Thursday, March 8, 2018

How finance became "productive"

National accounts have been recast since the 1980s to present the financial and real estate sectors as “productive”.

Remember UNSNA?
UNSNA is UN SNA, the United Nations System of National Accounts. Like NIPA. Except "NIPA" is pleasing to the ear, and "UNSNA" sounds like something you'd wipe off with a kleenex.
In a recent post JW Mason happened to mention problems of measurement in the financial sector. So of course I clicked the link.

Brings up a download page at IDEAS for Financial Output as Economic Input: Resolving the Inconsistent Treatment of Financial Services in the National Accounts by Jacob Assa. 28-page PDF. I like.

Excerpts from page 4:
Financial intermediation has long been problematic to measure. Christophers (2011) describes the history of the so-called ‘banking problem’ - the fact that, without imputations, the value-added of the financial sector (that is, output minus intermediate consumption) would be negligible or even negative (since if its costs are deducted from fee-based revenues alone, the former would often exceed the latter). At a first stage in the history of this question (SNA 53 and before), all financial intermediation activities were excluded from calculations of national output based on the value-added approach, since they were considered to be mere transfers of funds (similar to social security payments) and hence unproductive.
An intermediate approach followed with the SNA 68, where the output of the financial sector was considered to be an input to a notional (i.e. imaginary) industry which has no output. In spite of the bizarre nature of this approach, “ascribing a negative income to an imaginary industry sector...has probably been the most used for financial intermediation services in the entire history of Western national accounting” (Christophers 130).
A useful example is the Gross Value Added (GVA) of the UK financial sector in 2003, which would be £39.8 billion under SNA 1968 (4.1% of total GVA). The imputed banking service charge (IBSC), however, was a negative £45.9 billion. Under SNA 1953 the financial sector would have thus shown a negative £6.1 billion value added. “Adopting SNA 1968 had, in effect, made UK finance productive” (Christophers 130, emphasis in original).
[He shows a table, which I have omitted.]
Finally, with the 1993 SNA, financial intermediation became an explicitly productive activity, for which value added is imputed based on the net interest received by financial institutions (the FISIM approach).
The latest revision, SNA 2008, extends the boundaries of SNA 1993 to include ever more exotic financial ‘products’.

The "Christophers" reference is
Christophers, B. (2011). Making finance productive, Economy and Society, Volume 40 Number 1, February: 112-140.

Part 1 of 4


  1. Art

    “National accounts have been recast since the 1980s to present the financial and real estate sectors as “productive”.

    I think that is right

    CPI views housing units as capital (or investment) goods and not as consumption items. Spending to purchase and improve houses and other housing units is investment and not consumption.

    Economics see capital or investment as productive. CPI treats Houses like buying a new CNC machine, but only better because you do not have to account for the depreciation as the asset wears.

    Here is a funny thing about lowering interest rates, a $900 dollar payment at 6% interest you can spend about $150,000 on a house @ 30 years fixed. Interest moves to 3% you now can afford spend $213,000 which is a 40% increase in purchasing power (Sweet).

    You cannot see this in the CPI since the early 1980’s when they started using OER. For homeowners, the CPI series on Owners’ Equivalent Rent (OER) is designed to gauge how much homeowners’ shelter costs contribute to changing prices. This is particularly difficult since, unlike other goods such as groceries or cars, most homeowners’ monthly housing costs do not change much on a month to month basis due to the prevalence of fixed-rate mortgages and in a de-escalation interest rate environment a house can cost more but monthly housing cost to finance do not grow at the same rate.

    It is easy to spot where most of the inflation is and when rates start to go up where most of the deflation will be. The unfortunate thing is many individual have a lot of net worth tied up in their homes.

  2. You think the financial sector is productive? I would have to be convinced.

    Saying "I'd gladly pay you Tuesday for a hamburger today" does not make hamburger flipping part of Finance. Why is Real Estate part of Finance/"FIRE"? I can see including Insurance in there, because the only product of Insurance is money.

    BLS says:
    "Houses and other residential structures are not consumption items and, therefore, should not be CPI items."
    But that is an announcement, not an explanation. They support that statement by asserting a definition:
    "All buildings and structures are capital goods, which are items that provide a service."

    But I don't think that definition is right. Anything can be a capital if you use it to make money. If you DON'T use it to make money, it's not capital. That's the definition, as I understand it.

    If I am flipping houses for profit, MAYBE the houses are capital goods. Maybe not. The hamburger Wimpy wants is not a capital good, right? It's the product.

    I see Tim Iacono says:
    "And any economist who argues that OER better captures the "utility" component of housing or nonsense such as this, please, just stop it!"

  3. Art

    "You think the financial sector is productive? I would have to be convinced."

    No I do not think the FIRE sector is productive, but the statement was

    “National accounts have been recast since the 1980s to present the financial and real estate sectors as “productive”.

    Which I think is accurate.

    Prior to 1982 we treated homes as something we consume really did not care about how it was paid for. Only cared what was paid. Like buying a car, paying for education, medical expenses. When we borrow to buy these things and it causes inflation the change is seen in the CPI.

