Speech at a dinner on June, 12
Good evening Ladies and Gentlemen
I will not speak directly of the current economic outlook. It will come with my conclusion.
I will speak of two books that have had a real success recently. They are different but both of them are based on a sophisticated and robust empirical analysis. And this analysis is a support for their conclusions. I will jump on these conclusions because that’s what is interesting.
The first book is, without surprise, Thomas Piketty’s “Capital in the 21st century”. I will not analyze the book or make a criticism of it. There is an ample literature on these two issues.
Piketty’s book is on measures of inequality: inequality of incomes and inequality of wealth through time. In a nutshell, his results are that inequality has increased at the advantage of very high incomes and/or very high wealth. One of his main conclusions here is that a market economy is not spontaneously fair. That’s a very strong result.
We all had in mind Simon Kuznets’ analysis saying that economic development implied lower inequalities. This was true after World War II but on a longer and more recent period, Piketty shows that this result was only temporary and specific to the period analyzed by Kuznets.
This is because the economy is not fair that a regulation is needed. That’s a consequence of the conclusion mentioned above.
But such a regulation is complex because of the globalization. The regulation must also be global. We used to have this type of question concerning climate change and we know how complicated to find a solution. Greenhouse gas emissions are not specific to a country. But if only one country takes a measure to reduce emissions, it is not efficient and could be counterproductive for it. Piketty’s framework is of the same kind.
It’s another way to question global institutions and their design to regulate the world economy.
The second book is from Atif Mian and Amir Sufi. Their topic is the financial crisis dynamics in the United States. In their book “House of Debt” they show that the current financial crisis in the US is not very different from previous crisis and that it is the result of households’ debt accumulation. There is causality between the rhythm of debt accumulation and the drop in households’ expenditures: the larger the former, the deeper the latter.
The two authors are focused on households’ debt as a determinant of the financial crisis and of its depth.
- When debt accumulation is done on large-scale by low-income households it constrains the economy. Their propensity to consume is at 1. With uncertainty on their income and on their job due to the crisis, the amount of their debt implies a reduction in their consumption. Debt creates persistence of the crisis.
- In a crisis environment, arbitrage has to be done. It is between households’ debt and the stability of the banking and financial sector. The two authors said that in the US the arbitrage was in favor of the banking sector. But even if the banking sector is safer, the amount of debt is still there maintaining its constraint expenditures and on internal demand momentum. That’s why the exit from the recession has been so slow.
Nevertheless, since the beginning of the crisis, households’ debt has decreased. It could have been in a more efficient way according to the authors but it has been reduced.
That’s where the comparison with the Euro Area is interesting. Before the crisis in many countries of the Euro Area, there was a large debt accumulation associated with real estate. What has happened since then?
We can compare figures in the US and in the Euro Area. In 2007 households’ debt was 93.2% of nominal GDP in the USA. In 2013 the number was 77.5%. Lower debt has contributed to internal demand momentum even if it is not on the scale expected by the two authors.
The same calculus for the Euro Area with all households’ financial liabilities (BCE figures) can be done. The ratio was 64.8% in 2007 but 72% in 2013. The ratio has increased during the crisis.
The chart below shows that profiles were similar before 2007 even if the two lines are on different scales. But after the beginning of the crisis, there is a strong divergence. Debt dropped in the US, not in the Euro Area. If, as it is suggested by Atif Mian and Amir Sufi, internal demand is conditioned by households’ debt level, then the post crisis adjustment has not started in the Euro Area.
With a constrained internal demand and already very low rate of inflation (0.5% in May 2014), the risk of deflation in the Euro Area is far from being null. The debt deflation dynamics mentioned in 1933 by Irving Fisher is something that could weaken the Euro Area outlook (see here). Then the probability of very low interest rates for a very extended period in high in the Euro Area.