The Unassuming Economist

According to the latest IMF’s annual report on Sweden, the residential real estate cycle may have reached its long-predicted peak in Sweden. Housing starts halved over 2011 while the real prices dropped substantially in the second half of 2011 (-3.5 percent cumulatively) and remained flat in 2012 Q1 (q-o-q). The surge in late 2010 and early 2011, following the decline through 2008, appears to have been due to buyers taking advantage of the low interest rate environment and to the abolition of the real estate tax in 2008 in favor of a municipal tax set at the lower of SEK 6,825 (around 969 euros) or 0.75 percent of the property’s assessed value. Indeed, in the two years to 2011 Q2, residential investment (+37 percent) took off again, contrary to more muted developments during the previous recovery, offsetting the sharp drop in new homebuilding experienced during the global crisis.

Going forward, several factors may indicate further downward pressure on house prices. First, price-to-income and price-to-rent ratios remain 1.1 and 1.4 standard deviations respectively above historical averages. Second, staff’s model-based estimates from the Early Warning Exercise (EWE) and Vulnerability Exercise for Advanced Countries (VEA) suggest an overvaluation around 11–12 percent, exceeding the 10 percent threshold. (The EWE real estate model combines these three indicators to create a heat map for house price valuation.) Moreover, the predicted path of house prices based on WEO income projections suggests a decline of almost 5-6 percent through 2017.

These indicators put Sweden among the advanced countries where a house price correction is most likely to take place. Yet, the point estimate for the house price disequilibrium (the difference between actual prices and estimated equilibrium or long-run prices) is not large by historical standards, and Sweden ranks only 9th among 22 advanced economies in the VEA sample in terms of potential overvaluation. Furthermore, other components of residential real estate vulnerability (namely, potential impact on GDP, household balance sheets, and mortgage market characteristics) remain moderate or low in Sweden, compared to other advanced economies. That said, with most mortgages being “rollover” mortgages with terms of at most five years, any future interest rate increases could put additional strains on already highly indebted households.

The energy market in 2011 was characterized by disruptions and continuity. Political unrest and violence caused outages in oil and gas production in parts of the Arab world. On the other hand, the world economy benefited from an exceptional swing in European weather, the first release of strategic petroleum reserves since 2005 and an increase in OPEC production.

Christof Rühl, Group Chief Economist of BP spoke to the Fund staff on June 14.

Photo: Michael Spilotro/IMF

Last year, the Arab Spring caused significant interruption in the production and supply of oil. For example, the cessation of Libyan oil exports alone removed 1.2 millions of barrels per day of crude oil for the year. Moreover, in April, the earthquake in Japan damaged the Fukushima nuclear reactor which led to closures of nuclear plants in Japan and Europe. This resulted in losses of 43 millions of tons of oil equivalent, which is more than 11 percent of the European oil consumption. In 2011, average annual Brent prices increased by 40% to reach $111 per barrel. On a related note, huge floods in Australia impaired coal production.

So, with all the chaos, how did the energy market remain resilient? There was the first release of strategic petroleum reserves since 2005. There was a petroleum sale of 30 million barrels non emergency to offset disruptions caused by political upheaval in Libya and elsewhere in the Middle East. The amount was matched by IEA countries for a total of 60 million barrels released from stockpiles around the world. Also, there was the largest increase in OPEC production since 2008 and a mild winter in Europe.

In 2011, energy consumption stayed steady in Non-OECD countries, while it declined in OECD countries. Non-OECD energy consumption stayed firm, in contrast, OECD energy consumption fell by 0.8 percent, despite average GDP growth. Energy consumption in OECD countries has declined in three out of the last four years. Why last year? First, the impact of high oil prices everywhere and of high coal and gas prices outside the US. Second, the decline was due to the impact of Fukushima nuclear disaster. And third, Europe experienced a mild winter in 2011 compared to 2010.

