With university fees for home students in England of £9250 per year and with many students receiving maintenance loans of around £9000 per year, many students are graduating with debts in excess of £50 000. Loans are repaid at a marginal rate of 9% on incomes over £25 716.
Many students also study for a masters degree. The average fee for a taught, classroom-based masters (MA) is £7392 and for a laboratory-based masters (MSc) is £8167 but can be considerably higher at some prestigious universities where demand is high. Government loans of up to £10 906 are available to contribute towards fees and maintenance. These are paid back at a marginal rate of 6% for people earning over £21 000, giving a combined marginal rate of 15% for first and masters degrees.
For high earners on the 40% income tax rate, the combined marginal rate of payment out of income is 40% tax, plus 2% national insurance, plus 15% for those with undergraduate and masters loans. This gives a combined marginal rate of 57%.
Average student debt in England is higher even than in the USA, where the average is $37 000. US university courses are more expensive than in the UK, costing an average of $34 000 per year in tuition alone. But undergraduates can borrow less. They can borrow between $5500 and $12 500 per year in federal loans towards both fees and maintenance, and some private loans are also available. Most students do some paid work during their studies to make up the difference or rely on parents contributing. Parental contributions mean that students from poor families end up owing more. According to a Guardian article:
Race is a huge factor. Black students owe an average of $7400 more than white students when they graduate, the Brookings Institution found. After graduation, the debt gap continues to widen. Four years after graduation, black graduates owe an average of nearly $53 000 – nearly double that of white graduates.
Student debt looks to become one of the key issues in the 2020 US presidential election.
Pressure to cancel student fees and debt in the USA
Most of the Democratic candidates are promising to address student fees and debt. Student debt, they claim, places an unfair burden on the younger generation and makes it hard for people to buy a house, or car or other major consumer durables. This also has a dampening effect on aggregate demand.
The most radical proposal comes from Bernie Sanders. He has vowed, if elected, to abolish student fees and to cancel all undergraduate and graduate debt of all Americans. Other candidates are promising to cut fees and/or debt.
Although most politicians and commentators agree that the USA has a serious problem of student debt, there is little agreement on what, if anything, to do about it. There are already a number of ways in which student debt can be written off or reduced. For example, if you work in the public sector for more than 10 years, remaining debt will be cancelled. However, none of the existing schemes is as radical as that being proposed by many Democrats.
Criticisms of the Democrats’ plans are mainly of two types.
The first is the sheer cost. Overall debt is around $1.6tn. What is more, making student tuition free would place a huge ongoing burden on government finances. Bernie Sanders proposes introducing a financial transactions tax on stock trading. This would be similar to a Tobin tax (sometimes dubbed a ‘Robin Hood tax’) and would include a 0.5% tax on stock transactions, a 0.1% tax on bond trades and a 0.005% tax on transactions in derivatives. He argues that the public bailed out the financial sector in 2008 and that it is now the turn of the financial sector to come to the aid of students and graduates.
The other type of criticism concerns the incentive effects of the proposal. The core of the criticism is that loan forgiveness involves moral hazard.
The moral hazard of loan forgiveness
The argument is that cancelling debt, or the promise to do so, encourages people to take on more debt. Generally, moral hazard occurs when people are protected from the consequences of their actions and are thus encouraged to make riskier decisions. For example, if you are ensured against theft, you may be less careful with your belongings. As the Orange County Register article linked below states:
If the taxpayers pay the debts of everyone with outstanding student loans, how will that affect the decisions made by current students thinking about their choices for financing higher education? What’s the message? Borrow as much as you can and wait for the debt to be canceled during the next presidential primary campaign?
Not only would more students be encouraged to go to college, but they would be encouraged to apply for more costly courses if they were free.
Universities would be encouraged to exaggerate their costs to warrant higher fees charged to the government. The government (federal, state or local) would have to be very careful in auditing courses to ensure costs were genuine. Universities could end up being squeezed for finance as government may try to cut payments by claiming that courses were overpriced.
