Interest rates have, for some years, been the main tool of monetary policy and of steering the macroeconomy. Across the world interest rates were lowered, in many cases to record lows, as a means of stimulating economic growth. Interest rates in the UK have been at 0.5% since March 2009 and on 2nd May 2013, the ECB matched this low rate, having cut its main interest rate from 0.75%. (Click here for a PowerPoint of the chart.)

Low interest rates reduce the cost of borrowing for both firms and consumers and this in turn encourages investment and can boost consumer expenditure. After all, when you borrow money, you do it to spend! Lower interest rates will also reduce the return on savings, again encouraging spending and for those on variable rate mortgages, mortgage payments will fall, increasing disposable income. However, these above effects are dependent on the banks passing the ECB’s main interest rate on its customers and this is by no means guaranteed.

Following the cut in interest rates, the euro exchange rate fell almost 2 cents against the dollar.

Interest rates in the eurozone have been at 0.75%, but a 0.25 point cut was widely expected, with the ongoing debt crisis in the Eurozone continuing to adversely affect growth and confidence. A lack of trust between banks has also contributed to a lack of lending, especially to small and medium sized enterprises. The ECB has injected money into financial institutions with the aim of stimulating lending, but in many cases, banks have simply placed this extra money back with the ECB, rather than lending it to other banks or customers. The fear is that those they lend to will be unable to repay the money. In response to this, there have been suggestions of interest rates becoming negative – that is, if banks want to hold their money with the ECB they will be charged to do it. Again, the idea is to encourage banks to lend their money instead.

Small and medium sized businesses have been described as the engine of growth, but it is these businesses who have been the least able to obtain finance. Without it, they have been unable to grow and this has held back the economic recovery. Indeed, GDP in the Eurozone has now fallen for five consecutive quarters, thus prompting the latest interest rate cut. A key question, however, will be how effective this quarter of a percent cut will be. If banks were unwilling to lend and firms unwilling to invest at 0.75%, will they be more inclined at 0.5%? The change is small and many suggest that it is not enough to make much of a difference. David Brown of New View Economics said:

The ECB rate cut is no surprise as it was well flagged by Draghi at last month’s meeting. Is it enough? No. The marginal effect of the cut is very limited, but at least it should have some symbolic rallying effect on economic confidence.

This was supported by Howard Archer at HIS Global Insight, who added:

Admittedly, it is unlikely that the trimming of interest rates from 0.75% to 0.5% will have a major growth impact, especially given fragmented credit markets, but any potential help to the eurozone economy in its current state is worthwhile.

Inflation in the eurozone is only at 1.2%, which is significantly below the ceiling of 2%, so this did give the ECB scope for the rate to be cut. (Click here for a PowerPoint of the chart.) After all, when interest rates fall, the idea is to boost aggregate demand, but with this, inflation can emerge. Mr Draghi said ‘we will monitor very closely all incoming information, and assess any impact on the outlook for price stability’. The primary objective of the ECB is the control of inflation and so had inflation been somewhat higher, we may have seen a different decision by the ECB. However, even then, 5 consecutive quarters of negative growth is hard to ignore.

So, if these lower interest rates have little effect on stimulating an economic recovery, what about a movement away from austerity? Many have been calling for stimulus in the economy, arguing that the continuing austerity measures are stifling growth. The European Council President urged governments to promote growth and job creation. Referring to this, he said:

Taking these measures is more urgent than anything … After three years of firefights, patience with austerity is wearing understandably thin.

However, Mr. Draghi urged for policymakers to stick with austerity and continue to focus on bringing debt levels down, while finding other ways to stimulate growth, including structural reform. The impact of this latest rate cut will certainly take time to filter through the economy and will very much depend on whether the 0.5% interest rate is passed on to customers, especially small businesses. Confidence and trust within the financial sector is therefore key and it might be that until this emerges, the eurozone itself is unlikely to emerge from its recession.

