The in-betweeners

How effective is monetary policy?

Highly effective, according to the Governor of the Bank of England. In a speech earlier this week, Mark Carney robustly defended the Bank of England's record:
"Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work."
Well, lots of us might agree that monetary policy did help to offset the damaging effects of bank and household deleveraging in the aftermath of the worst financial crisis since the 1930s.

Carney suggested that monetary policy also dampened the effect of premature fiscal consolidation when everyone panicked about government deficits in the wake of the Greek crisis:
Fiscal policy quickly came under severe strain as tax revenues plunged, the costs of social benefits rose sharply, and the huge bills for too-big-to-fail banks came due. Since then sustained austerity has reduced the fiscal deficit from around 10% of GDP in 2010 to around 3 ½ % today. While necessary, this has, on average, subtracted around 1 percentage point from demand each year. Over that time, structural policies have boosted participation in the labour market but have been unable to return productivity growth to anything resembling its historic average. For seven years, in the face of severe headwinds to growth, monetary policy has been the only game in town. 
He is probably right. The counterfactual is the Eurozone, where severe fiscal consolidation has been undertaken by several countries without monetary policy support. Eight years on, unemployment remains distressingly high, growth is flat and inflation is negative, reflecting a massive collapse of aggregate demand. The ECB's monetary easing has been too little, too late for countries like Spain, where some of the unemployed have been out of work for over four years. Whole generations have been thrown on the scrapheap because of monetary and fiscal intransigence. Eventually, the price for such harshness will be paid politically.

But the most persistent criticism of monetary policy is that it has, in the words of HSBC's Stephen King, "unfortunate distributional effects". It benefits the holders of financial assets - primarily the rich - at the expense of those dependent on interest income, who are believed to be much poorer, though not necessarily the poorest.

Carney is having none of it. He rejected the distributional criticism of monetary policy on the grounds that savers are also asset holders:
Just 2% of households have deposit holdings in excess of £5,000, few other financial assets, and don’t own a home. So the vast majority of savers who might have lost some interest income from lower policy rates have stood to gain from increases in asset prices, particularly the recovery in house prices.  
Of course, realising those gains is not necessarily easy. Your house may have gone up in value, but you are still living in it. For those trying to live on declining interest income from savings, asset price rises are cold comfort.

But Carney is not having that either. He points to these two charts as evidence that the poor have done better than the rich from monetary policy:

These charts do indeed appear to show that the poorest have seen the largest rises in both wealth and income since 2006. But they are presented without explanation or notes, and they are opaque to say the least. The wealth chart, in particular, is something of a mystery.

The wealth increase of the top two quintiles is easily explained. These quintiles not only own property, they own financial assets - and monetary policy has increased the value of financial assets. But the rest of the chart is much less clear.

Firstly, it shows a very large increase in wealth for the poorest quintile, followed by a sizeable collapse and then a recovery. The Governor says that the wealth buildup for the lowest quintile after 2010 came from brutal deleveraging of property debt. I don't believe it.

This is the UK's wealth distribution in 2012-14, from the fourth and final "wave" of the Wealth and Assets Survey (WAS). The divisions are deciles: the Bank of England has used quintiles, but these are easy to derive from this chart.

Wave 4 of the WAS does say that the principal form of wealth for poorer people is property. However, the survey says that only 40% of those in the bottom half of the wealth distribution own property - i.e. P50 and below. That includes the lower-middle quintile and part of the middle quintile in the Bank of England's chart. Given that only about two-thirds of UK households own property, and the proportion of high-wealth households that own no property is vanishingly small, it is highly unlikely that the lowest quintile (P0 to P20) would include sufficient homeowners for property rises to have such a dramatic effect on net wealth for that quintile.

I think the net wealth changes for the poorest quintile are much more likely to stem from rapid buildup and deleveraging of unsecured debt (credit cards and high-interest loans), followed by renewed saving. This is supported by this statement from Wave 1 of the WAS (2006-8):
25 percent of households had net financial wealth that was negligible: a large number of households at the lower end of the distribution had negligible, zero or negative net financial wealth. 
The poorest 20% didn't have mortgages, they had credit cards and payday loans. And in the deep recession after the financial crisis, many of them defaulted on them. Some had their possessions seized to pay off debts. The few that might have owned houses in 2006 don't, any more. Now, they are free of debt and are beginning to build up savings, perhaps with the help of charities such as Stepchange.

