Consumer spending is crucial to an economy. In the UK total consumer spending is equivalent to almost two-thirds of the value of country’s GDP. Understanding its determinants is therefore crucial in attempting to forecast the short-term path of the economy. In other words, the growth of the economy in 2013 will depend on our inclination to spend.
While the amount of disposable income (post-tax income) will be one factor influencing our spending, other factors matter too. Amongst these ‘other factors’ is the stock of wealth of households. Here we look at the latest available figures on the net worth of the UK household sector. Will our stock of wealth help to underpin spending or will it act to constrain spending?
The household sector’s net worth is the sum of its net financial wealth and non-financial (physical) wealth. Net financial wealth is the balance of financial assets over financial liabilities. Financial assets include funds in savings accounts, shares and pension funds. Financial liabilities include debts secured against property, largely residential mortgages, and unsecured debts, such as overdrafts and unpaid balances on credit cards. Non-financial wealth largely includes the value of the sector’s holdings of property and buildings.
The following table summarises the net worth of the UK household sector at the end of 2011 and 2010. The figures are taken from the Office for National Statistics release, National Balance Sheet. They show that at the end of 2011, the household sector had a net worth of £7.04 trillion. This was up just 0.1 per cent up 2010. At the end of 2011, the stock of net worth of the household sector was 7 times the amount of disposable income earned by the sector in 2011.
We can also see from the table the significance of the value of non-financial assets to net worth. The value of households’ physical wealth is slightly larger than the value of its financial assets, though in 2011 both equate to around 4¼ times the annual flow of disposable income.
2011 saw the value of the stock of non-financial wealth grow by 0.7 per cent while the value of the sector’s stock of financial assets fell by 0.4 per cent. Meanwhile, the value of the stock of financial liabilities was virtually unchanged at a little over £1½ trillion. In 2011, the sector’s financial liabilities were equivalent to around 1½ times its annual disposable income. While this is down from the 2007 peak of 1¾ times income, it is considerably higher than during the period from 1987 to 1999 when the financial liabilities to income ratio remained consistently close to 1. The 2000s saw a rapid expansion of the sector’s liabilities relative to its income and, hence, today there remains what economists call a debt overhang.
Despite the very small overall increase in net worth in 2011, the stock of net wealth was up by 18 per cent on 2008. During 2008, net worth fell by 12 per cent. This was on the back of a fall in non-financial wealth of 9.4 per cent, a fall in the value of financial assets of 10.1 per cent and an increase in the value of financial liabilities of 1.9 per cent.
Chart 1 gives an historical picture of net worth. It shows the two principal balances that comprise net worth: net financial wealth and physical wealth. Each is shown relative to annual disposable income. Again, we can see the importance of physical wealth to overall net worth. The growth in house prices from the late 1990s through to the economic downturn of the late 2000s helps to explain its rising relative importance in net worth. We can also see from the chart that the relative level of net worth is roughly on a par with its value at the end of the 1990s. However, the composition is different. Today, relatively more of the sector’s net worth comes from non-financial wealth compared with that from net financial wealth.
A crucial question for spending in the months ahead is how inclined the household sector feels to consolidate its balance sheets further. Chart 2 includes more recently available data on financial assets and liabilities from United Kingdom Economic Accounts, Q3 2012. From it we can see the declining stock of financial liabilities relative to disposable income. This has been driven by an actual fall in the stock of unsecured financial liabilities. In the 12-month period up to the end of Q3 2012, the stock of unsecured financial liabilities fell by 6.4 per cent (the stock of secured debt rose by 1.8 per cent). This consolidation of unsecured debt suggests that households remain understandably cautious given the uncertain economic environment. Hence, the household balance sheet will most probably continue to constrain consumption growth in the short-term.
Are the components of the balance sheet stocks or flows. Explain your answer. What about disposable income?
List those factors that might affect the value of each component of the household balance sheet.
