How to stop a house fire

Key points

• US “excess demand for goods” played a key role in the emergence of global bottlenecks
• Even cut in half, Joe Biden’s green and social package will have a noticeable impact on the deficit next year
• Some at the ECB are looking at house prices through monetary policy lens. Focusing on the French example, we think it still makes sense to allow macro-prudential measures to work their way first.

At the peak of the pandemic the shift in household consumption towards goods often supplied via long and tortuous global value chains, to the detriment of services, has been a key driver of the emergence of bottlenecks and the ongoing inflation spike. We think we need to be more granular though. In Europe or In Japan, while the share of goods in household spending has indeed risen, the volume of this form of consumption did not increase relative to the pre-pandemic level. The US, conversely, has seen the steepest rise in consumption of goods ever recorded in the national accounts since they have been made available in 1947, standing in the third quarter (Q3 2021) at 15% above the Q4 2019 level. Given the still dominant role US consumption plays (30% of the world’s consumer spending in nominal US dollars), this has been a key source of tension on global capacity. The latest developments on this front are reassuring: US consumption in goods has started to recede.

The House of Representatives has finally passed the shrunk version of Joe Biden’s green and social package, which still needs to clear the Senate hurdle. Headlines reporting on the Crogressional Budget Office (CBO) assessment were misleading. While over 10 years its impact on the deficit would be very small, in the first few years it will be noticeable (0.7% of GDP for 2022). True, even combined with the investment programme passed earlier this year it is a much smaller stimulus than the packages of the last two years. However, a lot of the 2020 and early 2021 stimulus has been stored in the form of excess household saving, which constitutes an interesting “reserve of demand” ahead.

Fast-rising house prices seem to be ranking high in the European Central Bank (ECB)’s preoccupations. We were intrigued by Isabel Schnabel’s statement on the possibility it could affect the central bank’s reaction function. We estimated a simple model of French house prices to explore the issue. Our conclusion is that the ECB should start by giving time to macro-prudential measures before using the blunt tools of monetary policy to try to curb house prices. The direct contribution of interest rates to the further rise of the last few years has been modest. The steps taken by Banque de France to stop the lengthening of mortgage terms and cap the share of disposable income which can be spent on mortgage servicing seem to start having some dampening effect.