RBA Rates Decision & Roy Morgan Unemployment

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The RBA's decision not to reduce rates this month caught most pundits by surprise—including me. Given the international and local data, I thought they'd err on the side of caution and cut rates.

As I always note when asked to call what the RBA will do next, this is a call on how another body will respond to what they perceive as the economic data and the direction their model of the economy predicts the actual economy will move in. That's closer to picking which cockroach is going to walk out of a circle first in a Changi prison gambling den than it is to economic forecasting per se (which is dubious enough activity in itself). So making a wrong guess about what the RBA will do is not the same as making a wrong economic forecast; you're just making a different forecast of the future than is the RBA.

The RBA's explanation for its decision shows that it is making a rosy call of both the current data and the direction in which the Australian economy is headed.

Information on the Australian economy continues to suggest growth close to trend… the unemployment rate increased slightly in mid year, though it has been steady over recent months… In underlying terms, inflation is around 2½ per cent… the Bank expects inflation to be in the 2–3 per cent range.

Credit growth remains modest, though there has been a slight increase in demand for credit by businesses. Housing prices showed some sign of stabilising at the end of 2011, after having declined for most of the year. The exchange rate has risen further, even though the terms of trade have started to decline … With growth expected to be close to trend and inflation close to target, the Board judged that the setting of monetary policy was appropriate for the moment.

As the Sydney Morning Herald editorialised, the RBA message was that the future looks good:

MOVE right along folks. Nothing to see here. By keeping interest rates on hold this week, the Reserve Bank is sending a subconscious message to borrowers: the economy is doing reasonably well. There is no need to panic…

Although we in NSW seem bogged Eeyore-like in our sad and dank little corner of the forest, glumly chewing our thistles day after day, perhaps we really ought to cheer up. Gloom is not just miserable in itself. When it comes to the economy, it's dangerous.

This is not the take that the majority of economic pundits have on the data—and for once, I'm with the majority. Normally the majority is bullish (because they have a Neoclassical perspective on the economy that largely ignores credit, and thinks the economy always returns to equilibrium) and I'm bearish (because I have a "Post Keynesian" perspective that sees credit as the key motive economic force, and believes the economy is always in disequilibrium).

The majority of economic pundits lined up with me for a change because there was a range of data that implied the economy was stalling. Firstly, unemployment has been trending up, and the "steady over recent months" phenomenon that the RBA referred to above was entirely due to a fall in the participation rate. Had this remained at the November level, the ABS unemployment rate would have jumped to 5.6% last month.

Figure 1

And that's the good news: as was widely reported, employment fell by almost 30,000 last month, so that net job growth in 2011 was zero—the worst outcome in 20 years.

Secondly, a broader measure of unemployment maintained by Roy Morgan Research hit 10.3 percent—5 percent above the ABS figure. The ABS treats someone who has worked for one hour in the previous two weeks as employed, a definition that Roy Morgan rightly rejects:

"Surely if someone is not working, is looking for work and considers themselves to be unemployed, then they should be considered unemployed regardless of whether they happen to have done a couple of hours work here and there during the month?"

The ludicrous official definition of unemployment is a classic case of bureaucracies (including the United Nations International Labor Organization in this case) eliminating a problem by redefining it rather than solving it. Many people have criticised this definition (including Peter Brain from the National Institute for Economic and Industry Research, who found that over a dozen official redefinitions of unemployment had all reduced the recorded level); since the late 1990s, Roy Morgan has gone one better and conducted a monthly survey using a definition of unemployment that actually makes sense:

" According to the ABS definition, a person who has worked for one hour or more for payment or someone who has worked without pay in a family business, is considered employed regardless of whether they consider themselves employed or not.

The ABS def­i­n­i­tion also details that if a respon­dent is not actively look­ing for work (ie: apply­ing for work, answer­ing job adver­tise­ments, being reg­is­tered with Centre-link or ten­der­ing for work), they are not con­sid­ered to be unemployed.

The Roy Mor­gan sur­vey, in con­trast, defines any respon­dent who is not employed full or part-time and who is look­ing for paid employ­ment as being unem­ployed. ” (Roy Mor­gan, Sep­tem­ber 2011)

Roy Morgan’s def­i­n­i­tion there­fore nec­es­sar­ily records a higher level of unem­ploy­ment than the ABS—and they are also a more legit­i­mate mea­sure of real unem­ploy­ment. How­ever their results are also more volatile, since their sam­ple is smaller than the ABS’s, and the results are not sea­son­ally adjusted.

Fig­ure 2

Over­all how­ever, Roy Morgan’s fig­ures are a more accu­rate indi­ca­tor of the level of unem­ploy­ment than the ABS’s, and also as a har­bin­ger of where the ABS data may move in the future. The cur­rent gap between the two mea­sures is the high­est it has ever been—over 5 per­cent, when the aver­age gap has been about 2.5 percent—and this implies that the next move in the ABS fig­ures could be sub­stan­tially upwards. Gary Mor­gan warned that the econ­omy is a lot weaker than the RBA seems to think:

Today’s Roy Mor­gan unem­ploy­ment esti­mates strongly sup­port anec­do­tal evi­dence of con­tin­u­ing job losses through­out Aus­tralia. Just in the past week we have been told that West­pac has announced 550 jobs to go; ANZ is axing 130 jobs; Holden will cut 200 jobs at its Ade­laide plant; Toy­ota will cut 350 jobs in Mel­bourne; Reckitt Benckiser (maker of Mortein & Det­tol) is to retrench 200 jobs at its Syd­ney oper­a­tions; defence firm Thales shed­ding 50 jobs in Bendigo — these are just the most promi­nent exam­ples of job losses occur­ring in the Aus­tralian economy!