Again considering the balance sheet, try drawing up a list of ways in which the components of the balance sheet could affect spending.
What do you think has been the motivating factor behind the declining stock of unsecured financial liabilities? What impact is this likely to have on consumer spending?
If the real value of disposable income increases in 2013 shouldn’t this be enough to see real value of consumption increase?
How would the balance sheet of a household that rents differ from a household that is an owner-occupier?
In the wake of the financial crisis of 2007/8, the international banking regulatory body, the Basel Committee on Banking Supervision, sought to ensure that the global banking system would be much safer in future. This would require that banks had (a) sufficient capital; (b) sufficient liquidity to meet the demands of customers.
The Basel III rules set new requirements for capital adequacy ratios, to be phased in by 2019. But what about liquidity ratios? The initial proposals of the Basel Committee were that banks should have sufficient liquid assets to be able to withstand for at least 30 days an intense liquidity crisis (such as that which led to the run on Northern Rock in 2007). Liquid assets were defined as cash, reserves in the central bank and government bonds. This new ‘liquidity coverage ratio’ would begin in 2015.
These proposals, however, have met with considerable resistance from bankers, who claim that higher liquidity requirements will reduce their ability to lend and reduce the money multiplier. This would make it more difficult for countries to pull out of recession.
In response, the Basel Committee has published a revised set of liquidity requirements. The new liquidity coverage ratio, instead of being introduced in full in 2015, will be phased in over four years from 2015 to 2019. Also the definition of liquid assets has been significantly expanded to include highly rated equities, company bonds and mortgage-backed securities.
This loosening of the liquidity requirements has been well received by banks. But, as some of the commentators point out in the articles, it is some of these assets that proved to be wholly illiquid in 2007/8!
Inflation is a key macroeconomic variable and governments typically aim for both low and stable rates of inflation. In the UK there are two main measures of the rate of inflation in the UK – the CPI and the RPI. Over the past few years there has been a growing gap between the two measures and this has led to consultations about how the RPI could be adapted to allow it to rise more slowly in the future. (Click here for a PowerPoint of the chart.)
The RPI and CPI measure inflation in different ways – they don’t measure the same basket of goods. The RPI measure includes the costs of housing, whereas the CPI does not include this. Furthermore, the RPI is an arithmetic mean and the CPI is a geometric mean, which will be lower than the arithmetic mean. The ONS says that a key advantage of using the geometric mean (i.e. the CPI) is that:
…it can better reflect changes in consumer spending patterns relative to changes in the price of goods and services.
Typically the RPI has been about 1% higher than the CPI and governments can benefit from this by linking state benefits to the CPI (the lower rate) and payments they receive to the RPI, thus maximising the difference between earnings and expenditure.
However, the gap between these two measures of inflation has been growing and this has been causing concern for the ONS and the Office for Budget Responsibility (OBR). This has led to the consultative process regarding making changes to the RPI. However, any change made to the RPI would put certain groups at a disadvantage. One such group is pensioners – many pensioners in the private sector have their pensions linked to the RPI and if a change were made to bring it more in line with the CPI (i.e. lower it) they would suffer. Ros Altman, director general of SAGA said:
After 30 years of retirement, someone who receives 0.6% lower inflation uprating will end up with a pension nearly 20% lower…Therefore, over time, pensioners will be able to afford less and less and pensioner poverty will increase once again.
There would be some beneficiaries of any change to the RPI – the government would benefit in some areas; company pension schemes might also see gains made; some students might benefit and even rail travellers.
An announcement was made by the National Statistician, Jil Matheson, on the 10 January. Much to the surprise of most experts, she has decided to keep the RPI measure unchanged. She did recommend, however, that a new index be introduced that would be published alongside RPI and CPI. The new index would better meet international standards.
The following articles look at the arguments for and against changing the RPI measure.
We know two things about economic growth in a developed economy like the UK: it is positive over the longer term, but highly volatile in the short term. We can refer to these two facts as the twin characteristics of growth. The volatility of growth sees occasional recessions, i.e. two or more consecutive quarters of declining output. Since 1973, the UK has experienced six recessions.
