Debt and inequality

Adair Turner Senior Fellow, INET

Resolution Foundation 3 June, 2014

www.ineteconomics.org

300 Park Avenue South | New York, NY 10010

22 Park Street | London W1k 2JB

Private domestic credit as a % of GDP: Advanced economies 1950 – 2011

2

Source: Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten, C. Reinhart & K. Rogoff, 2013

Dynamics of real GDP and credit (Year on year % change)

Source: Monthly Bulletin, European Central Bank, January 2014

Real GDP Real credit to households Real credit to NFCs

United States United Kingdom

3

The Dilemma

We seem to need credit growth faster than

GDP growth to achieve an optimally growing

economy, but that leads inevitably to crisis

and post-crisis recession.

4

Debt contracts: The finance theory perspective

Non-state contingent contracts overcome “costly state verification” advantages over equity contracts in business finance

Essential to mobilisation of capital

Empirical evidence of benefits of financial deepening, i.e. bank credit ÷ GDP

5

Three conceptually distinct functions of lending

Finance of new capital investment

• Enabling inter-temporal shift of consumption within life time income

Finance of purchase of existing assets

Finance of increased consumption

• Non-real estate

• Commercial real estate

• Residential real estate

• Human capital

• Real estate

• Collectibles

• Existing business assets – e.g. Leveraged Buy Outs

6

Categories of bank lending: UK, 2009

7

227

1235

243

232 Primarily productive investment

Some productive investment and some leveraged asset play

Mainly purchase of existing assets

Pure life-cycle consumption smoothing

Other corporate

Commercial real estate

Residential mortgage (including securitizations

and loan transfers)

Unsecured personal

£bn

But also achieves life-cycle consumption smoothing

Share of real estate lending in total bank lending

Source: The Great Mortgaging, Professor Alan Taylor, University of California, Davis

8

Credit and asset price cycles: upswing

9

Expectation of future asset price

increases

Increased credit extended

Low credit losses: high bank profits • Confidence reinforced • Increased capital base

Increased asset prices

Increased lender supply of credit

Favourable assessments of

credit risk

Increased borrower

demand for credit

Credit extension and house prices

House prices 2000 – 2007 Household debt as a % of GDP 2000 – 2007

Source: BEA; ONS; ECB

0

20

40

60

80

100

120

Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 %

GD

P

US UK Spain Ireland

0

50

100

150

200

250

Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007

Index:

2000 =

100

Spain US UK Ireland

Source: Ministry of Housing (Spain), S&P (US), DCLG

10

11

Shifting leverage: Private and public debt-to-GDP

Real yields to maturity on UK indexed linked gilts

Source: Bank of England Statistics, Zero coupon real yields

-2

-1

0

1

2

3

4

5

01

-Mar

-85

01

-Mar

-86

01

-Mar

-87

01

-Mar

-88

01

-Mar

-89

01

-Mar

-90

01

-Mar

-91

01

-Mar

-92

01

-Mar

-93

01

-Mar

-94

01

-Mar

-95

01

-Mar

-96

01

-Mar

-97

01

-Mar

-98

01

-Mar

-99

01

-Mar

-00

01

-Mar

-01

01

-Mar

-02

01

-Mar

-03

01

-Mar

-04

01

-Mar

-05

01

-Mar

-06

01

-Mar

-07

01

-Mar

-08

01

-Mar

-09

01

-Mar

-10

01

-Mar

-11

01

-Mar

-12

01

-Mar

-13

10-year Yield 20-year Yield

12

Perc

ent

Shifting leverage: back to private again

Source: OBR Economic and Fiscal Outlook, March 2014

13

Public net debt as % of GDP: 2009 - 2019

40

45

50

55

60

65

70

75

80

85

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

% P

erce

nt

140

145

150

155

160

165

170

20

09

Q1

20

09

Q4

20

10

Q3

20

11

Q2

20

12

Q1

20

12

Q4

20

13

Q3

20

14

Q2

20

15

Q1

20

15

Q4

20

16

Q3

20

17

Q2

20

18

Q1

20

18

Q4

Household gross debt as % of income: 2009 - 2019

% P

erce

nt

Average income increases US (1980=100)

0

50

100

150

200

250

300

350

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

bottom 20% top 5% top 1%

S

Source: US Census Bureau; World Top Incomes Database

14

Inequality, demand and credit

15

Rich have higher marginal

propensity to save than poor

Rising inequality

Deflationary impetus – growth of NGDP falls

Rich lend to poor

Deflationary impetus offset: • NGDP growth

maintained • Growth in credit

intensity

Savings not matched by investment

+

Changes in housing wealth: UK 2003 – 2013

Households with no mortgage debt

Buy-to-let landlords

Households with mortgages

£bn

556

434

-59

Source: Savills, Private landlords gain the most from rising property market, Financial Times, 18 January 2014

16