Econ­o­mists and politi­cians are wrong to talk about a ‘tight’ labour mar­ket in Aus­tralia dri­ving wage pres­sures. Wage demands (infla­tion) at the moment are being dri­ven by unions — a small minor­ity of the Aus­tralian work­force — not by a tight labour mar­ket with work­ers chang­ing jobs to secure bet­ter wages and con­di­tions. Today’s Roy Mor­gan employ­ment esti­mates show why infla­tion in Aus­tralia is con­tained, and will remain con­tained — at its meet­ing next Tues­day the RBA must drop inter­est rates by at least 0.5% and prob­a­bly more.”

Fig­ure 3


If Gary Mor­gan is right, the RBA’s rosy fore­cast for the future will be shown to be in error. The pri­mary source of that error will be not merely mis­placed opti­mism, but reliance upon neo­clas­si­cal eco­nomic mod­els about the econ­omy that ignore the role of credit just at the moment that decel­er­at­ing credit is finally set­ting in in earnest in Aus­tralia, after being delayed by the First Home Ven­dors Boost.

Fig­ure 4

The First Home Ven­dors Boost was the sole cause of the rever­sal of delever­ag­ing in Aus­tralia after the cri­sis began, with the growth in mort­gages more than off­set­ting the reduc­tion in debt by the busi­ness sector.

Fig­ure 5

With that arti­fi­cial stim­u­lus to credit growth over, credit growth is now decel­er­at­ing in Aus­tralia, and caus­ing unem­ploy­ment to rise despite the off­set­ting impact of the resources boom.

Fig­ure 6

Mort­gage debt is now decel­er­at­ing strongly, and tak­ing house prices down with it.

Fig­ure 7

From its com­ment that “Hous­ing prices showed some sign of sta­bil­is­ing at the end of 2011″, the RBA appears to be buy­ing the RPData spin that a one month upwards blip in their data series after 11 months of decline sig­nals a bot­tom to the hous­ing mar­ket. How­ever a sim­ple com­par­i­son of house prices here to those in Japan and the USA after their bub­ble economies burst makes it hard to argue that “Aus­tralia is different”.

Fig­ure 8

Of course, at this stage it is too early to tell whether we’ll fol­low the long slow decline of Japan­ese prices, or the sud­den fall that marked the USA. But by the end of 2012, Australia’s house price decline pro­file should be apparent.

Fig­ure 9

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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74 Responses to RBA Rates Decision & Roy Morgan Unemployment

  1. glubilee says:

    As to Aus hous­ing mar­kets, con­sider trend in US…imagine what young adult employ­ment does to house­hold unem­ploy­ment. Over 20 per­cent of young men in US are now liv­ing with parents,this num­ber has dou­bled in the last decade or so. And young­sters in US are most debt dis­tressed folks, with­out buy­ing a house, they are drown­ing to stu­dent loan debt, that can­not be dis­charged via bank­ruptcy typ­i­cally. What does this do to our future hous­ing mar­ket, econ­omy, house­hold for­ma­tion. Rents up for now, I think due a temp one time shift away for peo­ple want­ing to live in houses/buy houses in sub­urbs and instead live in apt com­plexes that are in con­ve­nient neigh­bor­hoods. Once hous­ing sup­ply has aught up to his­toric shift in type of demand, rents will decrease again.


  2. koonyeow says:

    Title: Lec­tur­ing Birds on Flying

    @ Lyon­wiss Feb­ru­ary 12, 2012 at 10:57 pm

    I think that Pablo Tri­ana will agree with you too.


  3. clive says:

    “so as long as amer­i­can spend­ing power is main­tained in its sov­er­eign cur­rency and it is will­ing to run an exter­nal deficit with the rest of the world, for­eign­ers have no choice but to accumi­late dol­lar assetts thus main­tain­ing the demand for the dollar

    the amer­i­cans still have the largest econ­omy in the world and
    amer­i­cans have to pay their taxes in green­backs, and if for­eign­ers want to do busi­ness with amer­i­cans they have to do busi­ness in greenbacks.”

    Putting aside the cur­rent kaos in the in the EU. Would it be true to say that one of the biggest threats to Amer­i­can supremacy is changes to the com­mon cur­rency, the Euro, as that would allow what you say to occur? It would appear a com­mon cen­tral bank with the abil­ity to ‘print’ could be dele­te­ri­ous to the US.

    Wasn’t Iran trad­ing oil in Euros already?

  4. RJ says:

    The euro is no threat at all to the US dollar.

    As euro coun­tries can not run large deficits as they are not mon­e­tary sovereign

    –Where does money come from. Answer. From debt. Either non Govt or Govt
    –How much debt can the non Govt take on. Answer. Only so much
    –What do peo­ple need money for. Answer. For con­sump­tion and esp as we age for sav­ings. Money is needed for sav­ings then an asset is needed (eg bonds) to invest this money in. Govt bonds release money then bonds drain this money if pur­chased by a non bank.

    We are cur­rently world­wide very short of finan­cial assets saved for retire­ment. So the need for debt is massive

  5. mahaish says:

    great insight lyon­wiss on black scholes.

    the only thing i would say is that some of these prod­ucts were designed to fail and peo­ple took bets on them failing.

    so its not totally cor­rect to argue that they only new about the fail­ure after the fact.

