Category: Economics: Ch 15

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.

The International Monetary Fund consists of 187 countries and is concerned with its members’ economic health. It promotes co-operation, economic stability and is also there to lend to those countries facing difficulties. The role of the IMF as a lender has come into question, as critics argue that the conditions placed on loans to countries can cause more problems than they solve, as the cause of the problems is not always identified. However, despite the criticisms and the current charges facing the former IMF Chief, the International Monetary Fund continues to play an important role in the global economic environment.

Many countries have used IMF credit and over the past two decades it has predominantly been the transition and the emerging market economies that have demanded the IMF’s resources. Whilst its lending did drop off in the mid 2000s, the global financial crisis of 2008/09 saw an increase in the demand for IMF funds from emerging economies to some $60 billion. In May 2010, we saw the IMF together with the EU put together a rescue package for Greece and it is now the turn of Egypt. The uprisings in Egypt put the stability of the economy in jeopardy, as investment declined, tax revenues decreased and the usually buoyant tourist industry started to struggle. Despite the efforts of the government to stabilise the economy, it remains short of cash and the IMF looks set to agree a loan deal of $3 billion (£1.8 billion). Egypt would have five years to repay the loan at an interest rate of 1.5%, after a three year ‘grace period’.

Other countries to receive loans include Ireland, Belarus, the Ukraine and Iceland, the latter of which owes the IMF $2,828.67 per person of its population. The UK has used the IMF back in 1976 and it may be something to look out for, depending on how our recovery continues. The following articles look at the IMF and its role in promoting global financial stability.

Articles

IMF to lend Egypt $3 bn: Ministry Associated Press (6/5/11)
IMF agrees $3bn financing deal with Egypt BBC News (5/6/11)
Timeline: Greece’s debt crisis Reuters (5/6/11)
Egypt strikes $3bn IMF deal to ‘re-launch’ economy Guardian, Jack Shenker (5/6/11)
The IMF versus the Arab Spring Guardian, Austin Mackell (25/5/11)
EU/IMF/ECB statement on Greek bailout Reuters (3/6/11)
Belarus wins $3 billion loan from Russia-led fund, still seeks IMF’s help Bloomberg, Scott Rose and Daryna Krasnolutska (4/6/11)
IMF frees up $225mn for Iceland Associated Press (4/6/11)
IMF loan: which country owes the most? Guardian (24/5/11)

International Monetary Fund
International Monetary Fund Homepage
IMF outlines $3 billion support for Egypt International Monetary Fund, IMF Survey Online (5/6/11)

Questions

  1. What is the role of the IMF and how is it financed?
  2. What are the objectives of the loans to countries such as Greece, Iceland and Egypt?
  3. What other countries has the IMF lent to and what are the conditions that have been placed on these loans?
  4. What has been the impact on the Egyptian economy of the uprisings? Think about all the industries that have been affected and the wider impacts.
  5. Can you find any examples of circumstances in which the conditions of an IMF loan have made problems worse for the recipient?
  6. Why are the conditions of the IMF loan to Egypt favourable and how will the loan help the economy?
  7. Look at the trend in IMF lending. What factors explain the peak and troughs? In particular, what is the explanation for the incresae in lending during the financial crisis?

The banking sector was at the heart of the credit crunch and it may also be at the heart of the recovery. Too much lending to those who could not repay has now translated into government encouragement and targets to stimulate further lending. Banks made a deal with the government (Project Merlin) to lend £76bn to small and medium sized companies (SMEs) in 2011, however, the data for the first quarter of 2011 shows that the top five UK banks lent only £16.8bn, some £2.2bn short of their quarterly target (about 12%). Despite this sum still being a significant figure, small companies have said that they are still finding it difficult to obtain credit from banks. A poll found 44% of companies that asked for a loan were turned down and many were discouraged from even applying as they had almost no chance.

Encouraging banks to lend and hence stimulating investment by businesses may prove crucial to the UK’s recovery. Vince Cable’s words with regard to lending emphasise its importance:

“We will monitor the banks’ performance extremely closely and if they fail to meet the commitments they have agreed we will examine options for further action.”

If small businesses can obtain credit, it will help them to develop and expand and this should have knock on effects on the rest of the economy. Jobs could be created, giving more people an income, which in turn should stimulate consumption, further investment and finally aggregate demand. It may not be the case that the UK’s recovery is entirely dependent on bank lending, but it could certainly play an important role, hence the government’s insistence for further lending. It may also act to create confidence in the economy. The following articles consider the bank’s role in providing credit to SMEs.

