Pearson - Always learning

All your resources for Economics

RSS icon Subscribe | Text size

Posts Tagged ‘household spending’

Little cheer in forecasts for consumer spending

A crucial determinant of the economy’s short-term prospects is the appetite of households for spending. This is because household spending makes up roughly two-thirds of the total demand for firms’ goods and services or two-thirds of what economists refer to as aggregate demand. So what are the latest forecasts for consumer spending? We briefly consider the forecasts of the Office for Budget Responsibility for consumer spending and, in doing so, update an earlier bog Gloomy prospects for spending in 2012?

In its March 2012 Economic and Fiscal Outlook the Office for Budget Responsibility presents it forecasts for economic growth and household spending. The following table summarises these forecasts.

OBR Forecasts (annual real percentage change)

2012 2013 2014 2015 2016
GDP 0.8 2.0 2.7 3.0 3.0
Consumption 0.5 1.3 2.3 3.0 3.0
Disposable income –0.2   0.5 1.9 2.4 2.5

Source: Economic and Fiscal Outlook (Table 3.6) (Office for Budget Responsibility)

The OBR are forecasting that household spending will increase in real terms in 2012 by 0.5 per cent and by a further 1.3 per cent in 2013. This is on the back of a fall in real consumption in 2011 of 1.2 per cent. Therefore, the rebound in consumer spending is predicted to be only fairly modest. The long-term average annual real increase in household spending is around 2½ per cent.

The drag on consumer spending growth remains the weakness of growth in real disposable income. The post-tax income of the household sector fell in real terms by 1.2 per cent in 2011 and is expected to fall by a further 0.2 per cent in 2012. It is not until 2015 that growth in real disposable income returns to its long-term average which, unsurprisingly, is roughly the same as that of household sector spending.

As we noted in our earlier blog, the OBR’s short-term figures on spending growth critically depend on the ability of households to absorb the negative shocks to their real income. Empirical evidence tends to show that household spending growth is less variable than that in income and that households try and smooth, if they can, their spending. Therefore, the marginal propensity of households to consume out of changes in their income is below 1 in the short-run. This is consistent with the idea that households are consumption-smoothers disliking excessively volatile spending patterns.

The actual figures for consumption and income growth in 2011 help to show that consumption-smoothing cannot be taken for granted. In 2011, the fall in consumption exactly matched that in income. An important impediment to consumption-smoothing in recent times has been the impact of the financial crisis on bank lending. Banks have become more cautious in their lending and so households have been less able to borrow to support their spending in the face of falling real incomes. Another impediment to consumption-smoothing is likely to be the continuing unease amongst households to borrow (assuming they can) or to draw too heavily on their savings. In uncertain times, households may feel the need for a larger buffer stock of wealth to act as a security blanket.

In short, the latest OBR figures suggest that the growth in consumption in the medium-term will remain relatively weak. Retailers are likely to ‘feel the pinch’ for some time to come.

Articles
OBR raises forecast for economic growth Financial Times, Chris Giles (19/03/12)
Threat of recession receding but economy still at risk, says OBR Guardian, Katie Allen (21/3/12)
Punch Tavern sees profits slump 19pc Telegraph, Natalie Thomas (12/4/12)
U.K. Consumer spending slows as fuel prices climb, Times says Bloomberg, Agnieszka Troszkiewicz (7/4/12) )
Uk retail sales warmed by sunny weather in March BBC News (11/4/12)
Budget 2012: George Osborne raises UK growth forecast BBC News (21/4/12)

Data
Quarterly National Accounts, time series dataset Q4 2011 Office for National Statistics (see consumption series ABJR and HAYO in Table C2; disposable income series NRJR in Table J2 and GDP series ABMI in Table A2).

Questions

  1. Compare the consumption forecasts produced by the Office for Budget Responsibility in March 2012 with those it produced in November 2011. To see the earlier forecasts go to Gloomy prospects for spending in 2012?
  2. What do you understand by a consumption function? What variables would you include in such a function?
  3. Using the figures in the table in the text above, calculate ‘rough’ estimates of the income elasticity of consumption for each year. Why are these estimates only ‘rough’ approximations of the income elasticity of consumer spending?
  4. Draw up a list of factors that are likely to affect the strength of consumer spending in 2012. Explain how similar or different these factors are likely to have been to those that may affect spending during periods of strong economic growth.
  5. Explain what you understand by the term consumption-smoothing. Explore how households can smooth their spending and the factors that are likely to both help and prevent them from doing so.
  6. What do you understand by the net worth of households? Try drawing up a list of factors that could affect the net worth of households and then analyse how they might affect consumer spending.
Share in top social networks!

Gloomy prospects for UK consumer spending in 2012?

A key determinant of our economy’s rate of growth over the year ahead is likely to be the behaviour of households and, in particular, the rate of growth in consumer (or household) spending. In other words, your appetite for spending will help to determine how quickly the economy grows. The importance of household spending for the economy is straightforward to understand given that it accounts for roughly two-thirds of the total demand for firms’ goods and services, i.e. two-thirds of aggregate demand. In its November 2011 Economic and Fiscal Outlook the Office for Budget Responsibility presents it forecasts for economic growth and household spending. The following table summarises these forecasts.