Even if fees were not abolished, cancelling debts would encourage students to take on larger debt, if that was to be cleared at some point in the future. What is more, students (or their parents) who could afford to pay, would choose to borrow the money instead.
But many countries do have free or highly subsidised higher education. Universities are given grants which are designed to reflect fair costs.
- Assess the arguments for abolishing or substantially reducing student fees.
- Assess the arguments against abolishing or substantially reducing student fees.
- Assess the arguments for writing off or substantially reducing student debt.
- Assess the arguments against writing off or substantially reducing student debt.
- If it were decided to cancel student debt, would it be fair to pay students back for any debt they had already paid off?
- Does tackling the problem of student debt necessarily lead to a redistribution of wealth/income?
- Give some other examples of moral hazard.
- If student fees were abolished, would there be any problem of adverse selection? If so, how could this be overcome?
- Find out what the main UK parties are advocating about student fees and debt in the nations of the UK for home and non-home students. Provide a critique of each of their policies.
Confidence figures suggest that sentiment weakened across several sectors in June with significant falls recorded in retail and construction. This is consistent with the monthly GDP estimates from the ONS which suggest that output declined in March and April by 0.1 per cent and 0.4 per cent respectively. The confidence data point to further weakness in growth down the line. Furthermore, it poses the risk of fuelling a snowball effect with low growth being amplified and sustained by low confidence.
Chart 1 shows the confidence balances reported by the European Commission each month since 2007. It highlights the collapse in confidence across all sectors around the time of the financial crisis before a strong and sustained recovery in the 2010s. However, in recent months confidence indicators have eased significantly, undoubtedly reflecting the heightened uncertainty around Brexit. (Click here to download a PowerPoint copy of the chart.)
Between June 2016 and June 2019, the confidence balances have fallen by at least 8 percentage points. In the case of the construction the fall is 14 points while in the important service sector, which contributes about 80 per cent of the economy’s national income, the fall is as much as 15 points.
Changes in confidence are thought, in part, to reflect levels of economic uncertainty. In particular, they may reflect the confidence around future income streams with greater uncertainty pulling confidence down. This is pertinent because of the uncertainty around the UK’s future trading relationships following the 2016 referendum which saw the UK vote to leave the EU. In simple terms, uncertainty reduces the confidence people and businesses have when forming expectations of what they can expect to earn in the future.
Greater uncertainty and, hence, lower confidence tend to make people and businesses more prudent. The caution that comes from prudence counteracts the inherent tendency of many of us to be impatient. This impatience generates an impulse to spend now. On the other hand, prudence encourages us to take actions to increase net worth, i.e. wealth. This may be through reducing our exposure to debt, perhaps by looking to repay debts or choosing to borrow smaller sums than we may have otherwise done. Another option may be to increase levels of saving. In either case, the effect of greater prudence is the postponement of spending. Therefore, in times of high uncertainty, like those of present, people and businesses would be expected to want to have greater financial resilience because they are less confident about what the future holds.
To this point, the saving ratio – the proportion of disposable income saved by households – has remained historically low. In Q1 2019 the saving ratio was 4.4 per cent, well below its 60-year average of 8.5 per cent. This appears to contradict the idea that households respond to uncertainty by increasing saving. However, at least in part, the squeeze seen over many years following the financial crisis on real earnings, i.e. inflation-adjusted earnings, restricted the ability of many to increase saving. With real earnings having risen again over the past year or so, though still below pre-crisis levels, households may have taken this opportunity to use earnings growth to support spending levels rather than, as we shall see shortly, looking to borrow.
Another way in which the desire for greater financial resilience can affect behaviour is through the appetite to borrow. In the case of consumers, it could reduce borrowing for consumption, while in the case of firms it could reduce borrowing for investment, i.e. spending on capital, such as that on buildings and machinery. The reduced appetite for borrowing may also be mirrored by a tightening of credit conditions by financial institutions if they perceive lending to be riskier or want to increase their own financial capacity to absorb future shocks.