  6. TruthIsThereIsNoTruth says:

    Regard­ing finan­cial engi­neer­ing and the crisis

    Its true that ulti­mately it was due human greed, but there are the­o­ret­i­cal lessons to be learnt as well. How­ever these lessons are a long way from black scholes. In fact the les­son about black schole assump­tions was learnt in 87. This time round the the­o­ret­i­cal inad­e­quacy of CDO pric­ing was the assump­tion behind default cor­re­la­tion, this was mod­elled as a con­stant small num­ber, which was con­sis­tent with default his­tory at the time. What it missed is the con­ta­gion effect, or the depen­dance of default cor­re­la­tion to eco­nomic con­di­tions. If this was con­sid­ered the con­se­quences would be that the CDO price would show that these are not eco­nom­i­cally viable prod­ucts and they would not receive AAA rat­ings. I per­son­ally believe that this is the rea­son it wasn’t con­sid­ered. I can imag­ine the ana­lysts hav­ing to come up with a model that made these prod­ucts look attractive…

    Allain­ton, black scholes got a lot of trac­tion aca­d­e­m­i­cally and in prac­tice due to the avail­abil­ity of closed form solu­tion. Aca­d­e­mics love it because the maths behind it is inter­est­ing and extendible, so they could pro­duce research. Prac­ti­tion­ers at the time liked it because of the com­pu­ta­tional effi­ciency of closed form pric­ing and really the lack of any­thing tractably bet­ter at the time. Things have changed since, the BS argu­ment is at least 20 years old and only keeps being bashed out at some mar­ginal aca­d­e­mic insti­tu­tions. Stu­dents are still taught it as a start­ing point to option pric­ing, but where it is taught prop­erly BS is put in the cor­rect his­tor­i­cal context.

  7. clive says:

    RJ I agree, the point I was mak­ing is that should they head down one cen­tral bank model as some Europhiles have sug­gested and they were pre­pared to run deficits it’s prob­a­bly a big­ger player then the US. It seems every time Timmy G turns up there he seems to be encour­ag­ing them to do just that. Which if they did (I know unlikely) might not play out so well for the US.
    China already exports more into the EU than the US.

  8. RJ says:


    The US (and the world) would be MUCH bet­ter off not worse off with more Euro Govt debt financed by the ECB.

  9. joshua says:

    Dont know if this is one of Chris hur­ried arti­cles as usual or whether Guy Debelle has real­ized the RBA is now irrel­e­vant so bet­ter option is to side with the banks hop­ing that peo­ple dont real­ize this? http://www.smh.com.au/business/rba-backs-banks-over-higher-borrowing-costs-20120214-1t2ry.html

    The guys at Busi­ness Spec­ta­tor have writ­ten some­thing use­ful http://www.moneymorning.com.au/20120213/at-2-35pm-last-friday-the-rba-became-irrelevant.html. I must admit they are con­fus­ing me. one time they say stocks prices are 40% over­val­ued and a crash is immi­nent. Then they say mar­ket is head­ing for a highs since last April.

  10. joshua says:

    sorry that should be money morning!

  11. mahaish says:

    hi clive,

    the euro­peans have one cen­tral bank,

    but the prob­lem is that the ECB is not pre­pared to act, or it argues the laws gov­ern­ing it pre­vent it from act­ing in the cur­rent crisis

    and infact national gov­ern­ments are sov­er­eign in euros,

    that is domes­tic trea­suries through their own cen­tral banks can the­o­ret­i­cally cre­ate as many euro deposits as they like.

    thats how this whole euro prob­lem came to light in that some if not all gov­ern­ments were in con­tro­ven­tion of their maas­tre­icht deficit ratios.

    the only way they could have been break­ing the rules is by cre­at­ing excess euro deposits in their domes­tic bank­ing system

    and those excess euro deposits needed to be neu­tralised by the national cen­tral banks through bond issuance so that national inter­est rates match the inter­bank rate tar­get set by ECB.

    and the rest is history.

    the fun­da­mentsl prob­lem is the sin­gle cur­rency and the sin­gle inter­bank inter­est rate itself . its basi­cally a de facto gold stan­dard sys­tem, in that trade sur­plus nations accumi­late euro’s while there is a euro drain from the deficit nations.
    which needs to be financed by the debt markets.

    recipe for disaster.

    and there is no sin­gle tax­a­tion power either, so you get the fis­cal mess in greece as a con­se­quence, since the euros value isnt dri­ven by the tax­a­tion framework.

    think rj is right,

    the euros is toast, and the yanks have noth­ing to fear.unless the ECB is given the power firstly to neu­tralise the bond mar­kets, and the euro zone is pre­paired re draw the maas­tre­icht guidlines.

    just as an aside, if you want to park your money right now on some US trea­sury assetts, you have to pay the fed. thats right you have to pay them not the other way around. so much is the demand for US gov­ern­ment finan­cial assetts.

    so much for all those pre­dict­ing the hyper infla­tion­ary demise of the greenback

  12. centerline says:

    It is not about the sov­er­eigns and sover­iegn debt. It is about the banks. All of these bank­ing insti­tu­tions are inter­con­nected via coun­ter­party expo­sure rel­a­tive to both pri­vate debts AND sov­er­eign debts — much of which exists out of sight in the shadow bank­ing sys­tem — in a space where bank­ing liq­uid­ity is only by sus­pen­sion of nor­mal prac­tice (mark to mar­ket), ongo­ing cen­tral bank inter­ven­tion, and recur­sive gains obtained almost entirely by expand­ing lever­age (i.e. rehy­poth­e­ca­tion). You cant sim­ply decou­ple Euro woes from Green­back prob­lems and vice versa and every­one knows it. Just take a look at the Greek drama. The real­ity is that facade is very thin and can­not be allowed to break (until it is time for it to be bro­ken). The PRIVATE bank­ing sys­tem has no alle­giance to any coun­try and this is who is in the dri­vers seat.