OBR Forecasts (annual real percentage change)

2011 2012 2013 2014 2015 2016
GDP 0.9 0.7 2.1 2.7 3.0 3.0
Consumption –1.1 0.2 1.2 2.2 2.7 2.9
Disposable income –2.3 –0.3 0.9 2.0 2.5 2.5

Source: Economic and Fiscal Outlook (Table 3.6) (Office for Budget Responsibility)

The OBR are forecasting that household spending will fall in real terms in 2011 by 1.1 per cent and grow by only 0.2 per cent in 2012. This is not good news for retailers nor, of course, for the economy. The drag on consumer spending growth is largely attributed to expected falls in real disposable (after-tax) incomes in both 2011 and 2012. In 2011, the household sector’s real income is forecast to decline by 2.3 per cent and then by a further 0.3 per cent in 2012.

The OBR’s figures on spending growth critically depend on the ability of households to absorb the negative shock to their real income. Empirical evidence tends to show that household spending growth is less variable than that in income and that households try and smooth, if they can, their spending. This means that the marginal propensity of households to consume out of changes to their income is below 1 in the short-run. In fact, the shorter the period of time over which we analyse income and consumption changes the smaller the consumption responses become. This is consistent with the idea that households are consumption-smoothers disliking excessively volatile spending patterns. In other words, the size of our monthly shop will usually vary less than any changes in our real income.

Of course, consumption-smoothing cannot be taken for granted. Households need the means to be able to smooth their spending given volatile and, in the current context, declining real incomes. Some economic theorists point to the importance of the financial system in enabling households to smooth their spending. In effect, households move their resources across time so that their current spending is not constrained solely by the income available to them in the current time period. This could mean in the face of falling real income perhaps borrowing against future incomes (moving forward in time expected incomes) or drawing down past savings.

The ability of households to move future incomes forward to the present has probably been impaired by the financial crisis. Banks are inevitably less cautious in their lending and therefore households are unable to borrow as much and so consume large amounts of future income today. In other words, households are credit-constrained. Furthermore, it is likely that households are somewhat uneasy about borrowing in the current climate, certainly any substantial amounts. Uncertainty tends to increase the stock of net worth a household would like to hold. A household’s net worth is the value of its stock of physical assets (largely housing wealth) and financial assets (savings) less its financial liabilities (debt). If households feel the need for a larger buffer stock of wealth to act as a sort of security blanket, they will not rush to acquire more debt (even if they could) or to draw down their savings.

The impairment of the financial system and the need for a buffer stock are two impediments to households smoothing their spending. They tend to make consumption more sensitive to income changes and so with falling incomes make it more likely that consumption will fall too. There are other related concerns too about the ability and willingness of consumers to smooth spending. Uncertainty arising from the volatility of the financial markets imposes liquidity constraints because households become less sure about the value of those savings products linked to the performance of equity markets. Consequently, they become less certain about the money (liquidity) that could be raised by cashing-in such products and so are more cautious about spending. Similarly, the falls in house prices have reduced the ability of households to extract housing equity to support spending. Indeed, with fewer transactions in the housing market the household sector is extracting less housing equity because it has been quite common, at least in the past, for households to over-borrow when moving and use the excess money borrowed to fund spending.

In short, there are many reasons to be cautious about the prospects for household spending. The expected decline in real income again in 2012 will ‘hit’ consumer spending. The question is how big this ‘hit’ will be and crucially on the extent to which households will be able to absorb it and keep spending.

Articles
Household spending frozen says ONS report BBC News (29/11/11)
Families £13 a week worse off Telegraph (10/12/11)
Household spending power shrinks for 22nd month in a row Mirror, Clifton Manning (29/11/11)
Britons inject record £9 bn of housing equity in Q2 BBC News (30/11/11)
UK retail growth weakest since May, says BRC BBC News (6/12/11)

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

Questions

  1. What do you understand by a consumption function? What variables would you include in such a function?
  2. Using the figures in the table in the text above, calculate ‘rough’ estimates of the income elasticity of consumption for each year. Why are these estimates only ‘rough’ approximations of the income elasticity of consumer spending?
  3. Draw up a list of factors that are likely to affect the strength of consumer spending in 2012. Explain how similar or different these factors are likely to have been to those that may affect spending during periods of strong economic growth.
  4. Explain what you understand by the term consumption-smoothing. Explore how households can smooth their spending and the factors that are likely to both help and prevent them from doing so.
  5. What do you understand by the net worth of housholds? Try drawing up a list of factors that could affect the net worth of households and then analyse how they might affect consumer spending.
Share in top social networks!

Getting real with GDP (update)

Just how large is the UK economy and how rapidly is it growing? These were questions we asked, back at the turn of the year, in Getting real with GDP when reviewing economic data for the third quarter of 2010. We update this blog in light of the latest Quarterly National Accounts release from the Office for National Statistics.

The latest Quarterly National Accounts release estimates the value of our economy’s output during Q1 of 2011 at £375.3 million. When measured across the latest four quarters, i.e. from the start of Q2 2010 to the end of Q1 2011, the total value of our economy’s output was £1.472 trillion. Across calendar year 2010 the UK’s GDP is estimated to have been £1.455 trillion.

When analysed in terms of the total expenditure on the goods and services produced in the latest four quarters, household final consumption contributed £931 billion of Gross Domestic Product. In other words, household expenditure over these four quarters was equivalent to 63% of GDP, almost exactly in line with its average since 1948. This demonstrates the importance of spending by households for short-term economic growth. Households help to shape the business cycle.

Another important expenditure-component of GDP is gross capital formation. This is capital expenditure by the private and public sector and is estimated to have been £219.6 billion over the latest four quarters, equivalent to 15% of GDP. As well as affecting current levels of GDP, gross capital formation also affects our economy’s potential output. In other words, changes in capital expenditure can impact both on the demand-side and the supply-side of the economy. Interestingly, the long-term average share for gross capital formation in GDP is around 18% and so about 3 percentage points higher than is currently the case.