ECB ready to enter unchartered waters as bank cuts interest rate to fresh low of 0.5pc The Telegraph, Szu Ping Chan (2/5/13)
Draghi urges Eurozone governments to stay the course on austerity Financial Times, Michael Steen (2/5/13)
Eurozone interest rates cut to a record low of 0.5% The Guardian, Heather Stewart (2/5/13)
ECB’s Draghi ‘ready to act if needed’ BBC News (2/5/13)
Eurozone interest rates cut again as ECB matches Bank of England Independent, Russell Lynch (3/5/13)
Margio Draghi urges no let-up in austerity reforms after Eurozone rate cut – as it happened The Guardian, Graeme Wearden (2/5/13)
ECB cuts interest rate to record-low 0.5% in desperate measure to drag Eurozone out of recession Mail Online, Simon Tomlinson and Hugo Duncan (2/5/13)
ECB cuts interest rates, open to further action Reuters, Michael Shields (2/5/13)
Eurozone loosens up austerity, slowly Wall Street Journal (2/5/13)
ECB cuts interest rate, not enough to pull the region out of recession The Economic Times of India (2/5/13)
Euro steady ahead of ECB interest rate announcement Wall Street Journal, Clare Connaghan (2/5/13)
European Central Bank (ECB) cuts interest rates BBC News (2/5/13)
All eyes on ECB as markets expect rate cut Financial Times, Michael Steen (2/5/13)

The latest growth data for the UK is somewhat difficult to interpret. It’s positive, but not that positive. The Conservatives say it shows that the economy is moving in the right direction. Labour suggests it is evidence that the Coalition’s policies are not working. With a return to positive growth, the UK has avoided the triple dip recession and here we take a closer look at the economic performance of other key nations.

In the final quarter of 2012, the US economy grew at 0.4%, but in the 3 months to March 2013, economic growth in America picked up to 2.5%. Consumer spending significantly increased, growing at an annualized rate of 3.2%, according to the Commerce Department. This figure helped boost the growth rate of the US economy, as consumer spending accounts for around two thirds of economic activity.

However, the growth figure was lower than expected, in part due to lower government spending. Furthermore, there are suggestions that the positive consumer spending figures are merely a positive blip and spending will fall as the US economy moves through 2013.

If this does prove to be the case in the USA, it will do little to further boost UK economic growth, which was recorded at 0.3% for the first 3 months of 2013. The Chancellor has said that the growth figures are encouraging and are evidence that the government’s policies are working.

Today’s figures are an encouraging sign the economy is healing … Despite a tough economic backdrop, we are making progress. We all know there are no easy answers to problems built up over many years, and I can’t promise the road ahead will always be smooth, but by continuing to confront our problems head on, Britain is recovering and we are building an economy fit for the future.

While the USA and UK have recorded positive growth, expectations of growth throughout Europe remain uncertain. Spain has revised its forecasts downwards for 2013, expecting the economy to shrink by over 1%. Even after 2013, growth is expected to remain very weak, forecast to be 0.5% in 2014 and 0.9% in 2015. To make matters worse, Spain’s unemployment continues to move in the wrong direction, with data for the first 3 months of 2013, recording an unemployment rate of 27.2% – the highest on record.

However, it’s not just Spanish unemployment that is on the rise. Figures for March show that in France, 3.2 million people were out of work, a 1.2 % rise compared to February. In the UK, 2.56 million people were recorded as unemployed, representing just under 8% of the working population. The German economy continues to outperform its European partners, but eurozone growth continues to look weak for the rest of 2013.

Despite much bad news in Europe, growth in other parts of the world remains buoyant. South Korea has recorded economic growth that is at its highest level in 2 years. Economic growth was just under 1%, but construction and investment both increased, perhaps a sign of an economy starting its recovery.

The Chinese economy has seemed relatively unaffected by the economic downturn, yet its economic growth has slowed. Averaging over 10% per annum for the last decade, the growth for January – March 2013 was only 7.7%. This is a decline on the previous 3 months and is lower than expected. If the Chinese economy does begin to slow (relatively speaking), this could present the global economic recovery with an unwelcome obstacle.

Many Western economies are reliant on exports to boost their growth figures and with such high demand in China, this is a key export market for many countries. If the Chinese economy continues to slow, consumer spending may even fall and this could mean a reduction in Chinese imports: that is, a reduction in other countries’ exports to China. However, for China’s competitors, the news is better, as with China’s move from a low to middle-income country, other countries will now see an opportunity to grasp a competitive advantage in the production of cheaper products. David Rees from Capital Economics said:

Trade data show that Chinese imports of commodities, and industrial metals in particular, have been falling in recent months … That is bad news for those emerging markets in Latin America, the Middle East, and Africa that predominately export commodities to China. It is not all bad news … To the extent that China’s structural slowdown reflects its transition from low to middle-income status, opportunities will present themselves for other EMs as China moves up the value chain. We are particularly upbeat on the manufacturing-based economies of South East Asia, along with Mexico, Poland, and Turkey.