Chart 2 shows consumer confidence alongside the annual rate of growth of consumer credit (net of repayments) to individuals by banks and building societies. Consumer credit is borrowing by individuals to finance current expenditure on goods and services and it comprises borrowing through credit cards, overdraft facilities and other loans and advances, for example those financing the purchase of cars or other large ticket items. (Click here to download a PowerPoint copy of the chart.)
The chart allows us to view the confidence-borrowing relationship for the past 25 years or so. It suggests a fairly close association between consumer confidence and consumer credit growth. Whether changes in confidence occur ahead of changes in borrowing is debatable. However, the easing of confidence following the outcome of the EU referendum vote in June 2016 does appear to have led subsequently to an easing in the annual growth of consumer credit. From its peak of 10.9 per cent in the autumn of 2016, the annual growth rate of consumer credit dropped to 5.6 per cent in May 2019.
The easing of credit growth helps put something of a brake on consumer spending. It is, however, unlikely to affect all categories of spending equally. Indeed, the ONS figures for May on retail sales shows a mixed picture for the retail sector. Across the sector as a whole, the 3 month-on-3 month growth rate for the volume of purchases stood at 1.6 per cent, having fallen as low as 0.1 percent in December of last year. However, the 3 month-on-3 month growth rate for spending volumes in department stores, which might be especially vulnerable to a slowdown in credit, fell for the ninth consecutive month.
Going forward, the falls in confidence might be expected to lead to further efforts by the household sector, as well as by businesses, to ensure their financial resilience. The vulnerability of households, despite the slowdown in credit growth, so soon after the financial crisis poses a risk for a hard landing for the sector. After falls in national output in March and April, the next monthly GDP figures to be released on 10 July will be eagerly anticipated.
- Which of the following statements is likely to be more accurate: (a) Confidence drives economic activity or (b) Economic activity drives confidence?
- Explain the difference between confidence as a source of economic volatility as compared to an amplifier of volatility?
- Discuss the links between confidence, economic uncertainty and financial resilience.
- Discuss the ways in which people and businesses could improve their financial resilience to adverse shocks.
- What are the potential dangers to the economy of various sectors being financially distressed or exposed?
Latest data from the UK banking trade association, UK Finance, show that cash payments have continued to decline, while contactless and mobile payments have risen dramatically. In 2018, cash payments fell 16% to 11.0 billion payments and constituted just 28% of total payments; the compares with 60% in 2008 and a mere 9% projected for 2028. By contrast, in 2018, debit card payments increased 14% to 15.1 billion payments. Credit card payments increased 4% to stand at 3.2 billion payments. Mobile payments though media such as Apple Pay, Google Pay and Samsung Pay, although still a relatively small percentage, have also increased rapidly, with 16% of the adult population registered for mobile payments, compared with just 2% in 2016.
But what are the implications of this ‘dash from cash’? On the plus side, clearly there are advantages to consumers. A contactless payment is often more convenient than cash and does not require periodic visits to a cash machine (ATM) – machines that are diminishing in number and may be some distance away if you live in the countryside. What is more, card payments allow purchasing online – a form of shopping that continues to grow. Also, if a card is stolen or lost, you can cancel it; if cash is stolen or lost, you cannot cancel that.
Then there are benefits to vendors. Cashing up is time consuming and brings little or no benefit in terms of bank charges. These are typically around 0.75% for cash deposits and roughly the same for handling debit card payments (around 0.7%). What is more, with the closure of many bank branches, it is becoming harder for many businesses to deposit cash.
Finally, there is the problem that many illegal activities involve cash payments. What is more, cash payments can be used as a means of avoiding tax as they can be ‘kept off the books’.
But there are also dangers in the dash from cash. Although the majority of people now use cards for at least some of their transactions, many older people and people on low incomes rely on cash and do not use online banking. With bank branches and ATMs closing, this group is becoming further disadvantaged. As the Access to Cash Review, Final Report states:
Millions of people could potentially be left out of the economy, and face increased risks of isolation, exploitation, debt and rising costs.
