Tag: Net worth

The Bank of England’s Money and Credit release on 1 Feb provides us with data up to the end of 2015 on lending by banks and building societies to the rest of the UK private sector. In this post we update our blog of 17 December 2015 – is Minsky right yet again? – to analyse the latest data on lending. The headline numbers show that the flow of lending (net of repayments) by banks and building societies to UK households in 2015 was £40.8 billion up from £29.9 billion in 2014 taking their amount of outstanding lending to households to £1.26 trillion. Was American economist Minsky (1919-1996) right to have argued that cycles in credit are inevitable?

Chart 1 shows the stocks of debt acquired by both households and private non-financial corporations from MFIs (Monetary Financial Institutions), i.e. deposit-taking institutions. The scale of debt accumulation in the late 1980s and again from the mid 1990s up to the financial crisis of the late 2000s is stark. At the start of 1980 the UK household sector had debts to MFIs of around £53 billion. By the start of 2009 this had hit £1.29 trillion. To put these figures into context this corresponds to an increase in indebtedness to MFIs from 25 per cent of GDP to 86 per cent of GDP.

The chart also shows the increase in indebtedness of private non-financial corporations which are effectively every day businesses. They saw their debts to MFIs rise from around £25 billion to over £500 billion which is equivalent to an increase from 12 per cent of GDP to 33 per cent of GDP. (Click here to download a PowerPoint of Chart 1.)

The path of debt at the start of the 2010s is consistent with a story of consolidation. Although the term is readily used in the context of the public sector and measures to reduce public-sector deficits the term is also relevant for the private sector. Financially-distressed households, private non-financial corporations and MFIs took steps to repair their balance sheets following the financial crisis. Indeed the term is synonymous with the idea of a balance sheet recession which some economists argue describe the late 2000s. The result was that the demand for and supply of additional credit waned. Debt accumulation largely ceased and, as we can see from Chart 1, debt numbers fell.

More recently the indebtedness to MFIs of households has started to edge up again, though, as yet, not for private non-financial corporations. From the end of the first quarter of 2013 to the end of 2015 household indebtedness to MFIs has increased by 7 per cent to £1.26 trillion.

Chart 2 focuses on flows rather than stocks. (Click here to download a PowerPoint of Chart 2.) It allows us to see the accumulation of new credit (i.e. less repayments of debt). What is even more apparent from this chart is the evidence of cycles in credit. The growth in new credit during the 2000s is stark as is the subsequent squeeze on credit that followed. Across 2006 net flows of credit from MFIs to households reached £106 billion while the peak for PNFCs was across 2007 when they reached £71 billion. Subsequently, net credit numbers crashed with negative numbers for PNFCs indicating net repayments to MFIs.

The size of the credit flows emanating from MFIs and the magnitude of the resulting credit cycles is even more stark when presented as percentages of GDP. The annual flow of credit to households in the late 1980s reached 9.4 per cent of GDP while that to PNFCs peaked at the end of the decade at 5.2 per cent of GDP. Meanwhile, across 2006 net credit to households reached 7.5 per cent of GDP while the peak of lending to PNFCs was in the 12-month period to the end of 2007 Q1 equivalent to 4.8 per cent of GDP. In 2015, credit from MFIs to households reached 2.2 per cent of GDP while that to PNFCs was a mere 0.2 per cent of GDP.

Of course, the key question now is the path of credit. Clearly flows of credit to households are again on the rise. In part, this is driven by the rebound in the UK housing market. But, significantly there has been a significant rise in flows of consumer credit, i.e. unsecured debt.

Chart 3 shows the flows of consumer credit to individuals (excluding student loans involving the Student Loans Company) from MFIs and other credit providers. Again, we see the marked evidence of cycles. Across 2015 these net consumer credit flows amounted to £14.5 billion, the highest annual figure since 2005. (Click here to download a PowerPoint of the chart.)

To put the current rise in consumer credit into context, the net flow of consumer credit to individuals as percentage of GDP across 2015 as a whole amounts to about 0.8 per cent of GDP. This is the highest figure since the second half of 2006. While it might be a little early to say that credit numbers are a cause for concern, they do need to be seen in the context of a still relatively highly indebted household sector. Policymakers will be keeping a keen eye on credit patterns and assessing whether we have again acquired a real appetite for credit.

