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?
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.
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?
What do you understand by a consumption function? What variables would you include in such a function?
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?
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.
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.
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.
How much value do you place on that wonderful long weekend that a Bank holiday brings? The extra lie in; the ensuing 4 day week; the time you spend with your family. Some would say it’s invaluable – you can’t put a price on it. But those some people would not be economists! Each Bank holiday is worth about £2bn – at least that’s how much it costs the economy.
According to the Centre for Economics and Business Research, if the UK got rid of its Bank holidays, GDP would increase by approximately £18bn.
Some businesses will do well out the Bank holidays, but according to the research, the sectors of the economy that suffer are far greater, causing losses in productivity and hence in GDP. Indeed, the extra Bank Holiday we had last year for the Royal Wedding is thought to have been part of the cause for the slow down in growth to 0.1% during the second quarter of 2011.
Based on this data, there are unsurprisingly concerns that the extra Bank holiday this year for the Queen’s Diamond Jubilee could also cost the economy. Not particularly good news, considering how vulnerable the economy currently is. Although the Queen’s Diamond Jubilee will undoubtedly generate huge amounts of spending, it is thought that this will be more than offset by the sectors that are expected to lose out because of the loss in working hours and hence productivity.
Given the cost of Bank holidays to the economy, the CEBR says that they should be spread more evenly throughout the year. Is this the solution &ndash if one is needed – or should they be abolished altogether! The following articles consider the issue.
Between December 2007 and March 2009, the Bank of England reduced Bank Rate on several occasions in order to stimulate the economy and combat recession. By March 2009, the rate stood at a record low of 0.5%. Each month the Monetary Policy Committee meets to decide on interest rates and since March 2009, the members’ decision has consistently been that Bank Rate needs to remain at 0.5%.
Although the UK economy has been making tentative steps towards recovery, it is still in a very vulnerable state. Last month, the Bank of England extended its programme of quantitative easing to a total £325bn stimulus. This, together with the decision to keep interest rates down and with the shock fall in manufacturing output contributing towards first quarter growth of just 0.1%, is a key indication that the UK economy is still struggling, even though the central bank thinks it unlikely that the UK will re-enter recession this year.
Monetary policy in the UK has been very much geared towards stimulating economic growth, despite interest rates typically being the main tool to keep inflation on target at 2%. The problem facing the central bank is that economic growth and inflation are in something of a conflict. Low interest rates to stimulate economic growth also create a higher inflation environment and that is the trade-off the economy has faced. Inflation has been well above its target for some months (a high of 5.2% in September 2011), and the low interest rate environment has done little to deflate the figure. After all, low interest rates are a monetary instrument that can be used to boost aggregate demand, which can then create demand-pull inflation. However, inflation is now slowly beginning to fall, but this downward trend could be reversed with the sky high oil prices we are recently experiencing. If inflation does begin to creep back up, the Monetary Policy Committee will once again face a decision: keep Bank Rate low and continue with quantitative easing to stimulate the economy or increase Bank Rate to counter the higher rate of inflation.
The data over recent months has been truly inconsistent. Some indicators suggest improvements in the economy and the financial environment, whereas others indicate an economic situation that is moving very quickly in the wrong direction. A key factor is that the direction the UK economy takes is very much dependent on the world economy and, in particular, on how events in the eurozone unfold. The following articles consider some of the latest economic developments.
Which factors will the Monetary Policy Committee consider when setting interest rates?
Using a diagram to help your answer, illustrate and explain the trade-off that the MPC faces when choosing to keep interest rates low or raise them.
What is quantitative easing? How is it expected to boost economic growth in the UK?
Which factors are likely to have contributed towards the low growth rate the UK economy experienced in the first quarter of 2012?
Explain the trends that we have seen in UK inflation over the past year. What factors have caused the figure to increase to a high in September and then fall back down?
What do you expect to happen to inflation over the next few months? To what extent is your answer dependent on the MPC’s interest rate decisions?
Although the official figures suggest that the UK avoided a double-dip recession, do you agree with this assessment? Explain your answer.