Then there is the danger of fraud. As the Financial Times article below states:
The proliferation of new types of payment method has raised concerns over security. Criminals stole £1.2bn in 2018, according to previous data from UK Finance, up from £967m in 2017. This included a rise in fraudsters illegally accessing customers’ accounts and cards.
Complaints about banking scams reached a record high in the past financial year, according to figures in May from the UK’s Financial Ombudsman Service.
One of the biggest dangers, however, of the move to card payments, and especially contactless payments, is that people may be less restrained in their spending. They may be more likely to rack up debt with little concern at the time of spending about repayment. As the Forbes article below states:
Because items purchased with a credit card have been decoupled from emotion, shoppers can focus on the benefits of the purchase instead of the cost. Thus, paying with a credit card makes it more difficult to focus on the cost or complete a more rational cost–benefit analysis. For example, if a person had to count out $0.99 to purchase an app, they might be less inclined to buy it. However, since we can quickly buy apps with our credit card, the cost seems negligible, and we can focus on the momentary happiness of the purchase.
Finally, there is the issue of our privacy. Card payments enable companies, and possibly other agencies, to track our spending. This may have the benefits of allowing us to receive tailored advertising, but it may be used as a way of driving sales and encouraging us to take on more debt as well as giving companies a window on our behaviour.
- Millions choose a cashless lifestyle
BBC News, Kevin Peachey (6/6/19)
- The decline of cash in the UK – in charts
BBC News (7/6/19)
- One in 10 adults in UK have gone ‘cashless’, data shows
The Guardian, Rupert Jones (6/6/19)
- Going contactless is gloriously convenient – for all the wrong people
The Guardian, Peter Ormerod (7/3/19)
- Mobile banking and contactless cards continue to surge in popularity
Financial Times, James Pickford (6/6/19)
- Is a cashless society in Britain near? Banking data suggests just 9% of all payments will be cash by 2028
This is Money, George Nixon (6/6/19)
- Older and poorer communities are left behind by the decline of cash
The Conversation, Daniel Tischer, Jamie Evans and Sara Davies (16/5/19)
- As cash declines, research shows the most deprived communities are left behind
University of Bristol Press Release (16/5/19)
- Do People Really Spend More With Credit Cards?
Forbes, Bill Hardekopf (16/7/18)
- Why Cash Is Quickly Disappearing From China’s Economy—Data Sheet
Fortune, Aaron Pressman and Clay Chandler (5/6/19)
- Cashless in China: Why It Matters
CNA Insider on YouTube, Joshua Lim (28/10/17)
- Summarise the main findings of the UK Payments Market Report 2019
- What are the relative merits of using (a) cash; (b) debit cards; (c) mobile payment?
- Find out what has happened to consumer debt in a country of your choice over the past five years. What are the main determinants of the level of consumer debt?
- How has UK money supply changed over the past five years? To what extent does this reflect changes in the ways people access money in their accounts?
- Why and how is China going ‘cashless’? Does this create any problems?
- Make out a case for and against increasing the £30 limit for contactless payments in the UK.
Consumer credit is borrowing by individuals to finance current expenditure on goods and services. Consumer credit is distinct from lending secured on dwellings (referred to more simply as ‘secured lending’). Consumer credit comprises lending on credit cards, lending through overdraft facilities and other loans and advances, for example those financing the purchase of cars. We consider here recent trends in the flows of consumer credit in the UK and discuss their implications.
Analysing consumer credit data is important because the growth of consumer credit has implications for the financial wellbeing or financial health of individuals and, of course, for financial institutions. As we shall see shortly, the data on consumer credit is consistent with the existence of credit cycles. Cycles in consumer credit have the potential to be not only financially harmful but economically destabilising. After all, consumer credit is lending to finance spending and therefore the amount of lending can have significant effects on aggregate demand and economic activity.