Articles

Households put another £4.4 billion on credit cards and personal loans in December as debt rises at fastest pace in a decade ThisisMoney.co.uk, Rachel Rickard Straus (1/2/16)
One in four ‘living for the day’ as 700,000 more expected to default on debt Independent, Simon Read (2/1/16)
Surprise mortgage jump confounds expectations Independent, Russell Lynch (1/2/16)
U.K. consumer credit slows; mortgage approvals up MarketWatch, Jon Sindreu (1/2/16)
Family debt continues to rise – report BBC News (13/1/16)

Data

Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. How can the financial system affect the economy’s business cycle?
  2. What does it mean if households or firms are financially distressed? What responses might they take to this distress and what might the economic consequences be?
  3. How would you measure the net worth (or wealth) of an individual or a firm? What factors might affect their net worth?
  4. How might uncertainty affect spending and saving by households and businesses?
  5. What does it mean if bank lending is pro-cyclical?
  6. Why might lending be pro-cyclical?
  7. Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?
  8. What do you understand by a consolidation by the private sector? Discuss the possible macroeconomic effects of such a consolidation.
  9. What is meant by a balance sheet recession?
  10. How might the effect of attempts by a large number of individuals to improve their financial well-being differ from those when only a small numbers of individuals do so?

To what extent does history repeat itself? Minsky’s Financial Instability Hypothesis infers that credit cycles are fairly inevitable. We have seem them in the past and we will see them in the future. Human beings are subject to emotion, to irrational exuberance and to a large dose of forgetfulness! To what extent do the latest UK credit numbers suggest that we might be embarking on another credit binge? Are the credit data consistent with evidence of another credit cycle?

Chart 1 shows the stocks of debt acquired by households and private non-financial corporations from MFIs (Monetary Financial Institutions). The scale of debt accumulation in the late 1980s and again from the mid 1990s up to the financial crisis of the late 2000s is stark. At the start of 1985 the UK household sector had debts to MFIs of around £140 billion. By the start of 2009 this had hit £1.29 trillion. Meanwhile, private non-financial corporations saw their debts to MFIs rise from around £45 billion to over £500 billion. (Click here to download a PowerPoint of the chart.)

The path of debt at the start of the 2010s is consistent with a story of consolidation. Financially-distressed households, private non-financial corporations and, of course, MFIs themselves meant that corrective action was needed to repair their balance sheets. The demand for and supply of additional credit waned. Debt accumulation largely ceased and, in fact, debt numbers fell. This trend continues today for private non-financial corporations. But, for households debt accumulation resumed in the middle of 2013. At the end of the third quarter of 2015 the household sector had debt obligations to MFIs of £1.246 trillion.

Chart 2 focuses on flows rather stocks. It allows us to see the accumulation of new credit (i.e. less repayments of debt). What is even more apparent from this chart is the evidence of cycles in credit. The growth in new credit during the 2000s is stark as is the subsequent squeeze on credit that followed.

The question that follows is what path are we now on? Clearly flows of credit to households are again on the rise. In part, this is driven by the rebound in the UK housing market. But, in fact there is a more rapid increase in consumer credit, i.e. unsecured debt. (Click here to download a PowerPoint of the chart.)

Chart 3 shows the flows of consumer credit from MFIs and other credit providers. Again, we see the marked evidence of cycles. In the year to the end of Q1 of 2015 net consumer credit flows amounted to £22.8 billion, the highest figure since the 12-month period up to the end of Q3 of 2005. Click here to download a PowerPoint of the chart.)

While it might be a little early to say that another Minsky cycle is well under way, policymakers will be keeping a keen eye on credit patterns. Is history repeating itself?

Articles

Average UK mortgage debt rises to £85,000 The Guardian, Phillip Inman (15/12/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Recovery ‘too reliant on consumer debt’ as BCC downgrades forecast The Guardian, Heather Stewart (9/12/15)
BCC: UK Growth Too Reliant On Consumer Debt Sky News (9/12/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
IMF: UK’s economic performance ‘very strong’, but risks remain BBC News (11/12/15)

Data

Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. How can the financial system affect the economy’s business cycle?
  2. What does it mean if households or firms are financially distressed? What responses might they take to this distress and what might the economic consequences be?
  3. How would you measure the net worth (or wealth) of an individual or a firm? What factors might affect their net worth?
  4. How might uncertainty affect spending and saving by households and businesses?
  5. What does it mean if bank lending is pro-cyclical?
  6. Why might lending be pro-cyclical?
  7. Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?

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.