    Regard­ing the EU, I agree it is toast. Regard­ing the fate of the USD… who knows. This is a tough one. But, fat lady hasn’t even warmed up yet — so I wouldn’t place bets either way (I would hedge though).

  13. RickW says:

    MF Global was not too big to fail. The back­ground to its fail­ure is not unusual in terms of the prac­tices within finan­cial busi­nesses. If you can watch the series of con­gres­sional hear­ings on the demise with­out get­ting ill then it is instruc­tive in how greed over­rides the pru­dence you would hope the min­ders of your money dis­play:

    No one knows how the risks are spread but given Gold­man Sachs are now directly in charge of Greece and Italy it is cer­tain that GS stand to lose a bun­dle when these coun­tries default.

    Also I expect the politi­cians will have a much higher hur­dle with regard to what is too big to fail next time around.

  14. mahaish says:

    It is not about the sov­er­eigns and sover­iegn debt. It is about the banks. All of these bank­ing insti­tu­tions are inter­con­nected via coun­ter­party expo­sure rel­a­tive to both pri­vate debts AND sov­er­eign debts”

    well yes it is centreline,

    about sov­er­eign debt in non sov­er­eign framework.

    but you have a point since those excess euro deposits ended up in either domes­tic national banks, or ger­man and french banks where the liq­uid­ity swaps occured.

  15. mahaish says:

    actu­ally i should add that my first post was inac­cu­rate in that not only did the excess deposits occure in the domes­tic bank­ing sys­tems, but also in export power houses like ger­many, which pre­sented them with a ster­il­i­sa­tion prob­lem as well.

  16. GG says:

    you really need to sit down with Alan Kohler and give him a good les­son! There he is today on Busi­ness Spec­ta­tor mak­ing the dis­cov­ery that our prob­lem is debt because of high land prices, but then try­ing to say it’s because exces­sive reg­u­la­tion, etc, etc.

    Hasn’t he ever read your stuff on the high cor­re­la­tion between mort­gage finance accel­er­a­tion and land price?

  17. Steve Hummel says:

    This whole mess is about the sur­vival of the cur­rent finan­cial system.…..not the peo­ple who hap­pen to reside in its var­i­ous coun­tries. If it was about the sur­vival of the indi­vid­u­als there the gov­ern­ments would have simul­ta­ne­ously bailed out both the Banks AND the peo­ple with $50k/family every 6 mos. with 75% of that man­dated to reduce per­sonal /business debt and then rinse and repeat until every­one had like 50% equity in their homes and their other debts were paid off. This would have saved the Banks from their bad loans and hair cut­ted their income at the same time, and of course given the con­sumer a huge breath of fresh air which they haven’t been given since the Amer­i­can Home­stead Act expro­pri­ated Native Indian lands. 😉

    You want the econ­omy to run on all cylin­ders and pro­tect it from recession/depression give the con­sumer money, enough money to at least liq­ui­date pro­duc­tion as it comes to the mar­ket, and do it in per­pe­tu­ity. There are a few other things that need to be watched and/or regulated/banned, but its all much sim­pler than its usu­ally made out to be.

  18. Steve Keen says:

    Yes, I know. I deal with the edi­tors there, who know my work rather bet­ter than does Alan.

  19. taddles says:

    One day we WILL see one of Steve’s analy­ses in main­stream media but let’s all hope it’s as a fore­warn­ing and not a post mortem of a hous­ing bub­ble crash.

    I’ve just bought a beau­ti­ful, large sea­side prop­erty for half the price of 3 years ago and cheaper than 6 years ago. That’s cheap enough for me and I bought for old-fashioned rea­sons of hav­ing a place to call home. The banks are refus­ing mort­gage busi­ness in this town so val­ues are realisitic.

  20. Amotzza says:

    Tad­dles, If you want to buy some more sea­side or farm­ing prop­erty let me know. As we all know it takes 2 to tango — in regard approx $2M+ prop­erty it took me 1 year to sell a Toorak Vic­to­ria prop­erty 1/3 below bank val­u­a­tion and I have had another Morn­ing­ton Penin­sula prop­erty on the mar­ket for over 1 year — the inter­est and flow of money has really slowed.

  21. Endless says:

    Inter­est­ing Taddles,

    Despite falls in house prices this doesn’t mean buy­ing a home now is nec­es­sar­ily a bad move, for at least the rea­son you sug­gest — to have a place to call home. If house prices con­tinue to fall then at least if you sell in a few years the rest of the mar­ket will have also fallen so you pur­chas­ing power will be roughly the same for another home — assum­ing of course equity hasn’t been com­pletely eroded.

    The oppo­site was true, of course, for the fam­ily home buyer and seller in the up and up mar­ket: you may have made so much money on paper, but if you were look­ing for a another prop­erty to buy arguably it had gone up a sim­i­lar percentage.

    It is refresh­ing to think of buy­ing a house as some­where to live rather than a place to brag about or to make squil­lions off.

    It’s the prop­erty investor mar­ket which is really inter­est­ing, at what point do investors decide that run­ning a loss for tax rea­sons just doesn’t add up it if cap­i­tal gains are disappearing.

  22. taddles says:

    Exactly End­less, buy­ing now does not sup­pose a return to the old tech­ni­cal high. It does mean for sure that I didn’t pay that which is real comfort.

    The flood of real estate media spin also includes that the elderly should oblige by “down­siz­ing” which is euphemism for “dying a bit”. I have upsized sub­stan­tially and have every facil­ity imag­in­able. Already I am receiv­ing enquiries to slice my block into lit­tle pieces to build the jail cells AKA apart­ments that devel­op­ers dream.

    Amotzza, no need for more. One nice house is enough.

