Comments: Sunday reading

"The Sunday Telegraph's main story is that voters think "excessive" City bonuses should be curbed. Peter Hain, challenging for Labour's deputy leadership, has said a portion of City bonuses should be given to charity. Is a head of steam building on this one?"

People get very excited about the bonus season and with good reason. But in my view to attack the bonus system is to attack the symptom and not the cause. The bonus system is a result of monetary policy. Because rates are so low it means that there is a concentration of wealth held in fewer and fewer assets. This concentration is caused by depriving money of its investment status by making the income to be earned from money much less than the market rate. Because of this wealth is attracted to fewer and fewer assets which can be leased out to the market. These assets can be leveraged at below-market rates to earn even further profit. What we need is a free market for interest rates.

ps Have you been on holiday David, I watched the inflation report webcast and did not see you there!

Posted by the_austrian at February 18, 2007 05:50 PM

Yes, I was away. Two of the four quarterly inflation reports fall at inconvenient times - February tends to coincide with school half-term, while August is at peak holiday time. I've never been entirely sure why the Bank chooses these months rather than, say, March, June, September, December.

Posted by David Smith at February 18, 2007 07:41 PM

This post is in part related to Geoffrey Dick's article.

I ran the personal inflation calculator on the govt stats site.
My personal rate of inflation was 4.5%.

But the RPI hides the long term effect of increased property purchase price.

To illustrate this, I ran some spreadsheets to calculate exactly how much worse off the RPI mechanism makes the average wage earner buying the average priced house. Taking into account house price inflation since 1996.

I calculated this for the full period of the mortgage (25 years).

I used a benign interest rate of 4% and wage inflation of 2%.

I then calculated the percentage of salary taken up with repaying the mortgage (including capital) over a 25 year term.

I did this for two cases:
[1] If house prices had risen by RPI between 1996 and now.
[2] The actual rise in house prices between 1996 and now.

Without going into the figures in detail, the answer for case [1] is 11%. For case [2] it is 25%.

That means if house prices had risen with RPI since 1996, only 11% of total income would be spent repaying the mortgage.
But with the actual rise in house prices, 25% of income is required to pay off the mortgage. Over the total 25 years of the mortgage.

The impact of the rises in property prices is long term. It makes people poorer over tens of years.
Low inflation and low wage increases keep them there.

RPI deals well with short term fluctuations in interest payments. It hides the long term effects.

Which is why I didn't attach great significance to discovering my 4.5% personal RPI rate.


PS :

Here is more detail on the workings:

Average house price (as of a few months ago) is 179,000.
If it had risen by RPI since 1996, it would be 80,500.

I chose a wage of 36,000 per annum, rising by 2% per annum.

Assumed 4% interest rate, 2% wage inflation.

Flattened capital repayments to 3200 per annum for [1] (80,500 / 25yrs)
Flattened capital repayments to 7200 per annum for [2] (179,000 / 25yrs)

Interest payable calculated without compound interest on capital remaining at start of year.
Overall percentage of wages taken up is calculated as average of percentage for each year over the 25 years.

Spreadsheet available on request.

Posted by Nick Thorne at February 19, 2007 10:03 AM

I don't disagree with your calculations, which are interesting, but you could not expect this effect to be picked up by a single year's inflation calculation. What you could expect, given that the RPI includes a house-price component, is that it would be picked up in a higher inflation rate over the entire mortgage term.

Posted by David Smith at February 19, 2007 10:44 AM

I'm always amused by comments like this. If banks are forced to give part of their staff bonus payments to charity (or the Government, which may be the same thing), then surely the staff will just get paid more to compensate? The banks will charge more for their services and ultimately it will be the man on the street who has to fund this.

I also don't know why people get so excited by capitalism "at work". If they can justify paying their staff these sums of money, fair enough.

Posted by Peter Allen at February 19, 2007 07:33 PM

I calculated the component of RPI that caters for house prices. Namely mortgage interest payments, weighted between 39 and 50 points from 1000.


I did this for RPI level increases in house prices from 1997 to 2006. And then for actual increases in that time.

The effect on the RPI of the house price increases over that time are as follows: e.g. for 1997, RPI was increased by 0.62% due to increases in house price.

1997: 0.62%, 1998: 0.44%, 1999: 0.36%, 2000: 0.34%, 2001: 0.28%, 2002: 0.23%, 2003: 0.22%, 2004: 0.28%, 2005: 0.16%, 2006: 0.29%

So, the answer to your comment is yes, the RPI was increased by an amount, but corresponding increase in wage rises would fall well short of compensating for the long term increased capital repayments.

Posted by Nick Thorne at February 21, 2007 09:56 AM

I think there may be an element of double-counting in your calculations. If you look at the RPI weights you'll see an item called depreciation. That, though it's not obvious from its name, is the direct house-price element.

Posted by David Smith at February 21, 2007 10:43 AM
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