News is better in Japan, where growth forecasts have been raised to 2.9% over the same period and the economy is expected to grow by 1.5% throughout both 2013 and 2014. Furthermore, suggestions that inflation may also reach 0.7% have boosted confidence. This might be the end of Japan’s troubles with deflation.

So, we have something of a mixed picture across the world, although the IMF predicts a global rate of growth of 3.5% for 2013, which would be an improvement on 2012 figures. The following articles consider the global situation.

Spain slashes economic growth forecast Sky News (26/4/13)
UK avoids triple-dip recession with better than expected 0.3% GDP growth The Guardian, Heather Stewart (26/4/13)
US economy grows 2.5% on buoyant consumer spending BBC News (26/4/13)
Poor French and Spanish jobs data but UK economy returns to growth – as it happened The Guardian, Graeme Wearden and Nick Fletcher (25/4/13)
UK economy avoids tiple-dip recession with 0.3pc GDP growth The Telegraph, Szu Ping Chan (25/4/13)
South Korea economic growth hits two year high BBC News (25/4/13)
S. Korea economy grows at the fastest pace in two years Bloomberg, Eunkyung Seo (25/4/13)
Spain revises down its economic forecast BBC News (26/4/13)
US economy sees broad growth Financial Times, Robin Harding (25/4/13)
Germany’s private sector shrinks as Eurozone decline continues – as it happened The Guardian, Graeme Wearden and Nick Fletcher (23/4/13)
China economic growth lower than forecast BBC News (15/4/13)
China’s slowing economy: what you need to know Bloomberg Business Week, Dexter Roberts (25/4/13)
Modest Growth Pickup in 2013, Projects IMF International Monetary Fund (23/1/13)

The problem of obesity and healthy eating is a growing problem in many countries and governments have long been looking into designing policy to tackle this issue.

Some have gone for healthy eating campaigns and policies to encourage pregnant women to eat better, but one government took it a step further and introduced a Fat Tax. In October 2011, the Danish government introduced a tax on foods that are high in saturated fat in a bid to reduce consumption of these goods. However, this policy is now to be abolished.

The Fat Tax introduced by the government imposed a surcharge on foods that contained more than 2.3% saturated fat. Numerous products were affected, including meats, dairy and as expected – processed foods. The policy was criticised by scientists who said that saturated fat was the wrong target and perhaps they were proved right, but the government’s u-turn, which will now see the tax being abolished. The tax had gradually increased food prices throughout the country and authorities said that it had even put Danish jobs at risk.

With food prices much higher in Denmark with the tax, consumers switched from buying domestically produced goods to crossing the border into Germany and purchasing their cheaper food. This undoubtedly had an adverse effect on the Danish economy, as it represented a cut in consumer expenditure. Perhaps it also helps to explain Germany’s strong economy – it was feeding 2 nations! The Danish tax ministry said:

‘The fat tax and the extension of the chocolate tax — the so-called sugar tax — has been criticised for increasing prices for consumers, increasing companies’ administrative costs and putting Danish jobs at risk … At the same time it is believed that the fat tax has, to a lesser extent, contributed to Danes travelling across the border to make purchases … Against this background, the government and the (far-left) Red Green Party have agreed to abolish the fat tax and cancel the planned sugar tax’

Once the tax is abolished, other policies will need implementing to tackle the problem of obesity and encourage healthy eating, as it continues to be a big problem in this and many other countries. The following articles consider this problem.

Denmark to scrap world’s first fat tax Associated Press (10/11/12)
Denmark to abolish tax on high-fat foods BBC News (10/11/12)
Fat tax repealed The Copenhagen Post (10/11/12)
Businesses call fat tax a failure on all fronts The Copenhagen Post, Ray Weaver (10/11/12)

With the winter fast approaching, consumers have already begun to stock up on warmer clothes. This has contributed towards consumer spending increasing faster in September than it has in the past 3 years. According to Visa Europe’s UK expenditure index, sales in August increased by 1.2pc, but in September they rose month-on-month by 3pc.