Here we consider in a little more detail the growth numbers for the UK from the latest Quarterly National Accounts, focusing on the depth and duration of these six recessions. How do they compare?
The latest figures on British economic growth show that the UK economy grew by 0.9 per cent in the third quarter of 2012. However, when compared with the third quarter of 2011, output was essentially unchanged. This means that the annual rate of growth was zero. Perhaps even more telling is that output (real GDP) in Q3 2012 was still 3.0 per cent below its Q1 2008 level.
The chart helps to put the recent output numbers into an historical context. It shows both the quarter-to-quarter changes in real GDP (right-hand axis) and the level of output as measured by GDP at constant 2009 prices (left-hand axis). It captures nicely the twin characteristics of growth. Since 1970, the average rate of growth each quarter has been 0.6 per cent. This is equivalent to an average rate of growth of 2.35 per cent per year. The chart also allows us to pin-point periods of recessions.
One way of comparing recessions is to compare their ‘2 Ds’: depth and duration. The table shows the number of quarters each of the six recessions since 1973 lasted. It also shows how much smaller the economy was by the end of each recession. In other words, it shows the depth of each recession as measured by the percentage reduction in output (real GDP).
British recessions
Duration (quarters)
Depth (output lost, %)
1973Q3–74Q1
3
3.25
1975Q2–75Q3
2
1.76
1980Q1–81Q1
5
4.63
1990Q3–91Q3
5
2.93
2008Q2–09Q2
5
6.28
2011Q4–12Q2
3
0.90
We can see that three of the recessions lasted for five quarters. In the case of the recessions starting in 1975 and 2011 they occurred very shortly after a previous recession. Hence, we observe two so-called double-dip recessions.
The table reveals that the deepest recession by some distance was that in the late 2000s. As a result of this recession, UK output declined by 6.3 per cent. As the recent GDP numbers show, the UK has yet to recover the ‘lost output’ that followed the financial crisis.
While the Western world has struggled with economic growth for the past 6 years, emerging economies such as China, Brazil and India have recorded some very high rates of growth. Throughout 2012, there were signs that these economies were not going to be the saviour of the global economy that we all thought. But, as we enter 2013, is it these economies that still hold the hope of the West for more positive figures and better economic times?
The article below from BBC News, in particular, considers the year ahead for the Asian economies and what it might mean for the Western world. Although these countries are by no means safeguarded against the impending approach of the US economy to their fiscal cliff or the ongoing eurozone crisis, they have seemed to be more insulated than the rest of the world. A crucial question to consider is whether this will continue. Furthermore, are the growth levels and policies of a country such as China sustainable? Can it continue to record such high growth rates in the face of the global economic situation?
The Japanese economy has been in serious trouble for a couple of decades, but measures to boost growth for this economy are expected. If these do occur, then western economies may feel some of their positive effects. At present, there is a degree of optimism as we enter the New Year, but how long this will last is anybody’s guess. The following articles consider the year ahead.
Why have the Asian economies been more insulated to the global economic conditions over the past few years, in comparison with the Western world?
What challenges will the global economy be facing over the coming year?
What challenges are the Asian economies facing? How different are they from the challenges you identified in question 3?
Why is the rate of exchange an important factor for an economy such as Japan?
What does a low exchange rate for the yen mean for European countries? Is it likely to be seen as a good or bad thing? What about for South Korea? Use a diagram to help you answer this question.
Why is the economic situation in countries such as China and India so important for the rest of the global economy? Use a diagram to illustrate this.
Consumer spending is crucial to an economy. In the UK total consumer spending is equivalent to almost two-thirds of the value of country’s GDP. Understanding its determinants is therefore crucial in attempting to forecast the short-term path of the economy. In other words, the growth of the economy in 2013 will depend on our inclination to spend.