    So messing with interest rates does not necessarily get you more purchasing power.

    Changing in the 1980 CPI, OER calculates what it cost you to live in your home and cares nothing about what you paid for it. The increase in the cost of the home can be overcome with interest rate reductions, which increase wealth.

    The only constraint is how much the FIRE sector will let everyone borrow.

    IMO this changed was struck from the panic about SS in the 1980’s due to COLA provisions.

    MDOAH show the last peak at 2nd 2008 14.795 trillion and DGS10 3.9%. As of 3rd 2017 14.746 Trillion and DGS10 2.2%. 4th 2017 shows DGS10 at 2.4%

    Maybe all in is 15 trillion at rates above 2%; since Real Median Household Income in the United States is slightly up from 2007.

    If 15 Trillion is the top then what happens, especially if interest rates move up, IMO is the question that needs to be answered.

    I know what happened last time, but then again the FED was not set up to pay IOR which allows the them to expand its balance sheet as lender of last resort.

  4. Sorry, I wasn't sure if you thought that Bezemer & Hudson's observation was right, or that "recasting" to make finance "productive" was the right thing to do. Duh! Thanks for the clarification!

    I'm glad you won't be trying to convince me that finance is productive! :)

    I remember you talking about "Owners' Equivalent Rent" a few months back. Dunno if I ever heard of it before that, though. You seem to understand it pretty well. Way better than me, anyhow.

    Yeah. You mention "the panic about SS in the 1980’s due to COLA provisions" as the reason OER was added to the CPI calculation. I agree. When they can't fix the economy, they fix the statistics instead.

    And thanks for bringing that up. I remember two stats changes being in the news: one from the Reagan era and one from the Clinton years. One a change to the inflation calculation, and one a change to the unemployment calculation. This has come up before and I pretty well pinned down that the change in the 1990s was an unemployment tweak.

    Now you clarify for me that the change in the 1980s was definitely an inflation tweak.

    Judging by the Bezemer & Hudson quote and the Jacob Assa excerpt above, that little inflation tweak turned out to be a very big change after all.


    Regarding MDOAH: The default FRED graph shows the peak at Q2 2008. It also shows a slowdown at Q3 2006. That slowdown was an early warning. I don't see a similar warning in the data after the Great Recession.

    Also the rate of increase in the last couple years appears to be much slower than it was between 2003 and 2006. So the debt level may not be a problem yet.

    Hopefully there are few "adjustable rate" mortgages still around.

    I have seen quite a few graphs that show a slowdown in 2006, maybe even 2005. I don't remember what data I was looking at, but graphs like that might offer better forewarnings than the Mortgage Debt graph.

    It is terribly high though, the mortgage number.

  5. Art

    In regards to your statements on policy issues surrounding Private Debt Levels; how do you think the dialog and discussion would be if Real Disposable Personal Income included the cost of what a house cost to buy and not what it cost to rent.

    Interested in your thoughts.

  6. Well I have to think that CPI is lower than it would be if OER was never adopted. I wonder if that Shadow Stats site figures CPI the old way.

    Actual rents probably keep pace with home prices, no?

    Even during a housing bubble, the average person doesn't buy a house very often. It seems changes in home prices would be a slow-moving component of the CPI. That doesn't seem to be how it worked out, though. Probably because it is a LARGE component.

    Beyond those few stray thoughts, I don't know what to think about it.

  7. "Actual rents probably keep pace with home prices, no?"

    Good question.

    I would say no. What do you think? If OER had track anywhere near housing prices what do you think the FED policy on interest rates would have been from 2000 to 2006.

  8. I think that if housing rent tends to rise faster than housing prices, then people will rent less and buy more. Other factors of course have an effect: interest rates and the ability to save for a down payment, for example. And house flipping. But ceteris paribus, rising rent will drive people into home ownership. And ceteris paribus, I think the move toward home ownership would reduce rent and increase home prices, leading to rents that keep pace with home prices.

    I know: The practical world is not a "ceteris paribus" place.

    Google attributes this graph to the washington post. The graph says "mortgage payments have become more affordable relative to rents". But when I look at the "mortgage payment" on their graph I see interest rates, not house prices.

    Looking at your graph I say yeah, they should have raised rates to follow Case-Shiller. But then I add the rate of inflation to your graph and, from 2000 to 2004 inflation is going DOWN. Your blue line looks to be a good match to my green from mid 1998 to August 2006. If I am guided by the PCE price index, I don't worry about Case-Shiller.

    If I am guided by NGDP (as Scott Sumner is) I don't worry about anything until mid 2006. By then, it is too late.

    When Case-Shiller is high, the CPI shows more increase than either the PCE price index or the GDP Deflator. If OER had gone up with housing prices after 2000, then probably the CPI would have looked outlandishly high in comparison to the PCE index and the Deflator. The CPI would have looked wrong.

    But I don't know. This is the first time I'm looking at this stuff. I'm going more for context than detail. And maybe I'm leaving a lot out.

    Interesting stuff.