The rate of inflation in the UK is measured using the Consumer Prices Index (CPI). This is made up of a basket of goods and the ONS updates this ‘basket’ each year to ensure it is representative of what the average UK household buys. The basket contains 700 items, with 180,000 individual prices collected each month.
In recent years, items such as lip gloss have been added to the basket of goods and in the latest adjustment, the ONS has added tablet computers, amongst other things. This is a market that has seen enormous growth. It has been added to the basket as a means of giving a more accurate representation of the price changes faced by the average consumer. The ONS has made it clear that items are not added simply because they are new or removed simply because spending on them has fallen.
‘In each of these cases, the item has not been added because spending has increased or because the product is new on the market … It is purely as part of the rebalancing of the basket to improve its representation of overall price change.’
It is essential that these changes are made each year, as consumer buying habits do fluctuate considerably. One area in particular has been consumer responses to changes in technology. For example, developing and printing colour film has been removed as, with the development of digital cameras, this is no longer reflective of what a representative household spends its money on. Further to this, some items that have previously been used in calculating the RPI have now been added to the CPI, again to give a clearer picture of household spending in the UK. The following articles consider what’s in and what’s out.
What is the difference between the CPI and RPI? Which is usually higher? Explain your answer.
How is the CPI calculated and hence how is inflation measured?
What impact has technological progress had on the basket of goods that the representative household purchases? Do you think that technological progress make it more or less important for the basket of goods to be reviewed annually?
Do you think products such as the iPad should be included in the CPI? Are they truly representative?
In the second Guardian article, you can access a list of the products that are ‘in and out’. Is there anything on there that you think should be in or that should be out? Be sure to justify your answer!
Unemployment figures for the UK have been going in the wrong direction for some time. With consumer expenditure, investment and hence aggregate demand remaining low, job creation has been severely lacking. However, 2 pieces of news have emerged in the last couple of days, which as David Cameron said was ‘a massive confidence boost for the UK economy’. Tesco and Nissan have both announced the creation of thousands of new jobs.
Over the next 2 years, Tesco has said that it will create 20,000 new jobs through store improvement and the opening of new stores. Whilst it is not clear how many will be full-time, part-time or apprenticeship placements, it still represents net job creation. This huge investment represents what many are calling a ‘fight-back’ from Tesco, who issued its first profit warning in 20 years, following weak Christmas trading. That announcement slashed their shares by over £5bn and is perhaps partly responsible for this planned investment.
Despite this good news, criticisms have emerged that the major supermarkets are simply inflating the job creation figures and that the actual number of new jobs will be significantly less than the 20,000 suggested. This follows allegations made towards Asda, who claimed to have created 30,000 jobs. However, evidence from records at Companies House suggests that new job creation by the company was closer to 7,000. Whatever the true figure, it still means new jobs, which can only help UK unemployment data.
In addition to this, Nissan has also announced that it will be creating 2,000 new jobs, as it begins production on a new model at its Sunderland factory. The jobs will be created as part of a £125m investment, including a £9.3m grant from the government. This is especially good news, given the area where many of these jobs will emerge. The North East is a region that has been hit particularly hard by the recession and the grant from the government has come from its regional growth fund. Nissan has said that even in hard economic times, it is possible to sell cars, as long as they are competitively priced. Neither of the plans discussed above will create jobs immediately, but perhaps the key is that it creates confidence, which is a rarity in the UK with the current economic situation. The following articles consider these job creation plans and their wider implications.
Explain the process by which net job creation should provide a boost to the economy.
Will these new jobs have any impact on the government’s budget deficit?
Why is there concern that the supermarkets are inflating the employment creation figures?
What type of unemployment has been created by the recession? Why have certain areas, such as the North East been affected so badly by the recession and austerity measures?
Which factors could have led to Tesco’s weaker trading figures towards then end of 2011? Why did this lead to a £5bn loss in the value of the group’s shares?
Nissan has said that cars can be sold as long as they are competitively priced. To what extent do you think price is the main competitive weapon in the market for cars and in the supermarket industry?
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? 