So far we have looked at the level of economic activity measured at current prices. But, what about the rate at which the economy is growing? When analysing the rate of economic growth economists look at GDP at constant prices. By doing this economists can infer whether the volume of output has increased. This is important because in the presence of price rises, an increase in the value of output could occur even if the volume of output remained unchanged or actually fell. For instance, in 1974 the volume of output or real GDP fell by 1.3%, but because the average price of our domestic output – the GDP deflator – rose by 14.9%, GDP measured at current prices rose by nearly 13.4%.

The latest ONS figures show that in the first quarter of 2011 real GDP grew by 0.5% (nominal GDP grew by 1.7%). This follows a 0.5% fall in real GDP the final quarter of 2010 (nominal GDP grew by 1.2%). Compared with Q1 2010, the volume of output of the UK economy in Q1 2011 is estimated to have grown by 1.6%.

Exports were the fastest growing component of aggregate demand in Q1, rising in real terms by 2.4%, while import volumes decreased by 2.4%. Export volumes in Q1 were 9.3% higher than a year earlier. In contrast, capital expenditures contracted sharply in the first quarter, falling by 4.2%. This follows on the back of a 0.6% fall in the final quarter of last year. This has reversed much of the strong capital expenditure growth seen during the earlier part of 2010.

We finish by looking at the growth in household spending. In the first quarter of the year real household spending fell by 0.6%. This follows a 0.2 fall in Q4 2010 and zero growth in Q3 2010. This helps to explain some of the difficulties that particular retailers have faced of late. Some context to these disappointing consumption numbers is provided by patterns in household sector disposable income. The sector’s disposable income fell by 0.8% in Q1 2011 which follows on from a 0.9% fall in the last quarter of last year. The result of this is that the household sector’s real disposable income in Q1 2011 was 2.7% lower than in Q1 2010. This was the fastest annual rate of decline since the third quarter of 1977.

Articles
Household incomes sees biggest fall since 1977 BBC News (29/6/11)
UK service sector sees biggest fall for 15 months BBC News (28/6/11)
UK economic growth revised down BBC News (29/6/11)
Service sector output slumps Guardian, Phillip Inman (29/6/11)
Household raid savings as income squeezed Independent, Sean O’Grady (29/6/11)
Poor GDP numbers add pressure on Osborne Guardian, Phillip Inman (28/6/11)
UK economy suffers blow as tepid growth confirmed Telegraph (28/6/11)
Service sector slumps deals heavy blow to economic recovery hopes Scotsman, Natalie Thomas (30/6/11)

Data
Latest on GDP growth Office for National Statistics (28/6/11)
Quarterly National Accounts, 1st Quarter 2011 Office for National Statistics (28/6/11))
ONS Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission

Questions

  1. What do you understand by the terms nominal GDP and real GDP?
  2. Can you think of any other contexts in which we might wish to distinguish between nominal and real changes?
  3. The following are the estimates of GDP at constant 2006 prices:
    Q1 2011= £330.724bn, Q4 2010= £329.189bn, Q1 2010= £325.360bn
    Calculate both the quarterly rate of change and the annual rate of change for Q1 2011.
  4. What would happen to our estimates of the level of constant–price GDP in (3) if the base year for prices was 1996 rather than 2006? What if the base year was 2011? What would happen to the quarterly and annual growth rates you calculated in each case? Explain your answer.
  5. Explain how gross capital formation could have both demand-side and supply-side effects on the economy. How significant do you think such supply-side effects can be?
  6. How important for short-term economic growth do you think household spending is? What factors do you think will be important in affecting household spending in the months ahead?
  7. What factors do you think help to explain the 2.7% annual rate of decline reported in Q1 2011 in the household sector’s real disposable income?
  8. The real annual rate of decline in household spending reported in Q1 2011 was 0.5%. Would you have expected this percentage decline to have been the same as for real disposable income? Explain your answer.
Share in top social networks!

Colour by numbers: Painting an economic picture of UK households

I have something of an admission to make: I love data. I suppose it goes back to my time working as a civil servant. My job was to brief on the latest data releases relevant to the household sector and to try to interpret what the latest numbers might be telling us. It meant that on one day I might be briefing about the latest household spending numbers and the next on house prices. It was not only great fun but it also helped my understanding of economics and, importantly, my understanding of the issues and topics that economists wrestle with. Data help to give context perhaps by placing current outcomes, such as the latest high street sales figures, in an historical context or by enabling international comparisons, such as comparing UK consumer behaviour to that across the Channel in France. These days I spend my time teaching, but I retain my passion for data and I do all that I can to convey this to those I teach. So, what I thought we would do here is to look at a few numbers relating to UK households, show that we need not be frightened by them, and show how they can help to paint a picture of the current economic behaviour of the UK consumer.

My first teaching week back this academic term began by talking to students about consumer spending. I think it’s important that those new to economics and learning about household spending behaviour have a sense of how much UK households spend, how this varies, and why how much the sector spends is important. Let’s begin with the household spending figure for 2009 – the 2010 figure will not be available for a couple of months. By going to the latest release of the Quarterly National Accounts we discover that UK households spent £874 billion in 2009. Though a big enough figure in its own right, it is actually 2% less than the £892 billion in 2008. But, more than this, remember that these are nominal values reflecting the prices of 2008 and 2009. The average price of household consumption goods and services rose by 1.3% between these two years which, if we eliminate, means that the volume of consumer spending fell by 3.3%.

