Home > The Economics Profession, The Economy > Bubble spotting: the household investment rate.

Bubble spotting: the household investment rate.

from Merijn Knibbe

Spurred into action by the editor’s ‘call to arms’ I’ve investigated the ‘Household Investment Rate’, which might be useful as a ‘bubble spotter’, somewhat more thoroughly. In my opinion, this indicator clearly shows (see graphs below, both showing ‘Household investments’, mainly houses, as a % of GDP) that:

A. Yes, there can be housing bubbles  – ”even” in economies with a deregulated capital market (graph 1). Though I do not think that there are serious housing bubbles in Europe at the moment, it is important to emphasize this point as high-ranking individuals (the German president among them…) keep on repeating that the origins of our present mess were ‘government deficits’. The indicator clearly shows that other forces (private credit induced ‘malinvestments’) were at work (though there are of course differences between countries). And the bubbles tended to be largest in countries with a very deregulated capital market (which, by the way, is consistent with the result of IMF research). To the extent that housing investment declined in all European countries (graph 2),  it’s clear that the present slump is partly caused by a decline in demand for houses.

B. Yes, there can be housing bubbles. Considering developments in Spain, the Netherlands, Denmark and Estonia and the sheer madness in the neo-liberal prodigy Ireland, economists (including those working at private banks and at the European Central Bank) should have spotted these bubbles a lot earlier, using an indicator like this one. The information was available, economists just had to look at it.

C. Yes, bubbles can be spotted – we just have to look at the right metrics (like this one, or private debt and other ones). This should become part of the curriculum of economic departments, including of course more in-depth investigation of the countries at risk (to an extent, differences between countries might be explained by differences in demographics and rules and the like).

D. No, at this moment there are no serious bubbles on the European horizon (the high Dutch level went down further in 2010) – which is important information in its own right. A bubble on the housing market is at this moment no restraint to low ECB interest rates (as it was or at least should have been around 2005, though a land tax or German style equity rules might indeed have done a better job).

The indicator is based upon households and not on the government or companies – which is a good thing, as households are the most important economic entity in our societies. And it’s based upon gross disposable income, the amount of money available to households and one of the variables calculated in the National Accounts. Disposable Income is about equal to: GDP plus net income from abroad minus taxes minus retained earnings of companies. It’s often about 50 to 60% of GDP. It’s not the money which households can spend – anybody reading the National Accounts will notice that the amount households can spend is equal to Disposable Income plus net borrowing. But it is the amount of money which households have at their disposable to pay for current expenses as well as long-term obligations. In a theoretical sense, the indicator also shows that economists do not have to take recourse to weird and a-empirical constructs like ‘community indifference curves’ to investigate household behavior – the National Accounts actually measure what households are doing, where the money is coming from and where it’s going. No need for DSGE models – there’s a scientific alternative.

  1. Merijn Knibbe
    October 11, 2011 at 12:43 pm

    The original graphs are here:

  2. October 11, 2011 at 10:14 pm

    Yes, such realistic measures should be part of curricula, but of what discipline? Sure not plutonomics… Why, that would spoil the fun, etc… Perhaps the new subdiscipline of RWEs, ecoforensics. Now, some might call that a fancy name for good auditing, but since the discipline of auditing is an essential component of plutonomics, it is no more valid than the Big Con Game itself, which points to why there has never been an audit of the Fed. Now, who needs one? The emperor is very naked. No wonder he and his minions are shaking in their boots and bewildered. They never had to worry much about RWE before and it’s far beyond the scope of their expertise (lying & defrauding).

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