  23. foxbat101 says:

    Work­ing out of debt
    An update of our research on the efforts of devel­oped coun­tries to work out from under a mas­sive over­hang of debt shows how uneven progress has been. US house­holds have made the great­est gains so far.
    JANUARY 2012 • Karen Crox­son, Susan Lund, and Charles Rox­burgh
    Source: McK­in­sey Global Institute

    In This Arti­cle
    Side­bar: Delever­ag­ing: Where are we now?
    Side­bar Exhibit
    Exhibit 1: Although the debt ratio of US house­holds remains high, they may be halfway through the delever­ag­ing process.
    Exhibit 2: In the United States, house­hold delever­ag­ing may have only a few more years to go, while in Spain and the United King­dom it has just begun.
    Exhibit 3: If for­bear­ance is fac­tored in, up to 14 per­cent of UK mort­gages could be in difficulty—identical to the per­cent­age of US mort­gages in dif­fi­culty today.
    Exhibit 4: Signi?cant public-sector delever­ag­ing typ­i­cally occurs after GDP growth rebounds.
    About the authors
    Com­ments (11)
    The delever­ag­ing process that began in 2008 is prov­ing to be long and painful. His­tor­i­cal expe­ri­ence, par­tic­u­larly post–World War II debt reduc­tion episodes, which the McK­in­sey Global Insti­tute reviewed in a report two years ago, sug­gested this would be the case.1 And the eurozone’s debt cri­sis is just the lat­est demon­stra­tion of how toxic the con­se­quences can be when coun­tries have too much debt and too lit­tle growth.
    We recently took another look for­ward and back—at the rel­e­vant lessons from his­tory about how gov­ern­ments can sup­port eco­nomic recov­ery amid delever­ag­ing and at the sign­posts busi­ness lead­ers can watch to see where economies are in that process. We reviewed the expe­ri­ence of the United States, the United King­dom, and Spain in depth, but the sig­nals should be rel­e­vant for any coun­try that’s deleveraging.

    Tog­gle Sidebar

    Delever­ag­ing: Where are we now?

    Back to top
    Over­all, the delever­ag­ing process has only just begun. Dur­ing the past two and a half years, the ratio of debt to GDP, dri­ven by ris­ing gov­ern­ment debt, has actu­ally grown in the aggre­gate in the world’s ten largest devel­oped economies (for more, see side­bar, “Delever­ag­ing: Where are we now?”). Private-sector debt has fallen, how­ever, which is in line with his­tor­i­cal expe­ri­ence: overex­tended house­holds and cor­po­ra­tions typ­i­cally lead the delever­ag­ing process; gov­ern­ments begin to reduce their debts later, once they have sup­ported the econ­omy into recov­ery.
    Dif­fer­ent coun­tries, dif­fer­ent paths

    In the United States, the United King­dom, and Spain, all of which expe­ri­enced sig­nif­i­cant credit bub­bles before the finan­cial cri­sis of 2008, house­holds have been reduc­ing their debt at dif­fer­ent speeds. The most sig­nif­i­cant reduc­tion occurred among US house­holds. Let’s review each coun­try in turn.
    The United States: Light at the end of the tun­nel
    House­hold debt out­stand­ing has fallen by $584 bil­lion (4 per­cent) from the end of 2008 through the sec­ond quar­ter of 2011 in the United States. Defaults account for about 70 and 80 per­cent of the decrease in mort­gage debt and con­sumer credit, respec­tively. A major­ity of the defaults reflect finan­cial dis­tress: overex­tended home­own­ers who lost jobs dur­ing the reces­sion or faced med­ical emer­gen­cies found that they could not afford to keep up with debt pay­ments. It is esti­mated that up to 35 per­cent of the defaults resulted from strate­gic deci­sions by house­holds to walk away from their homes, since they owed far more than their prop­er­ties were worth. This option is more avail­able in the United States than in other coun­tries, because in 11 of the 50 states—including hard-hit Ari­zona and California—mortgages are non­re­course loans, so lenders can­not pur­sue the other assets or income of bor­row­ers who default. Even in recourse states, US banks his­tor­i­cally have rarely pur­sued bor­row­ers.
    His­tor­i­cal prece­dent sug­gests that US house­holds could be up to halfway through the delever­ag­ing process, with one to two years of fur­ther debt reduc­tion ahead. We base this esti­mate partly on the long-term trend line for the ratio of house­hold debt to dis­pos­able income. Amer­i­cans have con­stantly increased their debt lev­els over the past 60 years, reflect­ing the devel­op­ment of mort­gage mar­kets, con­sumer credit, stu­dent loans, and other forms of credit. But after 2000, the ratio of house­hold debt to income soared, exceed­ing the trend line by about 30 per­cent­age points at the peak (Exhibit 1). As of the sec­ond quar­ter of 2011, this ratio had fallen by 11 per­cent from the peak; at the cur­rent rate of delever­ag­ing, it would return to trend by mid-2013. Faster growth of dis­pos­able income would, of course, speed this process.

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    We came to a sim­i­lar con­clu­sion when we com­pared the expe­ri­ences of US house­holds with those of house­holds in Swe­den and Fin­land in the 1990s. Dur­ing that decade, these Nordic coun­tries endured sim­i­lar bank­ing crises, reces­sions, and delever­ag­ing. In both, the ratio of house­hold debt to income declined by roughly 30 per­cent from its peak. As Exhibit 2 indi­cates, the United States is closely track­ing the Swedish expe­ri­ence, and the pic­ture looks even bet­ter con­sid­er­ing that clear­ing the back­log of mort­gages already in the fore­clo­sure pipeline could reduce US house­hold debt ratios by an addi­tional six per­cent­age points.

