the blue and red lines below can be considered part of the contribution of the household sector (including employers’ social insurance contributions) to the non-cash-transfer cost of government.

Household Sector Income and Consumption 2004-2019

We can see that back in 2010 there was close to no difference between Gross National and Gross Disposable Income for the household sector.  This means the amount the government collected from income tax and social contributions from household income was almost fully matched by the amount the government paid in social benefits to households. 

Household Sector Net Tax Social Position with Government 1995-2019

Since 2010, the gap has opened significantly and exceeded €15 billion in 2019 as the amount of tax and social contributions collected (Income Tax, USC & PRSI) has risen but the amount of social contributions paid has been relatively stable (n.b. this only goes up to 2019!).

Going back to the previous chart, the gap between the red and green line gives the amount of disposable income that is not used for consumption: household savings.

Household Sector Savings Rate Revised 1995-2019

In 2019, the household savings rate is estimated to have been just over 12 per cent.  There have only been two years since 1995 when it was higher: the crisis years of 2009 and 2010. 

The income of the household sector had been growing rapidly in advance of the COVID-19 crisis but the gains were not being used for current consumption.  What was the household sector doing with the income it wasn’t spending?  The possibilities are that the money was used for capital spending or put on the financial balance sheet.  To assess that we can look at the capital account.

Household Sector Capital Account 2015-2019

The bottom line here is the household sector has not been using the additional savings from the current account for capital spending.  There are a couple of other minor capital flows to account for but the main take from the capital accounts is [S – I], savings minus investment.

In 2015, households had €8.0 billion of gross saving and did €4.4 billion of capital spending leaving €3.6 billion for net lending,  By 2019, household gross saving was nearly €14 billion and while household capital spending had increased it was still less than €7 billion.  This meant in increase in net lending to €7.4 billion.

Near the bottom of the above presentation of the capital account we can see net capital formation: the difference between gross capital formation and consumption of fixed capital (depreciation).  This shows that there have been very modest net additions to the household sector capital stock. 

Household Sector Gross and Net Capital Formation 2003-2019

Indeed, as recent as 2015, household gross investment was not sufficient to cover depreciation.  In 2019, the net increase in the household capital stock was just €1.1 billion which isn’t much more than the amount investment grants received by the household sector for the likes of retro-fit projects.  It’s probably not a surprise that household capital formation remains muted given the modest increases in the supply of new housing, which is the main capital formation the household sector engages in.

But let’s look at what the household sector did with the €7.4 billion that was left after all current and capital spending has been accounted for.  So we switch from the non-financial to the financial accounts and start with the Financial Transactions Account.

Household Sector Financial Transaction Accoun 2015-2019

The bottom line here, net financial transactions, is slightly larger than the net lending we saw at the end of the capital account, but not significantly so.  What are the household sector doing with the resources they have left after their spending has changed in recent years. 

Household Sector Contribution to Net Wealth

Back in 2012, the increase in net household wealth due to financial transactions was mainly happening via loan repayments with only a modest increase due to adding to deposits.  Over the following years this reversed and in 2019 most of the contribution to net wealth due to financial deposits was from increases to deposits.

Of course, this may not simply be due to changes in what the household sector is doing with its net lending surplus.  For example, if one household takes out a mortgage to buy a house from another household who put that money on deposit that will reduce the contribution of loans to net wealth and increase the contribution of deposits in net wealth but in overall terms the impact of this on the net wealth of the household sector is zero.

Anyway, let’s look at the impact on the financial balance sheet of the household sector.

Household Sector Financial Balance Sheet 2015-2019

Here we can see that the change from 2015 to 2019 in the values on the balance sheet roughly corresponds to the sum of transactions over the same period as shown in the previous table.  The only significant exception to this is insurance and pensions reserves which, as well as increasing due to household contributions, have also increase due to revaluation effects, i.e. rising asset values.

We can see that the above reflects the rising deposits and falling loans from the financial transactions account.  The stock of loan liabilities of households fell from €146.9 billion at the end of 2015 to €130.9 billion at the end of 2019.  On the asset side of the balance sheet, the amount of current and deposits rose from €129.0 billion to €147.2 billion.

Here is a chart with a longer series highlighting that the reversal of the relative size of loans and deposits takes us back to a position last seen in 2002.

Household Sector Loans and Deposits 2001-2019 CSO

Using these stocks of loans and deposits and the amount of interest paid we can calculated implied interest rates.  The average interest on loans was around three per cent.  The average interest rate on deposits is essentially zero.  After narrowing post 2008, the interest differential or margin between loans and deposits is back to where it was in the early 2000s (around three percentage points).

Household Sector Implied Interest Rates 2001-2019

We can get a better relative position if we put the stocks of loans and deposits as a share of income rather than just looking at the nominal levels.  This shows that the 2019 loan/deposit position of the household sector, in aggregate terms at least, was pretty much back to where it was in 2001/02.

Household Sector Loans and Deposits to GDI 2001-2019 CSO

The current account showed us that the income of the household sector has recovered all the losses suffered in the aftermath of the 2008 crash.  And now we can see that the worst of the excesses of the credit bubble have been purged from the household sector financial balance sheet. The COVID crisis is wrecking havoc.  The consequences of that would be far worse if the pre-crisis position of household sector was not as strong as it was.

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