by Yanis Varoufakis
How can real income growth
reflect a deepening recession?
Real National Income (or Real
Gross Domestic Product) is the ratio of (i) Money National Income (or Nominal
Gross Domestic Product) and (ii) an index of Average Prices.
In short, R = N/P (where R =
real income, N = money income and P = an index of average prices)
Clearly, real income is a
metric created so that, if all prices (P) and all money incomes (N) change by
the same proportion, real income (R) does not change, thus reflecting the real
of constant purchasing power. By construction, therefore, R only rises (falls)
when money income grows faster (more slowly) than average prices.
It is easy to show that an
economy’s real income growth rate is equal to the growth rate of money income
minus the proportional rate of change in average prices (i.e. of the inflation
rate) – See this Appendix for
the proof.
In short, g = m – p where
g is the proportional rate of
growth of R
m is the proportional rate of
growth of N, and
p is the inflation rate, i.e.
the rate of increase in P).
In plain words, when money
income grows faster than inflation (i.e. m>p) real incomes grow.
There are two conclusions to
draw from the above, depending on whether we live in inflationary or
deflationary times:
Conclusion 1: In inflationary
times, for real income to grow money income must be growing even faster
Proof: Since g = m – p, if p
is positive (reflecting rising average prices P), then real income (R) rises
(i.e. g>0) if and only if m>p>0
Conclusion 2: In deflationary
times, it is possible for real income to grow while money income is shrinking
Proof: Since g = m – p, if both
m and p are negative numbers (reflecting falling money income N and falling
average prices P), R grows (g appears positive) as long as prices are falling
faster than money income is rising (i.e. 0>m>p).
Moral of the story
When a depression gets deep
enough, real income can appear to be rising!
What does this mean? It means
that deflation has become so bad that money income continues to fall but not as
fast as average prices.
But is a shrinking money
income a problem when real income rises? Yes, falling money income is always terrible
news if households, government and companies labour under significant debt.
Private sector debt never falls of its own accord since indebted companies and
households are never offered a negative interest rate by their creditors. This
means that, when money income shrinks in an economy where firms, families and
government are seriously indebted, the economy is pushed into wholesale
insolvency. (The fact that prices are falling faster than incomes may make
goods and services more affordable but does not help individuals and the
government who are sinking deeper and deeper into debt, their debt-to-money
income ratio rising inexorably.)
In summary, in a deflationary
economy comprising indebted households, firms and government, real income
growth is utterly consistent with a Great Depression and a steady path toward
wholesale insolvency (of the indebted parties).[1] Only when real growth (g) exceeds the
rate of deflation (d) do money incomes recover during deflationary times.
Illustration: The cases of
Greece and Cyprus
Greece
The conventional ‘wisdom’ that
the financial press, the troika and the EU institutions have been peddling is
that: (1) Greece was recovering during 2014 and (ii) our Syriza government’s
election in January 2015 led to a ‘return to recession’.
The truth begs to differ. Let
us begin with the data from 2014. Yes, real income growth returned to Greece
for the first time since 2008. The annual value of g came in at 0.8%, the first
positive number in several years. However, 2014 remained a deeply deflationary
year, with p=-2.6% (as measured by the nation’s official GDP deflator). Given
the formula in (1), i.e. g = m – p, it turns out that money incomes shrunk
during 2014 at a rate of m = g + p = 0.8 – 2.6 = -1.8%
Turning to what happened after
our election on 25th January 2015, and during the second quarter of 2015 (which
coincided with my tenure at the Ministry of Finance – March to June 2015), the
data tells us that g = 0.3% and p = -1.28%. From (1), we derive m = g + p = 0.3
– 1.28 = -0.98%.
In other words, the reality
(and at odds with the troika’s propaganda) is that Greece was not recovering in
2014. Instead, throughout 2014 Greece continued to languish in its Great
Depression (its money income falling by 1.8%). Moreover, during our combative
negotiations with the troika in the spring of 2015 (the purpose of which was to
re-negotiate the cause of our Depression, i.e. the recessionary fiscal
consolidation program that the troika had imposed upon Greece), money incomes
continued to fall but at a reduced rate. The recession of course accelerated
again when, on 30th June 2015, the troika, in its bid to asphyxiate our
government, closed down Greece’s banks!
Cyprus
In recent weeks, Brussels and
media that take their cue from the EU’s institutions have been singing the
praises of Cyprus’ emergence from recession. Yet again, the truth insists of
differing. According to the official statistical service of the Republic of
Cyprus, real growth was g = 0.4% in the last quarter of 2015 (October to
December). However, during the same quarter, the rate of deflation was d =
0.75%. From equation (1), it is clear that the Cypriots’ total money (or euro)
income fell by 0.35% (m = g-d = -0.35). For a small nation languishing under a
total debt that is three times the level of its money income[2] (and with more than 60% of all bank loans
being non-performing), any celebration of Cyrpus’ recovery is seriously
premature.
[1]
Deflation is terrible for another reason too: Once people expect prices to keep
falling, they have an incentive to postpone purchases of durables (choosing to
wait until their price falls further). But this is catastrophic for the
producers of these durables who now postpone investment, pushing aggregate
demand lower and therefore accelerating the rate of deflation. Combined with
the increasing debt-to-income ratios, this development locks the economy into a
debt-deflationary doom loop.
[2]
Government debt equals 108% of GDP and household debt an astounding 202% of
GDP.
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About yanisv
Professor of Economics at the
University of Athens