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    As for the debt ser­vice ratio of US house­holds, it’s now down to 11.5 percent—well below the peak of 14.0 per­cent, in the third quar­ter of 2007, and lower than it was even at the start of the bub­ble, in 2000. Given cur­rent low inter­est rates, this met­ric may over­state the sus­tain­abil­ity of cur­rent US house­hold debt lev­els, but it pro­vides another indi­ca­tion that they are mov­ing in the right direc­tion.
    Nonethe­less, after US con­sumers fin­ish delever­ag­ing, they prob­a­bly won’t be as pow­er­ful an engine of global growth as they were before the cri­sis. That’s because home equity loans and cash-out refi­nanc­ing, which from 2003 to 2007 let US con­sumers extract $2.2 tril­lion of equity from their homes—an amount more than twice the size of the US fiscal-stimulus package—will not be avail­able. The refi­nanc­ing era is over: hous­ing prices have declined, the equity in res­i­den­tial real estate has fallen severely, and lend­ing stan­dards are tighter. Exclud­ing the impact of home equity extrac­tion, real con­sump­tion growth in the pre-crisis years would have been around 2 per­cent per annum—similar to the annu­al­ized rate in the third quar­ter of 2011.
    The United King­dom: Debt has only just begun to fall
    Three years after the start of the finan­cial cri­sis, UK house­holds have delever­aged only slightly, with the ratio of debt to dis­pos­able income falling from 156 per­cent in the fourth quar­ter of 2008 to 146 per­cent in sec­ond quar­ter of 2011. This ratio remains sig­nif­i­cantly higher than that of US house­holds at the bubble’s peak. More­over, the out­stand­ing stock of house­hold debt has fallen by less than 1 per­cent. Res­i­den­tial mort­gages have con­tin­ued to grow in the United King­dom, albeit at a much slower pace than they did before 2008, and this has off­set some of the £25 bil­lion decline in con­sumer credit.
    Still, many UK res­i­den­tial mort­gages may be in trou­ble. The Bank of Eng­land esti­mates that up to 12 per­cent of them may be in some kind of for­bear­ance process, and an addi­tional 2 per­cent are delin­quent— sim­i­lar to the 14 per­cent of US mort­gages that are in arrears, have been restruc­tured, or are now in the fore­clo­sure pipeline (Exhibit 3). This process of quiet for­bear­ance in the United King­dom, com­bined with record-low inter­est rates, may be mask­ing sig­nif­i­cant dan­gers ahead. Some 23 per­cent of UK house­holds report that they are already “some­what” or “heav­ily” bur­dened in pay­ing off unse­cured debt.2 Indeed, the debt pay­ments of UK house­holds are one-third higher than those of their US counterparts—and 10 per­cent higher than they were in 2000, before the bub­ble. This sta­tis­tic is par­tic­u­larly prob­lem­atic because at least two-thirds of UK mort­gages have vari­able inter­est rates, which expose bor­row­ers to the poten­tial for soar­ing debt pay­ments should inter­est rates rise.

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    Given the min­i­mal amount of delever­ag­ing among UK house­holds, they do not appear to be fol­low­ing Swe­den or Fin­land on the path of sig­nif­i­cant, rapid delever­ag­ing. Extrap­o­lat­ing the recent pace of UK house­hold delever­ag­ing, we find that the ratio of house­hold debt to dis­pos­able income would not return to its long-term trend until 2020. Alter­na­tively, it’s pos­si­ble that devel­op­ments in UK home prices, inter­est rates, and GDP growth will cause house­holds to reduce debt slowly over the next sev­eral years, to lev­els that are more sus­tain­able but still higher than his­toric trends. Over­all, the United King­dom needs to steer a dif­fi­cult course that reduces house­hold debt steadily, but at a pace that doesn’t sti­fle growth in con­sump­tion, which remains the crit­i­cal dri­ver of UK GDP.
    Spain: The long unwind­ing road
    Since the credit cri­sis first broke, Spain’s ratio of house­hold debt to dis­pos­able income has fallen by 4 per­cent and the out­stand­ing stock of house­hold debt by just 1 per­cent. As in the United King­dom, home mort­gages and other forms of credit have con­tin­ued to grow while con­sumer credit has fallen sharply.
    Spain’s mort­gage default rate climbed fol­low­ing the cri­sis but remains rel­a­tively low, at approx­i­mately 2.5 per­cent, thanks to low inter­est rates. The num­ber of mort­gages in for­bear­ance has also risen since the cri­sis broke, how­ever. And more trou­ble may lie ahead. Almost half of the house­holds in the lowest-income quin­tile face debt pay­ments rep­re­sent­ing more than 40 per­cent of their income, com­pared with slightly less than 20 per­cent for low-income US house­holds. Mean­while, the unem­ploy­ment rate in Spain is now 21.5 per­cent, up from 9 per­cent in 2006. For now, house­holds con­tinue to make pay­ments to avoid the country’s con­ser­v­a­tive recourse laws, which allow lenders to go after bor­row­ers’ assets and income for a long period.
    In Spain, unlike most other devel­oped economies, the cor­po­rate sector’s debt lev­els have risen sharply over the past decade. A sig­nif­i­cant drop in inter­est rates after the coun­try joined the euro­zone, in 1999, unleashed a run-up in real-estate spend­ing and an enor­mous expan­sion in cor­po­rate debt. Today, Span­ish cor­po­ra­tions hold twice as much debt rel­a­tive to national out­put as do US com­pa­nies, and six times as much as Ger­man com­pa­nies. Debt reduc­tion in the cor­po­rate sec­tor may weigh on growth in the years to come.
    Sign­posts for recovery