But whilst sales on the high-street increased, sales on-line and over the telephone declined. It seems that the recent decrease in temperature is just what the retail sector ordered, as people took to the high streets.

Furthermore, recent improvements in consumer income, together with lower inflation and rising employment have all contributed towards a growth in spending. However, as consumer confidence remains at a relatively low level, it is unlikely that the winter will bring much of a change to growth in the economy. The Chief Economist at Markit said:

However, consumer confidence remains historically low as uncertainty about the economy and job security persists, suggesting that the bounce in spending seen in the third quarter could be as good as it gets for the foreseeable future.

Although the lower temperature has caused a boost in consumption, once people have made their ‘investment’ in warmer clothes, retail spending may once again decline. Hence the above comment by Markit, which suggests that further sustained increases in consumer spending may still be some way off.

The following few articles look at the latest data on retail spending.

UK consumer spending ‘rose in September’ BBC News (5/10/12)
Consumer spending increases by 3pc The Telegraph (5/10/12)
Consumer spending increases by 3% The Press Association (5/10/12)
UK retail sales: what the analysts say Guardian (20/9/12)
Online sales and wet weather boost John Lewis Scotsman, Peter Ranscombe (5/10/12)

For some people, a pint of beer is a regular thing each week. Add all your pints of beer together, then add your friend’s pints, their friends’ pints and … you get the idea. Once you’ve done that for the entire population, you have an estimate of total beer consumption in the UK. This can then be compared with total consumption of beer in other countries and between continents.

Prior to 2007, Europe and the Americas were the biggest beer drinking continents, but since then, Asia has emerged as the leader of pints of beer consumed, drinking 67bn litres of beer compared with the Americas’ 57bn and Europe’s 51bn in 2011. In per capita terms, Asia is still some way off, with Japan leading the way as the highest Asian country in 41st place, consuming 64 litres of beer per year per capita of the population. So how is this relevant to economics and business?

Consumption of anything provides jobs – bar workers, manufacturers and in the case of beer, probably law enforcement! It probably also increases utility – after all, why consume it if it’s not going to give you some degree of satisfaction!

We can analyse the demand for beer and see how it varies with changes in price and income. Minimum prices for alcohol have been proposed as a means of reducing consumption, and tax and excise duties are always linked to alcoholic beverages and clearly have an effect on demand. In this case, however, we can also consider the emergence of Asia and how tastes have changed. It is the fastest growing beer market in the world; so what can we deduce from that? As the BBC News article states, it is ‘a sign of a young, upwardly mobile, and increasingly hedonistic population.’

Experts also say that the increased consumption of beer in Asian countries is closely correlated with growing incomes and prosperity. A consumer research analyst from Standard Chartered, Nirgunan Tiruchelvam, said:

“Beer has a clearer correlation with strong economic growth … People tend to drink beer in times of growth. They drink spirits when times are good and when times are bad.”

Data suggest that when a certain level of prosperity is reached in a nation, beer sales begin to rise. As many Asian economies begin to develop rapidly, beer sales have taken off. This could be regarded as a good thing for Europe. With stagnant Western economies, beer producers within Europe may be grateful for a growing demand in Asia. Indeed, many of the world’s biggest breweries are expanding rapidly, providing jobs and income. Consumers in Europe will also be happy to see that beer production remains profitable in other parts of the world. With unemployment still high and recession ongoing, a pint of beer will be a much needed pick-me-up for many people. At least, that’s what the evidence from the Great Depression of the 1930s suggested!!

It’s not good news for everyone, however. Beer production has also increased in Asian countries, most notably in China, which now leads the world as the largest beer producer. This clearly reduces the export potential for European beer producers.

Also, many argue that the growing consumption of beer in Asia is simply an illustration of growing Western influence and it is likely to create severe medical problems in the future. Binge drinking and under-age consumption is already a big problem in Western countries and this could soon begin to extend across the world. The following articles consider the growth in consumption of beer.