Data on consumer credit are available monthly and so provide an early indication of movements in economic activity. Furthermore, because lending flows are likely to be sensitive to changes in the confidence of both borrowers and lenders, changes in the growth of consumer credit can indicate turning points in the economy and, hence, in the macroeconomic environment.
Chart 1 shows the annual flows of net consumer credit since 2000 – the figures are in £ billions. Net flows are gross flows less repayments. (Click here to download a PowerPoint copy of the chart.) In January 2005 the annual flow of net consumer credit peaked at £23 billion, the equivalent of just over 2.5 per cent of annual disposable income. This helped to fuel spending and by the final quarter of the year, the economy’s annual growth rate had reached 4.8 per cent, significantly about its long-run average of 2.5 per cent.
By 2009 net consumer credit flows had become negative. This meant that repayments were greater than additional flows of credit. It was not until 2012 that the annual flow of net consumer credit was again positive. Yet by November 2016, the annual flow of net consumer credit had rebounded to over £19 billion, the equivalent of just shy of 1.5 per cent of annual disposable income. This was the largest annual flow of consumer credit since September 2005.
Although the strength of consumer credit in 2016 was providing the economy with a timely boost to growth in the immediate aftermath of the referendum on the UK’s membership of the EU, it nonetheless raised concerns about its sustainability. Specifically, given the short amount of time that had elapsed since the financial crisis and the extreme levels of financial distress that had been experienced by many sectors of the economy, how susceptible would people and organisations be to a future economic slowdown and/or rise in interest rates?
The extent to which the economy experiences consumer credit cycles can be seen even more readily by looking at the 12-month growth rate in the net consumer credit. In essence, this mirrors the growth rate in the stock of consumer credit. Chart 2 evidences the double-digit growth rates in net consumer credit lending experienced during the first half of the 2000s. Growth rates then eased but, as the financial crisis unfolded, they plunged sharply. (Click here to download a PowerPoint copy of the chart.)
Yet, as Chart 2 shows, consumer credit growth began to recover quickly from 2013 so that by 2016 the annual growth rate of net consumer credit was again in double figures. In November 2016 the 12-month growth rate of net consumer credit peaked at 10.9 per cent. Thereafter, the growth rate has continually eased. In January 2019 the annual growth rate of net consumer credit had fallen back to 6.5 per cent, the lowest rate since October 2014.
The easing of consumer credit is likely to have been influenced, in part, by the resumption in the growth of real earnings from 2018 (see Getting real with pay). Yet, it is hard to look past the economic uncertainties around Brexit.
Uncertainty tends to cause people to be more cautious. With the heightened uncertainty that has has characterised recent times, it is likely that for many people and businesses prudence has dominated impatience. Therefore, in summary, it appears that prudence is helping to steer borrowing along a downswing in the credit cycle. As it does, it helps to put a further brake on spending and economic growth.
- What is the difference between gross and net lending?
- Consider the argument that we should be worried more by excessive growth in consumer credit than on lending secured on dwellings?
- How could we measure whether different sectors of the economy had become financially distressed?
- What might explain why an economy experiences credit cycles?
- Explain how the growth in net consumer credit can affect economic activity?
- If people are consumption smoothers, how can credit cycles arise?
- What are the potential policy implications of credit cycles?
- It is said that when making financial decisions people face an inter-temporal choice. Explain what you understand this by this concept.
- If economic uncertainty is perceived to have increased how could this affect the consumption, saving and borrowing decisions of people?
Growth in the eurozone has slowed. The European Central Bank (ECB) now expects it to be 1.1% this year; in December, it had forecast a rate of 1.7% for 2019. Mario Draghi, president of the ECB, in his press conference, said that ‘the weakening in economic data points to a sizeable moderation in the pace of the economic expansion that will extend into the current year’. Faced with a slowing eurozone economy, the ECB has announced further measures to stimulate economic growth.
First it has indicated that interest rates will not rise until next year at the earliest ‘and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. The ECB currently expects HIPC inflation to be 1.2% in 2019. It was expected to raise interest rates later this year – probably by the end of the summer. The ECB’s main refinancing interest rate, at which it provides liquidity to banks, has been zero since March 2016, and so there was no scope for lowering it.