Can monetary policy take the credit for this? Absolutely not. If there had been no monetary policy support, far more of this group would have defaulted on their debts. Under UK law, if debt default results in personal bankruptcy, the individual is not left destitute. Possessions are seized, yes, but the individual is allowed to keep sufficient possessions to support a basic lifestyle. Writing off the debts therefore leaves the individual with net positive wealth. The Bank of England's chart is absolutely correct to show this as a noticeable increase in net wealth for the poorest 20%, but this is not due to monetary policy. It is due to the disastrous 2008 crash, the personal bankruptcies that resulted from it, and the determination of many of this group never to be so vulnerable again. Perversely, monetary policy has if anything impeded the deleveraging of this group and restricted improvement in net wealth.

That said, monetary policy has to some extent protected the poorest quintile from high unemployment and large income falls. So, indirectly, it has helped them to pay off problem debt and start to build up savings.

Now we have explained the wealth increases of the richest and the poorest on the Bank of England's chart. That leaves the lower-middle and middle income quintiles (P20 to P60) - what we might call the "in-betweeners".

These people were not as vulnerable as the poorest group in the 2008 crash. They had higher levels of property ownership than the bottom quintile, less unsecured debt and more savings. But the chart shows that as a group, they have apparently been largely unaffected both by the 2008-10 housing market crash and the subsequent housing market recovery. This cannot be explained by the fact that most homes are mortgaged. Mortgages are nominal, not real. They do not increase and decrease in response to house price changes. When the price of a mortgaged home rises, the homeowner's net wealth increases. So why have house price rises had so little effect on the wealth of the in-betweeners?

My reading of the chart is that it is the in-betweeners, not the poorest, that suffered distressed deleveraging of property debt. The WAS says that much of their wealth is tied up in property: Wave 2 tells us that the average value of their property fell sharply in 2008-10, in some areas by over 8%. But if the aggregate value of their mortgages also fell, because they were paying them off, then the net wealth of the group as a whole would remain the same even though house prices were falling.

Once the housing market started to recover, of course, the deleveraging stopped and new buyers entered the market, all of them mortgaged to the hilt. So although mortgages themselves don't adjust with property prices, rising property wealth for the "in-betweeners" is nonetheless offset by rising mortgage debt. Net wealth for these groups therefore does not rise as fast as it does for richer groups, who are much less likely to be mortgaged and for whom property wealth is less significant anyway. (The WAS says that pensions - notably defined-benefit pensions - are the most important part of the wealth of the top two quintiles.)

Can monetary policy claim credit for this? Not really. The US experienced a much worse property market crash than the UK despite drastic interest rate cuts and large amounts of QE. The reasons why the UK did not experience a housing market correction on the scale of 1990 are something of a mystery, but restricted supply, political support for the housing market through a variety of fiscal initiatives, and the rise of London property as an international safe asset are all important factors.

So now we have a full explanation for the wealth chart. Monetary policy supported the rich - we knew that. It supported the poor to some extent, though it was far from being the sole cause of the large increase in wealth evident from the chart. But it didn't help the in-betweeners much.

Now to the income chart. Once again, it shows a large increase for the poorest. Can monetary policy lay claim to this? No. This is mostly due to fiscal policy. The ONS observes that incomes in the lower half of the income distribution are extensively smoothed by benefit top-ups. Working-age benefits rose from 2007 to 2010, then were cut back sharply by the Coalition government. This should have caused aggregate income in the bottom two quintiles to fall, but the cutbacks were offset by rising payments to retirees and increases in the minimum wage. The resulting income stagnation from 2010-13 is apparent from the chart.

The income chart does show that the incomes of the higher quintiles have been squeezed. But when your own income is stagnating, you feel angry about the rich even if their incomes are falling. The position of the middle quintile is particularly stark: their income was flat from 2007 to 2013. They could be forgiven for thinking that monetary policy passed them by.

So, Governor, I remain unconvinced that monetary policy has been "highly effective". There are many moving parts in this particular machine, and you have ignored most of them.

