Month: June 2009

Deflation and Housing Costs

Today’s CPI release shows an eye-popping 4.7% year-over-year decline in the headline price index.  Most of the decline is due to a 42% year-over-year decline in mortgage interest (which has a weight of 6.7% in the index.)  Excluding mortgage interest, the rate of deflation is 1.2 percent. 

This brings up an issue which has been an old chestnut among economists of a certain disposition, namely the appropriate treatment of housing costs in a cost-of-living index. My opinion on this (drummed into me years ago while a junior lackey at the Fed) is that mortgage interest rates should not be used to measure the cost of housing and that housing costs are best proxied by matching housing units with equivalent rental properties.  This owners-equivalent rent is a major element of the US CPI.

The idea here is that the cost of living index should not depend on the particular financing method that people use to buy homes. If, for instance, we all inherited a large lump sum tomorrow and paid off our mortgages, then the mortgage interest element of the CPI would disappear (once re-based).  However, this would not mean that housing had no cost—the decision to pay off the mortgage is a financial one and the money could have been invested in other financial instruments.  (For similar reasons, I have also never agreed with people who argue that house prices should be included in cost of living indexes.)

In any case, it’s interesting to note that rents are also well down over the past year, declining 16.4% over the past year (see page 4 of this release).  So using this figure in place of the mortgage interest cost would still imply deflation of 2.2%.  (Of course, this is a crude calculation since the rental sample is different from the sample of owner-occupied homes and if you were doing all this correctly, you’d probably have different weights.)

One reason this issue matters is in relation to welfare benefits.  Those on welfare who don’t own their own home have not experienced a 4.7% decline in their cost of living and this is one reason to be careful in arguing, as many have, that the falling CPI has implied real benefit increases of whatever percent for recipients.

George Lee

I do not have any links with either Fine Gael or George Lee. I do think he merits special consideration from Economists as he is likely to be a key player in the shape of the economic policy of the current main opposition party. His maiden speech to the Dail is available on the link below. As one might expect, he seemed in command of economics in a way that will make him an interesting, though now partisan, figure in the national economic policy debate. A lot of his speech focused on the psychological and social cost of unemployment. In terms of economic policy, he argued that unemployment and private sector debt have been neglected from the debate and that he was going to contribute to correcting this. I will be watching with very strong interest as to how he follows up on this.

Link here (scroll about half way down)

The maths of NAMA-type valuations

And it’s not just NAMA.  From Boston to Berlin, valuation of distressed assets is a hot topic these days.  Jacco Thijssen‘s new Irish Economy Note “Valuing Distressed Assets Using Optimal Stopping Theory” looks at some of the underlying maths that could be used.

Anglo Wind-Up Debate a Distraction

A common pattern when an important economic story comes along is that the media and politicians decide quickly what the issue boils down to and then, even though they’ve got it wrong, this sets the tone for weeks.  Recent examples of this phenomenon include the February\March “do we need a bad bank?” debate, which was followed by the equally specious “NAMA versus nationalisation” debate. 

Over the last few days, the media and political debate about Anglo Irish Bank has largely focused on the question of whether the bank should be wound down or kept on as a going concern.  Those who favour winding down the bank appear to view the funds the government has committed to re-capitalising Anglo as the cost of keeping the bank going and, on that basis, they argue strongly for the wind-down option as being cheaper for the taxpayer.

An example of this line of reasoning is an article in today’s Irish Independent (titled “Taxpayer getting bullied into saving Anglo Irish”) by new Fine Gael TD, George Lee. George puts the case for winding up the bank along these lines:

The problem, of course, is that the people associated with the bank, including the Government, are refusing to bury it … Instead of pumping billions into a failed bank that will never, ever again be profitable, it is much better to wind Anglo down.

I do not think that this is a useful way to characterise the decisions facing the government in relation to Anglo Irish Bank, for a few reasons.

Continue reading “Anglo Wind-Up Debate a Distraction”

Fiscal Implications of the Global Crisis

The IMF has released a new staff position note which focuses on the fiscal implications of the global crisis.  It provides very useful comparative data on various dimensions of fiscal interventions, including the costs of banking sector policies.  You can download it here.