Second, although quantitative easing (the asset purchase programme) is coming to an end, there will be no ‘quantitative tightening’. Instead, the ECB will purchase additional assets to replace any assets that mature, thereby leaving the stock of assets held the same. This would continue ‘for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation’.
Third, the ECB is launching a new series of ‘quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years’. These are low-interest loans to banks in the eurozone for use for specific lending to businesses and households (other than for mortgages) at below-market rates. Banks will be able to borrow up to 30% of their eligible assets (yet to be fully defined). These, as their acronym suggests, are the third round of such loans. The second round was relatively successful. As the Barron’s article linked below states:
Banks boosted their long-term borrowing from the ECB by 70% over the course of the program, although they did not manage to increase their holdings of business loans until after TLTRO II had finished disbursing funds in March 2017.
Whether these measures will be enough to raise growth rates in the eurozone depends on a range of external factors affecting aggregate demand. Draghi identified three factors which could have a negative effect.
- Brexit. The forecasts assume an orderly Brexit in accordance with the withdrawal deal agreed between the European Commission and the UK government. With the House of Commons having rejected this deal twice, even though it has agreed that there should not be a ‘no-deal Brexit’, this might happen as it is the legal default position. This could have a negative effect on the eurozone economy (as well as a significant one on the UK economy). Even an extension of Article 50 could create uncertainty, which would also have a negative effect
- Trade wars. If President Trump persists with his protectionist policy, this will have a negative effect on growth in the eurozone and elsewhere.
- China. Chinese growth has slowed and this dampens global growth. What is more, China is a major trading partner of the eurozone countries and hence slowing Chinese growth impacts on the eurozone through the international trade multiplier. The ECB has taken this into account, but if Chinese growth slows more than anticipated, this will further push down eurozone growth.
Then there are internal uncertainties in the eurozone, such as the political and economic uncertainty in Italy, which in December 2018 entered a recession (2 quarters of negative economic growth). Its budget deficit is rising and this is creating conflict with the European Commission. Also, there are likely to be growing tensions within Italy as the government raises taxes.
Faced with these and other uncertainties, the measures announced by Mario Draghi may turn out not to be enough. Perhaps in a few months’ there may have to be a further round of quantitative easing.
- ECB statement following policy meeting
Reuters, Larry King (7/3/19)
- European Central Bank acts to boost struggling eurozone
BBC News, Andrew Walker (7/3/19)
- The European Central Bank Tries to Avoid Repeating Past Mistakes
Barron’s, Matthew C. Klein (8/3/19)
- ECB pushes back rate hike plans, announces fresh funding for banks
CNBC, Silvia Amaro (7/3/19)
- Why the ECB Followed the Fed’s Flip-Flopping
Bloomberg, Mohamed A. El-Erian (7/3/19)
- Central Banks Don’t Have the Answer and Markets Know It
Bloomberg, Robert Burgess (7/3/19)
- Missing out on monetary normalisation
OMFIF, David Marsh (12/4/19)
- The ECB is attempting to get ahead of event
Financial Times, The editorial board (8/3/19)
- Explainer: What is the fuss about European Central Bank TLTRO loans?
Reuters, Balazs Koranyi (4/3/19)
- Investigate the history of quantitative easing and its use by the Fed, the Bank of England and the ECB. What is the current position of the three central banks on ‘quantitative tightening’, whereby central banks sell some of the stock of assets they have purchased during the process of quantitative easing or not replace them when they mature?
- What are TLTROs and what use of them has been made by the ECB? Do they involve the creation of new money?
- What will determine the success of the proposed TLTRO III scheme?
- If the remit of central banks is to keep inflation on target, which in the ECB’s case means below 2% HIPC inflation but close to it over the medium term, why do people talk about central banks using monetary policy to revive a flagging economy?
- What is ‘forward guidance’ by central banks and what determines its affect on aggregate demand?