It is all very well crowing that the poorest have been supported. They have, to some extent, though perhaps not quite as much as you claim. But it is painfully evident that the "in-betweeners" have had much less support. Relative to the rich, they have lost out both in wealth and in income. And relative to the poor, they have lost out too: they no longer qualify for many benefits and other public support, and they are seeing public money going to people not much poorer than them while they are left to struggle on their own. These are people who see themselves as having done everything right: they have worked hard, saved and paid into the system. Now, they think the system has abandoned them. And with reason.

To be fair, it is not the Bank of England that has abandoned them, though some of them blame you for their woes: "in-betweener" pensioners are those who have been hardest hit by very low interest rates. The real failures lie on the fiscal side, and are of very long standing.

The promise of "cradle to grave" support upon which the British welfare state was founded has been systematically dismantled. Now, only the poorest are supported. The neglected in-betweeners are on their own. And their anger is shaking our political establishment to its foundations.

Related reading:

Austerity and the rise of populism
Raising interest rates is not that simple, Lord Hague

Image: "A mouse in between", by Open Graphics.  


  1. An interesting post and a interesting topic.

    I think the BoE is right that much of the change in wealth of the poorest quintile comes from property deleveraging. If you look at the data for table 2.3, you can see that changes in property wealth account for around 35% of the increase in wealth for this quintile between the first and last survey. 45% is changes in physical wealth, and only 6% is financial wealth. Both financial wealth (which includes non-property debt) and property wealth are negative for this group throughout the period.

    It's not entirely surprising to find lots of property owners in the lowest quintile. If you are in negative equity, that's pretty much going to push you into that quintile. Aggregate property wealth for the poorest decile is negative throughout the period.

    Also worth noting, that notwithstanding the governor's spin, this same data shows that around 70% of the total gain in household wealth between first and last survey went to the richest quintile and only 1% to the poorest (subject to various caveats about interpreting this data).

    1. «the BoE is right that much of the change in wealth of the poorest quintile comes from property deleveraging»

      Well, a large percentage change on a small base can still be pretty small in absolute terms. As you write later the absolute amounts are quite different:

      «around 70% of the total gain in household wealth between first and last survey went to the richest quintile and only 1% to the poorest»

      Disaggregating that by region is also going to be illuminating, here is a map of after-inflation capital gains for various UK regions from before to after the 2008 crash:

      Most UK regions have seen large real losses on property prices, and most of those regions have been low income low property prices ones. The superlative capital gains in the south-east and London, largely thanks to extremely loose credit policy and support by both BoE and Treasury, have more than compensated for that in the aggregate.

      In particular low income property owners in the south-east, like beneficiaries of older and recent waves of Right-to-buy discounts, must have received truly colossal percentage boosts to their wealth, and this of course can be spun by the BoE as a triumph for equality :-).

  2. This comment has been removed by the author.

  3. Maybe he should emerge from his simulation and check out the real world?

  4. «Of course, realising those gains is not necessarily easy. Your house may have gone up in value, but you are still living in it. For those trying to live on declining interest income from savings, asset price rises are cold comfort.»

    This is a common but very significant misunderstanding, because property capital gains can be easily realized as cashflow in at least two ways:

    * By cutting saving for a pension: for many southern property owners capital gains have been 20-40% boosts on their work income, largely the same or larger amount needed to save for a good pension.
    * By way of re-mortgaging or expanding an existing mortgage, which has been a huge boost to the financial and retail sectors.

    As to re-mortgaging two quotes, one about the overall impact:
    «Under Thatcher, this exploded to over £250bn across her premiership – a staggering 104% of GDP growth. ... But Blair did his homework and let loose – as did Thatcher – a wave of cheap credit, financial deregulation, house price inflation and an equity withdrawal-led consumption boom. Withdrawals under Blair’s leadership totalled around £365bn, that’s a full 103% of GDP growth over the same period,»

    and anedoctal:
    «Certainly, we overstretched ourselves when we bought our lovely period home for £419,000 in 2002. But with mortgage companies practically throwing loans at us in a rising property market, we slept soundly at night, smug in the knowledge the house was making us money. [ ... ] The valuer had barely been in the house for five minutes yet we were able to borrow a further £80,000. [ ... ] We were lulled into a false sense of security about our wealth. Whenever we overspent we just remortgaged without comprehending the consequences of taking yet more equity out of the property. [ ... ] In our defence, we weren’t spending the money on expensive designer clothes, luxurious holidays or flash cars. Much of it was going on school fees and upkeep of the house.»