    Par­ing debt and lay­ing a foun­da­tion for sus­tain­able long-term growth should take place simul­ta­ne­ously, dif­fi­cult as that may seem. For economies fac­ing this dual chal­lenge today, a review of his­tory offers key lessons. Three his­tor­i­cal episodes of delever­ag­ing are par­tic­u­larly rel­e­vant: those of Fin­land and Swe­den in the 1990s and of South Korea after the 1997 finan­cial cri­sis. All these coun­tries fol­lowed a sim­i­lar path: bank dereg­u­la­tion (or lax reg­u­la­tion) led to a credit boom, which in turn fueled real-estate and other asset bub­bles. When they col­lapsed, these economies fell into deep reces­sion, and debt lev­els fell.
    In all three coun­tries, growth was essen­tial for com­plet­ing a five– to seven-year-long delever­ag­ing process. Although the pri­vate sec­tor may start to reduce debt even as GDP con­tracts, sig­nif­i­cant public-sector delever­ag­ing, absent a sov­er­eign default, typ­i­cally occurs only when GDP growth rebounds, in the later years of delever­ag­ing (Exhibit 4). That’s true because the pri­mary fac­tor caus­ing pub­lic deficits to rise after a bank­ing cri­sis is declin­ing tax rev­enue, fol­lowed by an increase in auto­matic sta­bi­lizer pay­ments, such as unem­ploy­ment benefits.3 A rebound of eco­nomic growth in most delever­ag­ing episodes allows coun­tries to grow out of their debts, as the rate of GDP growth exceeds the rate of credit growth.

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    No two delever­ag­ing economies are the same, of course. As rel­a­tively small economies delever­ag­ing in times of strong global eco­nomic expan­sion, Fin­land, South Korea, and Swe­den could rely on exports to make a sub­stan­tial con­tri­bu­tion to growth. Today’s delever­ag­ing economies are larger and face more dif­fi­cult cir­cum­stances. Still, his­tor­i­cal expe­ri­ence sug­gests five ques­tions that busi­ness and gov­ern­ment lead­ers should con­sider as they eval­u­ate where today’s delever­ag­ing economies are head­ing and what pol­icy pri­or­i­ties to empha­size.
    1. Is the bank­ing sys­tem sta­ble?
    In Fin­land and Swe­den, banks were recap­i­tal­ized and some were nation­al­ized. In South Korea, some banks were merged and some were shut­tered, and for­eign investors for the first time got the right to become major­ity investors in finan­cial insti­tu­tions. The deci­sive res­o­lu­tion of bad loans was crit­i­cal to kick-start lend­ing in the eco­nomic– rebound phase of delever­ag­ing.
    The finan­cial sec­tors in today’s delever­ag­ing economies began to delever­age sig­nif­i­cantly in 2009, and US banks have accom­plished the most in that effort. Even so, banks will gen­er­ally need to raise sig­nif­i­cant amounts of addi­tional cap­i­tal in the years ahead to com­ply with Basel III and national reg­u­la­tions. In most Euro­pean coun­tries, busi­ness demand for credit has fallen amid slow growth. The sup­ply of credit, to date, has not been severely con­strained. A con­tin­u­a­tion of the euro­zone cri­sis, how­ever, poses a risk of a sig­nif­i­cant credit con­trac­tion in 2012 if banks are forced to reduce lend­ing in the face of fund­ing con­straints. Such a forced delever­ag­ing would sig­nif­i­cantly dam­age the region’s abil­ity to escape reces­sion.
    2. Are struc­tural reforms in place?
    In the 1990s, each of the cri­sis coun­tries embarked on a pro­gram of struc­tural reform. For Fin­land and Swe­den, acces­sion to the Euro­pean Union led to greater economies of scale and higher direct invest­ment. Dereg­u­la­tion in spe­cific indus­try sectors—for exam­ple, retailing—also played an impor­tant role.4 South Korea fol­lowed a remark­ably sim­i­lar course as it restruc­tured its large cor­po­rate con­glom­er­ates, or chae­bol, and opened its econ­omy wider to for­eign invest­ment. These reforms unleashed growth by increas­ing com­pe­ti­tion within the econ­omy and push­ing com­pa­nies to raise their pro­duc­tiv­ity.
    Today’s trou­bled economies need reforms tai­lored to the cir­cum­stances of each coun­try. The United States, for instance, ought to stream­line and accel­er­ate reg­u­la­tory approvals for busi­ness invest­ment, par­tic­u­larly by for­eign com­pa­nies. The United King­dom should revise its plan­ning and zon­ing rules to enable the expan­sion of suc­cess­ful high-growth cities and to accel­er­ate home build­ing. Spain should dras­ti­cally sim­plify busi­ness reg­u­la­tions to ease the for­ma­tion of new com­pa­nies, help improve pro­duc­tiv­ity by pro­mot­ing the cre­ation of larger ones, and reform labor laws.5 Such struc­tural changes are par­tic­u­larly impor­tant for Spain because the fis­cal con­straints now buf­fet­ing the Euro­pean Union mean that the coun­try can­not con­tinue to boost its pub­lic debt to stim­u­late the econ­omy. More­over, as part of the euro­zone, Spain does not have the option of cur­rency depre­ci­a­tion to stim­u­late export growth.
    3. Have exports surged?
    In Swe­den and Fin­land, exports grew by 10 and 9.4 per­cent a year, respec­tively, between 1994 and 1998, when growth rebounded in the later years of delever­ag­ing. This boom was aided by strong export-oriented com­pa­nies and the sig­nif­i­cant cur­rency deval­u­a­tions that occurred dur­ing the cri­sis (34 per­cent in Swe­den from 1991 to 1993). South Korea’s 50 per­cent deval­u­a­tion of the won, in 1997, helped the nation boost its share of exports in elec­tron­ics and auto­mo­biles.
    Even if exports alone can­not spur a broad recov­ery, they will be impor­tant con­trib­u­tors to eco­nomic growth in today’s delever­ag­ing economies. In this frag­ile envi­ron­ment, pol­icy mak­ers must resist pro­tec­tion­ism. Bilat­eral trade agree­ments, such as those recently passed by the United States, can help. Sal­vaging what we can from the Doha round of trade talks will be impor­tant. Ser­vice exports, includ­ing the “hid­den” ones that for­eign stu­dents and tourists gen­er­ate, can be a key com­po­nent of export growth in the United King­dom and the United States.
    4. Is pri­vate invest­ment ris­ing?
    Another impor­tant fac­tor that boosted growth in Fin­land, South Korea, and Swe­den was the rapid expan­sion of invest­ment. In Swe­den, it rose by 9.7 per­cent annu­ally dur­ing the eco­nomic rebound that began in 1994. Acces­sion to the Euro­pean Union was part of the impe­tus. Some­thing sim­i­lar hap­pened in South Korea after 1998 as bar­ri­ers to for­eign direct invest­ment fell. These soar­ing inflows helped off­set slower private-consumption growth as house­holds delever­aged.
    Given the cur­rent very low inter­est rates in the United King­dom and the United States, there is no bet­ter time to embark upon invest­ments. Those for infra­struc­ture rep­re­sent an impor­tant enabler, and today there are ample oppor­tu­ni­ties to renew the aging energy and trans­porta­tion net­works in those coun­tries. With pub­lic fund­ing lim­ited, the pri­vate sec­tor can play an impor­tant role in pro­vid­ing equity cap­i­tal, if pric­ing and reg­u­la­tory struc­tures enable com­pa­nies to earn a fair return.
    5. Has the hous­ing mar­ket sta­bi­lized?
    Dur­ing the three his­tor­i­cal episodes dis­cussed here, the hous­ing mar­ket sta­bi­lized and began to expand again as the econ­omy rebounded. In the Nordic coun­tries, equity mar­kets also rebounded strongly at the start of the recov­ery. This devel­op­ment pro­vided addi­tional sup­port for a sus­tain­able rate of con­sump­tion growth by fur­ther increas­ing the “wealth effect” on house­hold bal­ance sheets.
    In the United States, new hous­ing starts remain at roughly one-third of their long-term aver­age lev­els, and home prices have con­tin­ued to decline in many parts of the coun­try through 2011. With­out price sta­bi­liza­tion and an uptick in hous­ing starts, a stronger recov­ery of GDP will be difficult,6 since res­i­den­tial real-estate con­struc­tion alone con­tributed 4 to 5 per­cent of GDP in the United States before the hous­ing bub­ble. Hous­ing also spurs con­sumer demand for durable goods such as appli­ances and fur­nish­ings and there­fore boosts the sale and man­u­fac­ture of these prod­ucts.
    At a time when the eco­nomic recov­ery is sput­ter­ing, the euro­zone cri­sis threat­ens to accel­er­ate, and trust in busi­ness and the finan­cial sec­tor is at a low point, it may be tempt­ing for senior exec­u­tives to hun­ker down and wait out macro­eco­nomic con­di­tions that seem beyond anyone’s con­trol. That approach would be a mis­take. Busi­ness lead­ers who under­stand the sign­posts, and sup­port gov­ern­ment lead­ers try­ing to estab­lish the pre­con­di­tions for growth, can make a dif­fer­ence to their own and the global economy.