To convince anyone that patterns in household spending do matter is pretty straightforward. One way of doing this is to consider household spending relative to GDP, i.e. the value of our country’s output. If we return to latest Quarterly National Accounts we discover that GDP in 2009 is estimated at £1.39 trillion. So with household spending of £874 billion and total output of £1.39 trillion we can readily see the value of households as purchasers of this output. To be more specific, household spending in 2009 was equivalent to some 63% of GDP. This is one of the reasons why economists pay so much attention to trying to interpret the spending patterns of households – one of my old jobs – and, of course, trying to predict the future path of household spending.

You might be wondering about more recent patterns in household consumption since, after all, 2009 now seems quite a while ago. Well, in the third quarter of 2010 household spending was estimated at £232.3 billion and if we add to this the revised figures for the previous three quarters we get a 4-quarter total of £910.4 billion. For many analysts though the key numbers relate to the growth in the volume of household spending. In Q3 2009 real household spending grew by 0.3%. Whilst the first quarter of 2010 saw spending volumes decline by 0.1%, Q3 was the second consecutive quarter in which spending volumes increased. The concern, however, was that the 0.3% growth in Q3 was down on the 0.8% growth in Q2. We wait with much interest the Q4 figure.

When I talk to students about the determinants of household spending many, quite naturally, will point to the importance of disposable income. Again let’s return to the Quarterly National Accounts. In 2009 the disposable income, i.e. post-tax income, of the household sector was estimated at £942.2 billion. That’s another big number. Let’s put that alongside our spending number for households of £874.4 billion and we have an average propensity to consume (APC) out of disposable income of 0.92 which compares with 0.97 in 2008 and 0.98 in 2007. This suggests that households were inclined to do other things with their income in 2009 than just merely spend it. We observe this too if we take note of the real changes in consumption and income in 2009. After removing the impact of price changes, we find that while consumption volumes fell by 3.3%, the spending power of the sector’s disposable income actually rose by 1.1%.

But, what of more recent patterns in disposable income? Well, disposable income in Q3 2010 is estimated to have been £244.3 billion which with consumption of £232.3 billion equates to an average propensity to come out of disposable income of 0.95. If we again add the Q3 disposable income number to those from the previous three quarters we have a 4-quarter disposable income figure of £964.4 billion which gives us an average propensity to consume over this period of 0.94 and, hence, a tad higher than 2009, albeit not at the levels of 2007 and 2008. Meanwhile, real disposable income rose by 1.1% in Q3 following a 2% decline in Q2. The quarterly disposable income series is a notoriously volatile series and the recent past has seen no change in that. Perhaps the key fact though is that the real value of the household sector’s disposable income in Q3 2010 was 1.5% lower than it was a year earlier. Hence, while real disposable income grew across 2009, it is likely to have fallen across 2010.

So why did household spending fall so markedly in 2009 despite the rise in disposable income. It is likely that the impact of the financial crisis, the subsequent recession and a sense of uncertainty amongst households will have been contributory factors. One way in which these factors seems to have affected UK households is in their desire to reduce their exposure to debt. So we end with a few numbers, some a little eye-watering, which relate to household debt and demonstrate the attempt by households to improve their financial positions.

Figures from the Bank of England contained within Table 3 of their statistical release lending to individuals show that at the end of November 2010 households had a stock of debt of £1.454 trillion, not too dissimilar a number to that for GDP! But, this is £5.6 billion less than at the end of November 2009. The main reason for this is the sector’s repayment of unsecured debt, such as credit card debt and overdrafts. Unsecured debt fell by £13.4 billion over the year to stand at £214.1 billion.

The remaining £1.24 trillion of household debt is secured debt and so debt secured against property. This has risen by £7.7 billion over the 12 months to November. But, it would be a mistake to believe that because the overall stock of mortgage debt hasn’t fallen that households are not trying to paying it off. How can this be, you might ask? The answer lies in the growth of housing investment relative to that of mortgage debt. Housing investment relates, in the main, to the purchase of brand new homes and to major home improvements. As our population grows and the housing stock expands and as we spend more on improving our existing housing stock we acquire more mortgage debt. However, the Bank of England figures shows that housing investment has been greater than new secured lending. In other words, the additions to the stock of lending have been less than housing investment.

In Q3 the Bank of England estimates an increase of housing equity of £6.1 billion. Negative housing equity withdrawal (HEW), an injection of housing equity, has become something of a new norm dating back to when the UK economy went into recession in Q2 2008. Since then, the UK household sector has injected some £49.7 billion of housing equity. This, of course, comes at a potential cost for the economy because by increasing equity in property households are using money that cannot be used to fund current consumption or to purchase financial assets. The extent of this negative HEW over the past 10 quarters has been the equivalent to 2.1% of disposable income.

So that ends my tour of the household sector through numbers. Hopefully, the numbers have helped to paint a picture of the importance of the household sector for the economy and to make you think about some of the variables that affect the sector’s behaviour. Given these interesting economic times, painting by economic numbers has never been so much fun!