Brewers thirsty for expansion as taste for beer grows in emerging markets Guardian, Simon Neville (3/9/12)
Beer in Asia: the drink of economic growth BBC News, Saira Syed (6/9/12)
Study says world beer production hits new high Long Island Business News, Associated Press (8/8/12)
Global beer sales go up for 27th year running News Track India (9/8/12)

Binge drinking is a problem that has seen much attention, especially with regards to minimum price controls. However, in this blog, we consider attention in this sector concerning taxation on beer.

Alcohol is widely considered to be a de-merit good with negative externalities imposing external costs on society. This is one of the reasons why taxes are imposed on alcoholic beverages. By increasing production costs to the firms providing these drinks, prices rise and hence the policy aims to discourage consumption.

During the recession, many businesses have seen demand fall and one sector hit particularly hard because of this and very high tax rates has been the local pub community. Duty on beer has increased since 2008 by some 42%. As such, many rural and suburban communities have seen their local watering holes close down and this has led to a campaign by CAMRA to force a debate in Parliament, as a means of protecting ‘one of Britain’s oldest and best loved institutions’. Data suggests that 12 pubs per week are closing down, thus the future of the industry is now under threat. This may also have further damaging effects on local communities, as it may adversely affect the social aspect of communities. Camra’s Chief Executive, Mike Benner said:

‘Whether situated in a small village, city high street, or on the edge of a housing estate, pubs are so central to our society that whole communities can grow around a particular pub.’

According to a study, pubs in Lancashire and the West Midlands have been hardest hit by the pub closures. If pubs don’t pass the tax increase on to consumers in the form of higher prices, then they must bear the burden. If they do pass the tax rises on to consumers then the larger chain firms can increase their market share by selling at a lower price. They are also facing growing pressure from the supermarket industry, which are able to sell cheap alcohol, also contributing to going to the pub becoming an ‘unaffordable activity’. The following articles consider this industry.

Pub closures spark beer tax plea The Press Association (30/4/12)
A dozen pubs close each week Telegraph, James Hall (30/4/12)
Calls for beer tax rethink as 12 pubs shut every week BBC Radio 1, News Beat, Steve Holden (30/4/12)
Pubs in the West Midlands hit hardest by pub closures ITV News (30/4/12)

While inflation is a concern in the UK and is making the Bank of England think twice about keeping interest rates at their all time low of 0.5%, inflation in Japan is being celebrated. The Japanese economy has been plagued by deflation for over a decade and for the past 2 years inflation has never been above 0%. However, in April the consumer price index (CPI) rose to 0.6% from the previous year, fuelled by petrol prices. Strangely it might be the Japanese earthquake and tsunami that helped this situation, as Japan was unable to generate sufficient electricity and hence had to import fuel from abroad.

A typical question from non-economists is always about why deflation and hence falling prices is such a bad thing. Surely, it’s great for consumers? For those shopping for bargains, perhaps it is helpful – after all, if prices fall, a consumer’s real income will be higher. However, the problem with falling prices is that people start to hold off buying. If you want to buy a car, but expect prices to be lower next month, then it’s a rational decision to delay your purchase until next month when prices are lower. However, next month, you still expect prices to be lower in the following month and so delay purchasing again. And so the process continues. When people expect prices to fall they put off their purchases, this reduces demand and so prices do indeed fall. There are also costs for businesses: as consumers delay buying, sales begin to fall. And businesses are also consumers, and so they start delaying their purchases of inputs.

While many central banks across the world have begun to tighten monetary policy, the Japanese central bank seems inclined to keep monetary policy loose and has even considered expanding the emergency lending programme. As Azusa Kato, an economist at BNP Paribas, said:

“The bank will probably add stimulus if it sees more signs of weakening demand”. “If you strip out energy and food costs, consumer prices are basically flat now.”

Despite this inflationary pressure, many believe that it is unlikely to continue and deflationary pressures may appear once again in the near future. The following articles consider the Japanese deflationary situation.