What was the impact of high oil prices on oil importers? The overall effect of how high oil prices affect oil importers depends on how oil exporters use the additional income generated by higher prices. This extra income can be recycled in two ways – they can spend it to purchase goods and services from oil importing countries, this will offset the high import bill in oil consuming countries or they can spend it by purchasing foreign assets which increase the global supply of savings leading to low interest rates and low borrowing costs around the world. But, with interest rates close to zero, this option loses its meaning.

Photo: Michael Spilotro/IMF

Photo: Michael Spilotro/IMF

Photo: Michael Spilotro/IMF

Eric Swanson reports on the San Francisco Fed macro conference:

“Breaking down changes in output or employment into structural and cyclical components is very difficult, since these elements are not directly observable. Two papers at the conference applied cutting-edge methods to this question, providing estimates of the structural and cyclical components of the 2007–09 recession’s large employment and output declines.

Chen, Kannan, Loungani, and Trehan use differences in stock market returns across industries to help identify the magnitudes of cyclical and structural shocks to the economy … Chen and coauthors collected cross-industry stock return data from 1962 to 2011, which they use to construct an index of stock return dispersion across industries. The authors then estimate the typical response of output and employment to sudden changes in this index, providing an approximation to the effects of structural shifts on the economy. The authors find that such structural shifts account for about 25% of U.S. output and employment fluctuations since 1962. The remaining 75% is due to cyclical factors.”

Read the rest of Swanson’s excellent summary here. The Chen, Kannan, Loungani and Trehan paper is available here.

By John M. Biers

A big drop in oil prices due to a global economic slowdown constitutes a bigger worry than the relatively high price floor for oil that has prevailed recently period, an International Monetary Fund analyst said in an interview this week.

Oil prices have dropped roughly 20% in recent weeks amid weak jobs data and other economic indicators that have renewed fears of a global slowdown, yet remain high by historical standards, lingering around or above $100 a barrel Brent since January 2011.

In remarks that provided a view of how the IMF sees the oil market, Prakash Loungani said the global economy has adapted to a relatively high oil price floor as long as it isn’t caused by an unexpected supply disruption. But Mr. Loungani said the agency now fears a big drop in prices because it would likely be accompanied by a major global economic slowdown.

“The worry is that the economies are looking soft, both the U.S. and major emerging economies,” said Mr. Loungani, an advisor in the research department of the IMF who handles commodities research.

“We are very worried about the state of the world economy,” Mr. Loungani said in a telephone interview.

Thursday, ICE July North Sea Brent crude was 1.2%, or $1.23, higher at $101.87 a barrel. Light, sweet crude oil for July delivery was up 1.6%, or $1.34 higher, at $86.38 a barrel on the New York Mercantile Exchange.

Mr. Loungani said a relatively high oil price isn’t in itself a huge concern for the economy. The influential Saudi oil minister, Ali al-Naimi, said recently he wants oil prices around $100 a barrel. Other countries in the Organization of Petroleum Exporting Countries now also look for triple-digit oil prices, leaving the $22-$28 a barrel price band once favored by the cartel as a distant memory.

Mr. Loungani pointed to IMF research that has shown how the world has adapted to relatively high oil prices due to a number of factors. For one, much of the reason for higher oil prices rests on rising demand in emerging economies; in that case, the benefits of strong growth outweigh the negatives of higher oil prices.

Other mitigating factors to high prices include more sophisticated central bank policies that guard against oil-related inflation growth; greater efficiency in the use of energy in the economy; and greater diversification in energy supplies.

“The trends are in the direction of reduced impact” on the economy from higher oil prices, Mr. Loungani said. “The structure of the economy has adjusted.”

However, Mr. Loungani said the global economy can still be harmed by sudden price spikes if they are caused by unexpected supply disruptions, because “the economy still doesn’t have the means to handle that in the short-term.”

Some economists have highlighted the role that higher oil prices played in the global 2007-2008 slowdown related to lower disposable income. At the time, the dominant explanation for the slowdown concerned the bursting of the U.S. housing bubble and the ensuing financial crisis.

Mr. Loungani said he has been persuaded that “oil prices may have played a role” in that slowdown, but he said the current weakness relates more to lingering financial weakness and the ongoing euro zone crisis.

Write to John Biers at john.biers@dowjones.com