    That's what has determined politics and "growth" in the southern UK economy for the past 35 years.

    1. That affluent property owners in the south have been able to cash in tax-free their capital gains via reduced pension saving or remortgages or flexible mortgages has had a huge benefit for them: it has meant being able to avoid formally selling their property, thus avoiding depressing prices in their area.

      Remortgages and flexible mortgages have also hugely benefited the finance sector providing larger flows of interests and fees.

      Remortgages and flexible mortgages have also had another consequence: they are in effect ways of informally selling a property at a high "valuation" to a bank. Such sale is effectively guaranteed by the Treasury, directly or via the BoE, as it became quite obvious in 2008.

      Thus renters everywhere and property owners outside the south get to pay for the property price boom in the south in three ways:

      * If they want jobs in the south they have to pay high rents or property prices.
      * The capital gains cashed in by southern property speculators have created a huge "Barber boom" that has led to high imports and eventually a falling pound which has hit hard their living standards.
      * The enormous sums paid to protect southern banker jobs and their bonus pools have been partially compensated by lower spending on poor areas and poor workers, as all UK residents, not just the beneficiaries in the south, are liable for the banking system losses; of course recent governments have preferred lower spending on the poor to higher taxes on the affluent because these two categories are very differently distributed between south and the rest of the UK.

    2. As to remortgages, latest data show how important:

      «About 28,900 loans were granted to home movers in October, a 20% decrease on a year ago and 8% down month on month. Home movers borrowed £5.9bn, down 9% on a the previous month and 18% on a year ago.[ ... ]
      Remortgage activity totalled £6.1bn, up 11% on September and 7% on a year ago. There was also a rise in the number of loans to 34,700, up 10% month on month and 5% on a year ago.»

      it is easy to guess the geographical distribution of either mortgages and remortages.

      For southern property speculators the "economy" is doing very well.

  5. Dork of Cork, I remind you YET again that you are not welcome here. All comments you make will be deleted.

  6. There’s a whapping great elephant in the monetary policy room which advocates of monetary policy won’t admit to. It’s this. Given a recession, there is no earthly reason to assume that inadequate demand stems from inadequate lending, borrowing and investment, rather than an inadequate amount of one of the other constituents of aggregate demand, like exports or consumer spending.

    Second, even if it can be shown that lending, borrowing and investment declined just before a recession, they may have declined for good reasons.

    To describe monetary policy as an “emperor with no clothes” seems to me the understatement of the year.


  7. Since I have become aware of what monetary policy is, I have seen how the likes of Carney and Osborne colluded to inflate a giant asset bubble.

    My personal experience has been that existing owners of property in and around London have made more from their property than they could in several lifetimes of saving money from their normal jobs.

    The result is now that a whole generation is completely priced out of the market, whilst speculation has been encouraged.

    Recent monetary policy has killed social mobility and rewarded speculation. It will likely end in tears.

    1. «It will likely end in tears»

      That's a rather optimistic :-) view because it has *already* ended in tears in 2008 (first major bank meltdown and bank run for mnany decades), and yet after that the "establishment" *doubled down*!

      In part because there is strong political pressure from the City and south-east/London voters to keep property prices doubling every 10 years in the south-east and every 7 in London "forever", or a long as possible, as in "after me the deluge".

      In part I reckon because they are cynical operators, and they have guessed that the south-east will go the way of Merseyside or Tyne-and-Wear, sooner or later, when the debt bubble collapses for good, and their plan is to asset strip as much as they can in the meantime, and then keep London going as an international dirty money haven, as a kind of Hong-Kong style "entrepot".

      I guess that the overall policy is a variant of what a non-neoliberal right-winger in the USA, D Frum, describes as:
      «It’s fine to be unconcerned that the rich are getting richer, but blind to deny that middle-class wages have stagnated or worse over the past dozen years. In the aftershock of 2008, large numbers of Americans feel exploited and abused. Rather than workable solutions, my party is offering low taxes for the currently rich and high spending for the currently old, to be followed by who-knows-what and who-the-hell-cares. This isn’t conservatism; it’s a going-out-of-business sale for the baby-boom generation»

      One of my usual quotes...


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