Articles
Japan ends 25 months of deflation Bloomberg, Mayumi Otsuma (27/5/11)
Japan consumer prices log first rise in 28 months Associated Press (27/5/11)
Japan beats deflation for the first time in two years BBC News (275/11)
Japan overcomes deflation for first time in two years Guardian, Julia Kollewe (27/5/11)
Japanese consumer price rise (including video) BBC News (27/5/11)
Japan April core CPI rises 0.6 pct yr/yr Reuters (26/5/11)
Japan experiences inflation for first time in over two years Telegraph (27/5/11)

Data
Japan Inflation Rate Trading Economics
Consumer Price Index (Japan) Japanese Statistics Bureau
Inflation Rate and Consumer Price Index (CPI) (for USA, Canada, Australia, UK and Japan) Rate Inflation
Statistical Annex, Preliminary Version OECD

In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. And there it has remained for almost 2 years and as yet, no change is in sight. In the February 2011 meeting of the Monetary Policy Committee (who are responsible for setting interest rates to keep inflation on target), the decision was to keep interest rates at 0.5% rather than raise them to tackle high and rising UK inflation. Those in favour of keeping interest rates at this record low argue that any increase could damage the UK’s ability to recover and may lead to the dreaded double-dip recession. This is of particular concern given the economy’s performance in the last quarter of 2010.

However, one group that will certainly not be happy is the savers. With instant-access savings accounts paying on average just 0.84% before tax and with inflation at 3.7%, savers aren’t just not gaining much interest, but are actually seeing the value of their money in real terms fall. Howard Archer of HIS Global Insight said:

“For now, we retain our view that the Bank of England will hold off from raising interest rates until the latter months of the year. Even if interest rates do rise in the near term, the likelihood is still that they will rise only gradually and remain very low compared to past norms.

Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2pc by the end of 2012.”

Following some speculation that the Bank of England may succumb to the pressure of inflation and hike up interest rates (markets had priced in a 20% chance of a rate rise), sterling did take a hit, but after the decision to keep rates at 0.5%, sterling recovered against the dollar. There is a belief amongst some traders that rates will rise in May, but others believe rates may remain at 0.5% until much later in 2011, as the country aims to avoid plunging back into recession. Of 49 economists that responsed to a poll by Reuters, three quarters of them said that rates would rise by the end of 2011, with median forecasts predicting a rise around November. This is certainly a space to watch, as it has implications for everyone in the UK and for many in countries around the world.

BOE leaves bank rate unchanged at 0.5% at Feb meeting Automated Trader (10/2/11)
Economists predict interest rates will rise in November Telegraph, Szu Ping Chan (11/2/11)
UK May rate hike view holds firm after BOE Reuters, Kirsten Donovan (10/2/11)
Interest rates: What the economists say Guardian (10/2/11)
Fixed rate mortgages becoming more expensive BBC News (10/2/11)
Bank rate: savers’ celebrations on hold Telegraph, Richard Evans (10/2/11)
Inflation fears turn up heat ahead of bank rate decision City AM, Julian Harris (10/2/11)
Sterling takes BOE in its stride, higher rate talk aids Reuters, Anirban Nag (10/2/11)
Bank of England holds interest rates of 0.5% Telegraph, Emma Rowley (10/2/11)

With the UK economy borrowing 11% of GDP, it is undeniable that spending cuts are needed. Of course, the big question is should they be occurring now or delayed until the recovery is more stable. However, another question is now being asked. Should taxes be cut to help the worse off? David Cameron says that this is out of the question. While he is a ‘tax-cutting Tory’ who ‘believes in tax cuts’, any significant cuts in taxes specifically aimed at the poor would simply make matters worse, especially as the Coalition government is already helping to move thousands of families out of taxation altogether, albeit by increasing taxes on the better off.

“It’s no good saying we’re going to deal with the deficit by cutting spending, but then we’re going to make things worse again by cutting taxes. I’m afraid it doesn’t add up.”

Those in favour of cutting taxes include John Redwood, the head of the Tory’s economic affairs committee, who argues that they would help to boost the economy, by ‘encouraging the wealth creators and the private sector’. By reducing the burden on residents, disposable income will increase, helping to stimulate consumption and investment, which should in turn boost aggregate demand. This would be a much needed stimulus following the latest data which showed: a shrinking economy once again in the last quarter of 2010, consumer confidence at its lowest level in the past 20 years, the possibility of unstable markets should the government be seen to ‘twitch’ on the austerity drive and 57% in a YouGov poll saying that the cuts are ‘being imposed unfairly’. Public approval for the Coalition’s budget deficit reduction strategy has fallen from 53% in June 2010 to 38% in February 2010. Add to this rising inflation and unemployment and the last thing people want to hear is surely ‘No big tax cuts’.

