When prices start falling across the board (as has been happening in Japan) people delay consumer and capital spending with the expectation that the same goods can be purchased more cheaply later. The resulting decrease in spending fuels the price decline. The IMF appears to be clueless as usual:
The IMF's World Economic Outlook looks at the impact of recent stock price falls around the world on real economies and concludes that the fall in consumer spending associated with market declines could reduce GDP growth by one percentage point in the US and in Britain, and by one quarter of one per cent in Europe and Japan (where equity markets are less important in the overall financial scheme of things).
Oddly, however, the IMF takes comfort in the fact that 'buoyant housing markets' in the US and Europe are having a compensating effect by boosting consumption. Much of this consumption is financed by leveraging the equity in house price gains and if property markets fall - as many fear they will (hence the popularity of deflation as a dinner-table conversation topic) - then that equity will disappear. Meanwhile, the bank lending based upon house price gains could produce a rash of new non-performing loans (NPLs).
The real estate bubble has actually been fed by the bursting of the stock market bubble as investors have rushed for the supposed safety of real estate ownership:
According to the Milken Institute in Los Angeles, asset bubbles tend to both enhance and cannibalize each other. Profits from surging tradable securities are used to buy property and drive up its values. Borrowing against residential equity fuels overvaluations in fervid stock exchanges. When one bubble bursts, the other initially benefits from an influx of funds withdrawn in panic from the shriveling alternative.
Quantitatively, both in Britain and the U.S., a considerably larger share of the nation's treasure is tied in real estate than in the capital markets. Yet, the infamous wealth effect -- an alleged fluctuation in the will to consume as a result of changing fortunes in the stock exchange -- is equally inconspicuous in the realty markets. It seems that consumption is correlated with lifelong projected earnings rather than with the state of one's savings and investments.
This is not the only counterintuitive finding. Asset inflation -- no matter how vertiginous -- rarely spills into consumer prices. The recent stock market bubbles in Japan and the U.S., for instance, coincided with a protracted period of disinflation.
Central bankers need to come to the realization that asset price inflation can cause as much damage as consumer price inflation.
|Share |||By Randall Parker at 2002 September 27 01:04 AM Economics Political|