Articles
Mortgage debt falls for the 10th quarter in a row BBC News (29/12/10)
Homeowners make record mortgage repayments Independent, Hugo Young (30/12/10)
Homeowners reduce their mortgages by £6bn in just three months Telegraph, Louise Armistead (30/12/10)
Homeowners paying off mortgages at faster rate Guardian, Jill Insley (29/12/10)
Homeowners paying back mortgages at rapid rate Daily Mail (29/12/10)
Christmas trading hit by snow, says BRC Financial Times, Chris Giles (11/1/11)
Festive freeze hits sales across the high street Independent, James Thompson (11/1/11)
Shoppers hit hard by inflation Independent (12/11/10)
Families warned by Bank of England of even more painful year ahead Daily Mail, Lucy Farndon (28/12/10)
Shop inflation accelerated in December on commodities, retailers say Bloomberg, Svenja O’Donnell

Data
Lending to individuals statistical release Bank of England
Housing equity withdrawal (HEW) statistical release Bank of England
Latest on GDP growth Office for National Statistics (22/12/10)
Quarterly National Accounts, 3rd Quarter 2010 Office for National Statistics (22/12/10)
UK Economic Accounts, Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission

Questions

  1. What factors do you think affect consumer spending in the short-term, say over a three-month period? Would the same factors be important if we were looking at spending patterns over a longer period of time?
  2. Consumers are sometimes described as consumption-smoothers which means that they look to smooth their profile of spending in the face of volatile incomes. What factors do you think affect their ability to do this?
  3. Would you expect the relationship between consumption and income to be consistent and predictable? Explain your answer.
  4. Why do you think real spending values fell in 2009 despite real disposable income rising? Does this mean that households are not in fact consumption-smoothers?
  5. The financial system enables households to accumulate financial assets, financial liabilities and to acquire housing wealth. How might these three variables impact on household spending?
  6. Illustrate with examples what is meant by secured and unsecured debt. Does the long-term accumulation of stocks of these debts have any consequences for household spending?
  7. What do you understand by the term housing equity withdrawal? What is meant by negative HEW and which the UK has observed for the past ten quarters?
  8. What factors might help to explain the ten consecutive quarters of negative HEW? Would you expect things to change in the near future? Explain your answer.
  9. What is the opportunity cost of positive housing equity withdrawal (HEW)? What about the opportunity cost of negative HEW?
  10. To what extent do you think household spending affects economic growth? Is household spending a long-term driver of economic growth?
Share in top social networks!

Getting real with GDP

Just how large is the UK’s Gross Domestic Product and how quickly is it growing? Well, the latest Quarterly National Accounts from the Office for National Statistics show that the value of our economy’s output in Q3 2010 was £365.9 million. When measured across the latest four quarters, i.e. from the start of Q4 2009 to the end of Q3 2010, the total value of our economy’s output was £1.440 trillion. Across calendar year 2009 the UK’s GDP is estimated to have been £1.394 trillion.

When analysed in terms of the expenditure on the goods and services produced in the latest four quarters, household final consumption contributed £910.4 billion towards Gross Domestic Product. In other words, household expenditure over these four quarters was equivalent to 63% of GDP, exactly in line with its average since 1948. This only serves to demonstrate just how important the spending by households is for our short-term economic prospects.

Another important expenditure-component of GDP is gross capital formation. This is capital expenditure by the private and public sector and is estimated to have been £202.9 billion over the latest four quarters, equivalent to 14% of GDP. This is an important component because as well as affecting current levels of GDP, it also affects our economy’s potential output. This points to changes in capital expenditure having both a demand-side and a supply-side impact. Interestingly, the long-term average share for gross capital formation in GDP is around 18% and so about 4 percentage points higher than is currently the case.

So we now have a number which reflects the size of our economy: a little over £1.4 trillion. But, what about the rate at which the economy is growing? This time we have to be a little careful as to which GDP numbers we are using. The numbers we have so far considered have been measured at current prices and so at prevailing prices. When analysing the rate of economic growth, rather than analyse GDP at current prices, economists look at GDP at constant prices. By doing this we can immediately see whether the volume of output has increased. This is important because in the presence of price rises, an increase in the value of output could occur even if the volume of output remained unchanged or actually fell. For instance, in 1974 the volume of output or real GDP fell by 1.3%, but because the average price of our domestic output (known as the GDP deflator) rose by 14.8%, GDP measured at current prices rose by nearly 13½%.

The latest ONS figures show that real GDP grew by 0.7% in the third quarter 2010. For the record, GDP at current prices (nominal GDP) grew by 0.9%. The 0.7% increase in GDP in volume terms is down on the 1.1% figure for Q2. While this appears to constitute a reasonable rate of economic growth we can see from the articles below the concern amongst commentators that this third estimate of growth for Q3 had seen a downward revision from the previous estimates of 0.8%. Nonetheless, when compared with Q3 2009, the output of the UK economy in Q3 2010 is estimated to have grown by 2.7%. This is the strongest annual rate of economic growth since the third quarter of 2007.

Despite its relatively low historic share of GDP, gross capital formation was the most rapidly growing expenditure component in Q3, increasing by 5.2% over the quarter and by 16.6% over the latest four quarters. Household spending grew by 0.3% over the quarter and by 2% over the latest four quarters. Meanwhile, government final consumption, i.e. those government purchases not classified as capital expenditures, fell by 0.4% over the quarter and by 1.3% over the latest four quarters. Finally, the volume of exports rose by 1.5% over the quarter and by 7.5% over the latest four quarters, but the volume of imports increased more rapidly rising by 1.7% over the quarter and by 10.3% over the latest four quarters. This has contributed to a UK trade deficit from the start of Q4 2009 to the end of Q3 2010 of a little over £40.5 billion.