However, the budget deficit must be tackled: now or later. Whenever it happens and whichever party is in power, spending must be cut and/or tax revenues must rise and everyone will have to play their part.

Cameron: ‘Tax cuts impossible right now’ Sky News (6/2/11)
David Cameron says major tax cuts not possible BBC News (6/2/11)
Cameron vows ‘No to big tax cuts’ The Press Association (6/2/11)
David Cameron: Sorry, but we can’t afford tax cuts Telegraph, Patrick Hennessy (5/2/11)
George Osborne faces Conservative pressure for tax cuts BBC News (1/2/11)
Nick Clegg’s tax cuts will cost £4.3 billion, says IFS Telegraph, James Kirkup (2/2/11)
Doubts mount over Cameron’s austerity drive Associated Press (6/2/11)
Sorry it is so complicated BBC 2, Daily Politics, Stephanie Flanders (14/6/10)

It looks like being a busy time for economic commentators for many, many months as they keep an eye on how the economy is progressing in light of the squeeze in public spending and impending tax increases. Inevitably these commentators – including us here on the Sloman News Site – will be watching to see how the private sector responds and whether or not, as is hoped, private sector activity will begin filling the void left by the public sector.

Of course, the largest group of purchasers in the economy is the household sector. So, in the short term at least, they will be crucial in supporting the total level of aggregate demand. The effects of any rebalancing of aggregate demand as the public sector’s role is reduced will be more painful should the real growth in household spending slow or even go into reverse. As consumers we are well aware that our spending depends on more than just our current income. For instance, it is affected by our expectations of our future incomes and by our general financial position. In essence the latter reflects our holdings of financial assets and liabilities (debt) and any wealth we may be lucky enough to hold in valuables such as housing.

So, do we have any clues as to how the financial position of households might be impacting on our spending? Well, the latest numbers from the Bank of England on Housing Equity Withdrawal (HEW) offer us an important insight in to the extent of the fragility felt by households as to their financial position. These numbers show that households increased their stake in housing by some £6.2 billion in the second quarter of 2010. At least two questions probably spring to mind at this point! Firstly, what is HEW and, secondly, what has this got to do with spending?

Let’s begin by defining Housing equity withdrawal (HEW). HEW occurs when new lending secured on dwellings (net lending) increases by more than the investment in the housing stock. Housing investment relates largely to the purchase of brand new homes and to major home improvements, but also includes house moving costs, such as legal fees. When HEW is negative, new secured lending is less than the level of housing investment. In other words, given the level of investment in housing, we would have expected new mortgage debt to have been greater. This means that households are increasing their housing equity.

This brings us to answering our second question – the ‘so what question’. As with all the choices we make, there is an opportunity cost – a sacrifice. By increasing our equity in property and using housing as a vehicle for saving we are using money that cannot be used to fund current consumption or to purchase financial assets.

As we have already noted, the Housing Equity Withdrawal (HEW) figures for Q2 2010 show that households increased their stake in housing by some £6.2 billion. This is equivalent to a little over 2½% of disposable income in the period and income that, as we have also said, could have helped to boost aggregate demand through spending. And, there is another concern for those hoping that households will help support aggregate demand in the short term: negative HEW is not new. In fact, HEW has been negative since the second quarter of 2008, the exact same quarter that the UK entered recession. The magnitude of negative HEW over these past 9 quarters is equivalent to £44.2 billion or 2.1% of disposable income.

Of course, these latest HEW figures are figures from the past. What we are ultimately interested in, of course, is future behaviour. But, it might be that the prolonged period over which British households have been consolidating their own financial position – just as the public sector is looking to do – suggests that households are in cautious mood. So the question for you to debate is how cautious you think the household sector will remain and, therefore, how much households will help support aggregate demand in the months ahead.

Articles
Mortgage equity still increasing, Bank of England says BBC News (1/10/10)
Homeowners pay down loans Independent (2/10/10)
Paying off mortgages is a priority Telegraph, Philip Aldrick (3/10/10)
Homeowners pay off £6.2 billion in mortgage debt Guardian, Phillip Inman (1/10/10)
Families pay off £6bn mortgages Express, Sarah O’Grady (2/10/10)

Data
Housing equity withdrawal (HEW) statistical releases Bank of England