Tuesday, 13 August 2013

The Carney Short Straddle*

From that recent paper...

We find that rises in the home- ownership rate in a U.S. state are a precursor to eventual sharp rises in unemployment in that state...

What mechanism might explain this? We show that rises in home-ownership lead to three problems: (i) lower levels of labor mobility, (ii) greater commuting times, and (iii) fewer new businesses. Our argument is not that owners themselves are disproportionately unemployed. The evidence suggests, instead, that the housing market can produce negative 'externalities' upon the labor market. The time lags are long. That gradualness may explain why these important patterns are so little-known.

Let's add a possible explanation (iv) to that list as follows:

Politicians mainly want to stay in power, so they target the median or marginal voter; tyranny of the majority etc.

* Two-thirds of adults in the UK are owner-occupiers, so tenants don't matter (especially as most politicians seem to be BTL landlords nowadays).
* The bulk of owner-occupiers and landlords subscribe to the insane assumption that rising house prices make them richer.
* Two-thirds of working age adults in the UK are in work, so the unemployed don't matter.
* A third of voters are pensioners, but their votes can reliably be bought with promises of higher state pensions next year, they play little further part in the debate. Low interest rates are a two-edged sword - they don't like losing income from their savings, but they can be bribed with rising house prices the same as everybody else.

The largest easily identifiable sub-set of lowest-common-denominator target voters is thus owner-occupiers who are in work who believe that rising house prices make them richer, and the majority of these also have a mortgage and little in the way of savings.

The new Bank of England governor (who is of course entirely independent and did not discuss and agree this with the government beforehand) came up with a fantastic win-win strategy:

The promise that interest rates would not go up as long as unemployment stays fairly high!

The median target voter might be ever slightly worried about losing his job but as long as that is fairly safe, his next biggest concern is the amount he has to pay on his mortgage every month (or so the thinking goes).

Broadly speaking, the median target voter couldn't care less about other people who are unemployed because "it's all their fault" and he has little interest in there being an increase in employment because he already has a job; but now he has every interest in there being no increase in employment (or fall in unemployment) because high unemployment guarantees him a monthly windfall gain of several hundred pounds - as well as pushing up house prices (DoublePlusGood).

So in political terms, assuming that it is these median target voters who decide the outcome of the next general election, the UK government has absolutely zero interest in getting unemployment down.

There's your explanation (iv) on a plate.
* People have often referred to the Greenspan/Bernanke Put, which basically says that if share prices or land prices threaten to fall, interest rates will be cut to push them back up again. So they guarantee a floor price for owners of shares or land.

What the UK government is doing is now akin to a Short Straddle. They are gambling on everything staying pretty much the same - high unemployment (but not so high as to cause social unrest - blaming the unemployed for unemployment only gets you so far) combined with low interest rates.

If everything stays much the same, they are quids in. it's only if it tips too far in either direction, they are in big trouble, but they won't be the ones paying to sort out the mess, so what do they care?