Articles
UK recovery weaker than first thought, official data shows Telegraph, Emma Rowley and Philip Aldrick (23/12/10)
Service sector output dips Financial Times, Chris Giles (23/12/10)
UK’s official economic growth estimates revised down Guardian, Graeme Wearden (22/12/10)
UK economic growth revised down BBC News (22/12/10)
Economic growth weaker than thought Press Association (22/12/10)
UK economic growth in 3rd quarter revised downward Bloomberg, Robert Barr (22/10/12)
Economic growth ‘is lower than we thought’ admits ONS Scotsman, Natalie Thomas (23/12/10)
UK GDP growth: analysts view of the revised data Telegraph (22/12/10)

Data
Latest on GDP growth Office for National Statistics (22/12/10)
Quarterly National Accounts, 3rd Quarter 2010 Office for National Statistics (22/12/10)
UK Economic Accounts, Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission

Questions

  1. What do you understand by the terms nominal GDP and real GDP?
  2. Can you think of any other contexts in which we might wish to distinguish between nominal and real changes?
  3. The following are the estimates of GDP at constant 2006 prices:
    Q3 2009= £322.655bn, Q2 2010= £328.881bn, Q3 2010= £331.222bn
    Show how you would calculate both the quarterly rate of change and the annual rate of change for Q3 2010.
  4. What would happen to our estimates of the level of constant–price GDP in (3) if the base year for prices was 1986 rather than 2006? What would happen to the quarterly and annual growth rates you calculated? Explain your answer.
  5. Explain how gross capital formation could have both demand-side and supply-side effects on the economy? How significant do you think such supply-side effects can be?
  6. How important for short-term economic growth do you think household spending is? What factors do you think will be important in affecting household spending in the months ahead?
Share in top social networks!

Does housing offer clues as to whether households will help support aggregate demand?

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

Questions

  1. What do you understand by aggregate demand? And what do you think a ‘rebalancing’ of aggregate demand might refer to?
  2. What do you understand by the term housing equity withdrawal?
  3. What is the opportunity cost of positive housing equity withdrawal (HEW)? What about the opportunity cost of negative HEW?
  4. What factors might help to explain the nine consecutive quarters of negative HEW?
  5. List those items that you might included under: (i) household financial assets; (ii) household financial liabilities; and (iii) household physical assets. Using this information, how would you calculate the net worth of a household?
  6. Let’s think about the spending of households. Draw up a list of factors that you think would affect a household’s current spending plans. Given your list, what conclusion would you draw about the strength of household spending in the months ahead?
Share in top social networks!

Who’d be a forecaster? A taxing time for the new OBR

Under its terms of reference the new Office for Budget Responsibility is required to provide updated forecasts for the economy and the public finances at the time of each Budget in order take into account the impact of those measures contained in the Budget. Here we consider those economic forecasts contained in the June 2010 OBR Budget Forecast relating to economic growth. In particular, we consider the OBR’s interpretation of how growth is likely to be affected by the policy measures unveiled by George Osborne in his first Budget as Chancellor of Exchequer on 22 June.

The OBR forecasts that the UK economy will grow by 1.2% in 2010 and by a further 2.3% in 2011. These estimates are lower than those published by the OBR in its Pre-Budget Forecast published on 14 June. The Pre-Budget Forecasts predicted growth of 1.3% in 2010 and 2.6% in 2011. The downward revisions reflect the OBR’s assertion that the Budget’s measures to meet the Government’s fiscal mandate and, hence the resultant fiscal consolidation package, will weaken aggregate demand.

In terms of the components of aggregate demand, the fiscal consolidation will mean restraints on government spending (G) and, if the OBR is right, lower growth in household consumption (C). Lower consumption growth is expected as a result of reduced growth in household incomes and the rise in the standard rate of Value Added Tax next January from 17½% to 20%.

The OBR now forecasts that real household consumption will grow by just 0.2% in 2010, following last year’s contraction of 3.2%, and by 1.3% in 2011. General government final consumption – the Government’s expenditure on current goods and services – is forecast to grow in real terms by 1.7% this year before falling by 1.1% next year. The forecasts for general government capital spending are for a real fall of 4.9% this year, following last year’s rise of 15.7%, followed by a sizeable 19% decline in 2011.

A more positive note emerging from the OBR forecasts relates to capital expenditure by businesses. The measures to reform corporation tax, which include a reduction in the main rate of corporation tax from 28 per cent to 24 per cent over four years beginning with a one per cent reduction from April 2011, are predicted to have a favourable effect on investment. Business investment is forecast to rise in real terms by 1.4% this year, following last year’s fall of 19.3%, and to rise again in 2011 by 8.1%.

The projections for growth from 2013 are now stronger than in the OBR’s Pre-Budget Forecast with the economy portrayed as adjusting more quickly at this point towards its potential output. Potential output is the level of output level when the economy’s resources are operating at ‘normal capacity utilisation’. But, in 2015, which is at the end of the OBR’s five year forecast period, the UK economy is still forecast to be experiencing a negative output gap. In other words, actual output will still be less than potential output.

To help paint a picture of how the economy’s output will adjust towards its potential level consider the OBR estimates for the output gap. The OBR estimates that in financial year 2009-10 the economy’s output was 4.1% below its potential. This negative output gap is now expected to be reduced to 3.7% of potential output in 2010-11, to 2.8% in 2012-13 and to 0.9% of potential output in 2015-16.

