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UK growth fuelled by consumption as households again lose affection for their piggy banks

The latest data in the Quarterly National Accounts show that UK households in 2015 spent £1.152 trillion, the equivalent of 62 per cent of the country’s Gross Domestic Product (GDP). In real terms, household spending rose by 2.8 per cent in 2015 in excess of the 2.3 per cent growth observed in GDP. In the final quarter of 2015 real household spending rose by 0.6 per – the same rate of growth as that recorded for the UK economy. This was the tenth consecutive quarter of positive consumption growth and the twelfth of economic growth.

It is the consistent growth seen over the recent past in real household spending that marks it out from the other components of aggregate demand. Consequently, household spending remains the bedrock of UK growth.

Chart 1 helps to evidence the close relationship between consumption and economic growth. It picks out nicely the stark turnaround both in economic growth and consumer spending following the financial crisis. Over the period from 2008 Q1 to 2011 Q2, real consumer spending typically fell by 0.4 per cent each quarter. This weakness in consumption was mirrored by economic growth. Real GDP contracted over this period by an average of 0.2 per cent each quarter. (Click here to download a PowerPoint of the chart.)

Since 2011 Q3 real consumption growth has averaged 0.6 per cent per quarter – the rate at which consumption grew in 2015 Q4 – while, real GDP growth has averaged 0.5 per cent per quarter. Over this same period the real disposable income (post-tax income) of the combined household and NPISH (non-profit institutions serving households), has typically grown by 0.4 per cent per quarter. (NPISHs are charities and voluntary organisations.)

The strength of consumption relative to income is evidenced by the decline in the saving ratio as can be observed in Chart 2. The ratio captures the percentage of disposable income that households (and NPISHs) choose to save. In 2010 Q3 the proportion of income saved hit 11.9 per cent having been as low as 4.5 per cent in 2008 Q1. By 2015 Q4 the saving ratio had fallen to 3.8 per cent, the lowest value since the series began in 1963 Q1. (Click here to download a PowerPoint.)

The historic low in the saving ratio in the final quarter of 2015 reflects the strength of consumption alongside a sharp fall in real disposable income of 0.6 per cent in the quarter. However, the bigger picture shows a marked downward trend in the saving ratio over the period from 2012.

When seen in a more historic context the latest numbers taken on even greater significance. Chart 3 shows the annual saving ratio since 1963. From it we can see that the 2015 value of 4.2 was the first year when the ratio fell below 5 per cent. With 2014 being the previous historic low, there must be some concern that UK consumption growth is not being underpinned by income growth. (Click here to download a PowerPoint.)

Of course, consumption theory places great emphasis on expected future income in determining current spending. To some extent it may be argued that households were liquidity-constrained following the financial crisis. They were unable to borrow to support spending and, as time moved on, to borrow against the expectation of stronger income growth in the future. This would have depressed consumption growth. But, there may also have been a self-imposed liquidity constraint as the financial crisis unfolded. Heightened uncertainty may have led households to be more prudent and divert resources to saving. Such precautionary saving would tend to boost the saving ratio and so may be a factor in the sharp rise we observed in the ratio.

The easing of credit constraints as we headed through the early 2010s allied with stronger economic growth may help to explain the strength of the recovery in consumption growth. However, it is the extent and, in particular, the duration of this strong consumption growth that is fuelling a debate over its sustainability. The current uncertainty around future income growth and the need for households to be mindful of the indebtedness built up prior to the financial crisis point to households needing to retain a degree of caution. Consequently, the debates around the financial well-being of households and the need to rebalance the UK economy away from consumer spending are likely to be further intensified by the latest consumption and saving data.

Data
All data related to Quarterly National Accounts: Quarter 4 (Oct to Dec) 2015 Office for National Statistics
Office for National Statistics Office for National Statistics

Articles
Britons raid savings to fund spending as economists warn recovery ‘built on sand’ Telegraph, Szu Ping Chan (31/3/16)
UK Growth Higher But Deficit Hits New Record Sky News, (31/3/16)
Britain is a nation that has forgotten how to save Telegraph, Jeremy Warner (31/3/16)
A vulnerable economy: the true cost of Britain’s current account deficit Guardian, Larry Elliott (31/3/16)
U.K. Manufacturing ‘In the Doldrums’ Leaves Growth Lopsided Bloomberg, Emma Charlton (1/4/16)
Pound drops as UK manufacturing languishes in the doldrums Telegraph, Szu Ping Chan (1/4/16)

Questions

  1. Why is the distinction between nominal and real growth an important one when looking at many macroeconomic variables.
  2. Examine the argument that the historic low saving ratio in the UK is a cause for concern.
  3. What factors might we expect to impact on the saving ratio?
  4. To what extent do you think the current growth in consumer spending is sustainable?
  5. How important are expectations in determining consumer behaviour?
  6. Explain what you understand by consumption smoothing.
  7. Why would we would typically expect consumption growth to be less variable than that in disposable income?
  8. Why might consumption sometimes be observed to be less sensitive or more sensitive to income changes?
  9. What factors might cause households to be liquidity constrained?
  10. What is precautionary saving? What might affect its perceived importance among households?
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