    About the Authors
    Karen Crox­son, a fel­low of the McK­in­sey Global Insti­tute (MGI), is based in McKinsey’s Lon­don office; Susan Lund is direc­tor of research at MGI and a prin­ci­pal in the Wash­ing­ton, DC, office; Charles Rox­burgh is a direc­tor of MGI and a direc­tor in the Lon­don office.

    The authors wish to thank Toos Daru­vala and James Manyika for their thought­ful input, as well as Albert Bol­lard and Den­nis Bron for their con­tri­bu­tions to the research sup­port­ing this arti­cle.
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    1 The full report, Debt and delever­ag­ing: The global credit bub­ble and its eco­nomic con­se­quences (Jan­u­ary 2010), is avail­able online at mckinsey.com/mgi.
    2 NMG Con­sult­ing sur­vey (2010) of UK house­holds.
    3 See Fis­cal Mon­i­tor: Nav­i­gat­ing the Fis­cal Chal­lenges Ahead, Inter­na­tional Mon­e­tary Fund, May 2010.
    4 See Kalle Bengts­son, Claes Ekström, and Diana Far­rell, “Sweden’s growth para­dox,” mckinseyquarterly.com, June 2006; and Sweden’s Eco­nomic Per­for­mance: Recent Devel­op­ments, Cur­rent Pri­or­i­ties (May 2006), avail­able online at mckinsey.com/mgi.
    5A Growth Agenda for Spain, McK­in­sey & Com­pany and FEDEA, 2010.
    6 In 2010, res­i­den­tial real-estate invest­ment accounted for just 2.3 per­cent of GDP, com­pared with 4.4 per­cent in 2000, before the housing-bubble years. Per­sonal con­sump­tion on fur­ni­ture and other house­hold durables added about 2 per­cent to growth in 2000.
    Rec­om­mend (65)

  24. foxbat101 says:

    Hi Steve i noticed this paper on a site, hope it does not cause you a prob­lem post­ing it on your blog.
    Peter ps.it appears to be on the same train of thought as yourself

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