Office for Budget Responsibility
OBR home page
Office for Budget Responsibility Terms of Reference

Documents
Budget Forecast June 2010 OBR (22/6/10)
Pre-Budget Forecast June 2010 OBR (14/6/10)
Budget 2010 HM Treasury (22/6/10)

Articles
OBR endorses Budget but faces questions over its own predictions Telegraph, Philip Alrdrick (23/6/10)
UK growth forecasts could be revised again, says Sir Alan Budd Citywire, Deborah Hyde (23/6/10)
OBR says growth will take bigger hit Financial Times, Norma Cohen (22/6/10)
Budget 2010: Government cuts will slow economic recovery, says watchdog Telegraph, James Kirkup (23/6/10)
Highlights from the Budget BBC News (22/6/10)
Budget statement: George Osborne’s speech in full BBC Democracy Live (22/6/10)

Questions

  1. What do you understand by the concept of aggregate demand?
  2. What are the component expenditures of aggregate demand? Which of these do you think is the largest in value terms?
  3. The OBR is forecasting the household sector’s disposable income to grow in real terms this year by 0.2% and by 1.2% next year. Why then is the OBR identifying weaker consumer demand as a result of the Budget measures as a major reason for revising down its predictions for economic growth?
  4. The OBR argues that the fiscal consolidation measures will have a ‘direct effect’ on household incomes and so on spending, but that this will be ‘partially offset by a decline in saving’. Why might the OBR be arguing that a fiscal consolidation will lead to a decline in saving? Evaluate the OBR’s arguments.
  5. What do you understand by the concept of an output gap? What does a negative output gap signify?
  6. To see the sorts of problems that forecasters commonly face, try identifying reasons why the output gap could be eliminated more quickly or less quickly as a result of the Budget measures.
Share in top social networks!

Household wealth hits £6.316 trillion. Is it time to shop?

Research from the Halifax estimates that the total wealth of UK households at the end of 2009 was £6.316 trillion. Putting this into context, it means that the average UK household has a stock of wealth of £236,998. In real terms, so stripping out the effects of consumer price inflation, the total wealth of households has grown five-fold since 1959 while the average wealth per household has grown three-fold while. The growth in wealth per household is a little less because of the increase in the number of households from 6.6 million to 26.6 million. For those that like their numbers, total household wealth in 1959 was estimated at £1.251 trillion (at 2009 prices) while the average amount per household was £72,719 (at 2009 prices).

But, do changes in household wealth matter? Well, yes, but not necessarily in a consistent and predictable manner. That’s why so many of us love economics! For now, consider the prices of two possible types of assets: share prices and house prices. The prices of both these assets are notoriously volatile and it is this volatility that has the potential to affect the growth of consumer spending.

It might be, for instance, that you are someone who keeps a keen eye on the FTSE-100 because you use shares as a vehicle for saving. A fall in share prices, by reducing the value of the stock of financial assets, may make some people less inclined to spend. Housing too can be used as a vehicle for saving. Changes in house prices will, of course, affect the capital that can be realised from selling property, but also affect the collateral that can be used to support additional borrowing and, more generally, affect how wealthy or secure we feel.

The Halifax estimates that the household sector’s stock of housing wealth was £3.755 trillion at the end of 2009 while its stock of financial assets (such as savings, pensions and shares) was £4.024 trillion. In real terms, housing wealth has grown on average by 5% per year since 1959 while financial assets have grown by 2.8% per year. Of course, while households can have financial and housing assets they are likely to have financial liabilities too! We would expect households’ exposure to these liabilities – and their perception of this exposure – to offer another mechanism by which household spending could be affected. For instance, changes in interest rates impact on variable rate mortgages rates, affecting the costs of servicing debt and, in turn, disposable incomes.

The Halifax reports that the stock of mortgage loans was £1.235 trillion at the end of 2009, which, when subtracted from residential housing wealth, means that the UK household sector had net housing equity of £2.519 trillion. It estimates that the stock of mortgage loans has increased on average by 6.5% per year in real terms since 1959 while net housing equity has grown by 4.5%. The stock of households’ unsecured debt, also known as consumer credit, was £227 billon at the end of 2009. In real terms it has grown by 5.3% per year since 1959.

The recent patterns in household wealth are particularly interesting. Between 2007 and 2008 downward trends in share prices and house prices contributed to a 15% real fall in household wealth. The Halifax note that some of this was ‘recouped’ in 2009 as a result of a rebound in both share prices and house prices. More precisely, household wealth increased by 9% in real terms in 2009, but, nonetheless, was still 8% below its 2007 peak.

Given the recent patterns in household wealth, including the volatility in the components that go to comprise this stock of wealth, we shouldn’t be overly surprised by the 3.2% real fall that occurred in household spending last year. Further, we must not forget that 2009 was also the year, amongst other things, that the economy shrunk by 4.9%, that unemployment rose from 1.8 million to 2.5 million and that growing concerns about the size of the government’s deficit highlighted the need for fiscal consolidation at some point in the future. All of these ingredients created a sense of uncertainty. This is an uncertainty that probably remains today and that is likely to continue to moderate consumer spending in 2010. So, it’s unlikely to be a time for care-free shopping, more a time for window shopping!

Halifax Press Release
UK household wealth increases five-fold in the past 50 years Halifax (part of the Lloyds Banking Group) (15/5/10)

Articles
Household wealth ‘up five-fold’ UK Press Association (15/5/10)
We’ve never had it so good: Families five times richer than in 1959 Daily Mail, Steve Doughty (15/5/10)
Household wealth grows five-fold in past 50 years BBC News (16/5/10)
Average household wealth jumps £150,000 Telegraph, Myra Butterworth (15/5/10)

Questions

  1. Draw up a list of the ways in which you think consumer spending may be affected by: (i) the stock of household wealth; and (ii) the composition of household wealth.
  2. What factors do you think lie behind the annual 5% real term increase in the value of residential properties since 1959?.
  3. How might the sensitivity of consumer spending to changes in interest rates be affected by the types of mortgage product available?
  4. Why do you think consumer spending fell by 3.2% in real terms in 2009 despite real disposable income increasing by 3.2%?
  5. What would you predict for consumption growth in 2010? Explain your answer.
Share in top social networks!

Saving through housing: Households build firmer foundations

Housing Equity Withdrawal, or HEW for short, is new borrowing that is secured against property which is not reinvested in the housing market. In other words, it is borrowed money that is not used by households to purchase property or to undertake major refurbishments, such as extensions to existing residential properties. The latest HEW statistical release from the Bank of England shows that HEW in Q4 2009 was again negative, making it the seventh consecutive quarter of negative HEW. But, what does a negative HEW figure mean?

Negative HEW occurs when the total saving by households in housing (either by paying back mortgages or by purchasing property directly without borrowing) is greater than new borrowing secured against housing. It results in an increase in housing equity held by the household sector. In the fourth quarter of 2009, the Bank’s seasonally-adjusted figures show that negative HEW was just over £4.3 billion, equivalent to 1.6% of disposable income.

But why might the household sector have wanted to save through housing and how might this impact on consumer spending? In truth there is no single reason, but one potentially important reason is likely to be the sector’s desire to rebuild its balance sheets. In times of uncertainty, such as those that we face now, a perfectly understandable response by households is to try to reduce their exposure to debt. During the seven quarters in which HEW has been negative, households have used housing as a vehicle for saving to the tune of £36.5 billion, equivalent to 2.2% of the sector’s disposable income. To some extent the fact that, as a result of the banking crisis, house-buyers have had to put down larger deposits when purchasing housing helps to reduce their exposure to debt. But, the extent of the negativity of HEW means that households more generally have been actively looking to repay some of their outstanding mortgage debt.

So what of the impact of HEW on consumer spending? Negative sums of HEW mean that consumers are either reducing consumer spending, reducing holdings of financial assets, increasing levels of unsecured debt (e.g. personal loans or credit card debt) or, of course, undertaking some combination of these. Given that the stock of unsecured debt has actually declined by £7.9 billion to £224.8 billion in the 12 months to February, the impact would seem to be falling on consumer spending.

Some commentators are pointing to the weakening pace with which households are saving through housing. The current level of saving through housing is, as we said earlier, equivalent to 1.6% of disposable income, down from the 3.0% recorded in both Q4 2008 and Q1 2009. But, this would seem to simply highlight the extent of the precautionary behaviour by households in the midst of the economic downturn. It would be a surprise to see any significant end soon to the UK household sector’s precautionary behaviour.

Articles
Britons plough cash into repaying debt The Times, James Charles (6/4/10)
The great mortgage payback Reuters, Harry Wallop (6/4/10)
Home owners’ housing equity still increasing BBC News (6/4/10) )
Brits pay off £4bn of mortgage debt Press Association (6/4/10)
UK Q4 housing injection smallest since Q2 2008 – BOE MarketNews.com (6/4/10)

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

Questions

  1. Explain what are meant by positive and negative values of HEW.
  2. What implications might additions to housing equity have for consumer spending?
  3. What factors do you think lie behind the seven consecutive quarters of negative HEW?
  4. If house price inflation were to start picking up in the near future, would you expect to see positive values of HEW and, if so, how strongly positive?
  5. Other than through HEW, how might the housing and mortgage markets impact on consumer spending?
Share in top social networks!

Repairing their balance sheets: households increase housing equity

Figures released by the Bank of England show that in the third quarter of 2009 UK households increased their housing equity (i.e. repaid mortgage debt) by £4.9 billion, equivalent to 2% of their disposable income. This was the sixth consecutive quarter in which saving in housing exceeded net mortgage lending. Interestingly, during each of these six quarters the UK economy contracted.

Saving in housing (or ‘negative housing equity withdrawal’ (HEW)) will reduce aggregate demand if it is funded out of income that would otherwise have been spent on consumer goods and services. Since the proportion of income saved, as measured by the saving ratio, climbed from an historic low of 0.9% in the third quarter of 2008 to 8.6% in the same quarter of 2009, increased saving in housing equity has been depressing spending levels. Indeed, across the six quarters in which HEW has been negative, households have increased their stock of housing equity by £33.9 billion, equivalent to 2.3% of disposable income – money which could otherwise have been spent.

Increased saving in housing by households is an example of the household sector’s attempt to repair its balance sheets. Another example has been the fall in the sector’s outstanding stock of unsecured debt (e.g. outstanding personal loans and credit-card debt). Elsewhere in the economy, banks too have been looking to repair their badly damaged balance sheets and, of course, there is the considerable interest in how the UK government will reduce its budget deficit. We can expect these repairs to balance sheets to have some impact on the pace of economic recovery. What is less certain is the size and duration of these balance sheet effects.

Home loan repayments ‘a priority’ BBC News (29/12/09)
Homeowners pay off £5bn of mortgage debt Financial Times, Vanessa Houlder (30/12/09)
Homeowners stop cashing in on the value of their homes Telegraph, Myra Butterworth (29/12/09)
Mortgages paid off at the fastest rate for 40 years Guardian, Larry Elliott (30/12/09)
Homeowners rush to repay mortgages thisismoney, Rosamund Urwin (29/12/09)

Questions

  1. What factors might explain why UK households have been increasing their saving in housing equity during 2009?
  2. Why might increasing amounts of HEW, such as those in the mid 2000s, not necessarily result in higher levels of consumer spending?
  3. What do you understand by the ‘household balance sheets’? What do you think is likely to be the most significant item on the sector’s balance sheets?
Share in top social networks!