Articles

Bank lending falling short of promises by £25m a day Mail Online, Becky Barrow (24/5/11)
Cable tells banks to increase lending to small firms BBC News (23/5/11)
Bank lending targets: What the experts say Guardian, Alex Hawkes (23/5/11)
Major banks fail to meet their lending targets Independent, Sean Farrell (24/5/11)
Banks on course to miss small business lending target Guardian, Philip Inman (23/5/11)
Project Merlin needs to be less woolly and more wizard Guardian, Nils Pratley (23/5/11)
Bankers caused the crash and now they strangle recovery Guardian, Polly Toynbee (27/5/11)

Data

Trends in Lending Bank of England (see in particular, Lending to UK Businesses)

Questions

  1. Why have banks not met their lending targets for the first quarter of 2011?
  2. Why is project Merlin so potentially important to the recovery of the economy?
  3. Using an AD/AS diagram, illustrate the possible effects of further lending.
  4. Are there any possible adverse consequences of too much lending?
  5. Why might banks have little incentive to increase their lending to SMEs?

Each month the Bank of England releases figures on the amount of net lending to households. Net lending measures the additional amount of debt acquired by households in the month and so takes into account the amount of debt that households repay over the month. For some time now, the levels of net lending have been remarkably low. Over the first quarter of 2011, monthly net lending to households averaged £1.2 billion. This might sound like a lot of money and in many ways this is true. But, to put the weakness of this figure into perspective, the monthly average over the past ten years is £7 billion.

Household debt can be categorised as either secured debt or unsecured debt. The former is mortgage debt while the latter includes outstanding amounts due on credit and store cards, overdrafts and personal loans. Levels of net secured lending have averaged £1 billion per month over the first 3 months of 2011. This compares with a 10-year average of £5.8 billion per month. Levels of net unsecured lending have averaged £196 million per month over the first 3 months of 2011. This compares with a 10-year average of £1.2 billion per month. In 12 of the months between December 2008 and January 2011 net unsecured lending was actually negative. This means that the value of repayments was greater than new unsecured lending. Once bad debts are taken into account we observe from the autumn of 2008 almost persistent monthly falls in the stock of unsecured debt.

Weak levels of net lending reflect two significant factors. First, on the supply-side, lending levels remain constrained and credit criteria tight. Second, on the demand-side, households remain anxious during these incredibly uncertain times and would appear to have a very limited appetite for taking on additional credit.

Finally, a note on the stock of debt that we households collectively hold. The stock of household debt at the end of March 2011 was £1.45 trillion. This is £7.2 billion or 0.5% lower than in March 2010. The stock of secured debt has risen over this period by only £2.6 billion or 0.2%, while unsecured debt – also known as consumer credit – has fallen £9.9 billion or 4.5%. These figures help to reinforce the message that British households continue to consolidate their financial positions.

Articles

Latest data shows UK economy still sluggish Euronews (4/5/11)
Bank reveals weal lending on mortgages City A.M., Julian Harris (5/5/11)
Mortgage lending plummets by 60% Belfast Telegraph (5/5/11)
Mortgage lending down as borrowers repay debt thisismoney.co.uk (4/5/11)
Average UK household owes more than £50,000 in debts Mirror, Tricia Phillips (6/5/11)

Data

Lending data are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Tables A5.2-A5.7).

Questions

  1. What is the difference between gross lending and net lending?
  2. What do you understand by a negative net lending number?
  3. What is the difference between net secured lending and net unsecured lending?
  4. What factors do you think help to explain the recent weakness in net lending?
  5. How would you expect the net lending figures in a year’s time to compare with those now?
  6. As of 31 March 2011, UK households had accumulated a stock of debt of £1.45 trillion. In what ways could we put this figure into context? Should we as economists be concerned?
  7. It is said that households are consolidating their financial position. What do you understand by this term and what factors have driven this consolidation?
  8. What are the implications for the wider economy of households consolidating their financial position?

Growth figures across many countries still remain vulnerable, including the UK, where growth lies at only 0.5%. Despite some countries starting to grow more rapidly, the numbers still remain close to 0. The eurozone area is a particularly interesting case, as there are so many individual countries that are all interdependent. So, despite growth in the eurozone area increasing to 0.8% in the first three months of 2011, which is higher than that for the UK, this doesn’t explain the full story in the area. Germany has grown by 1.5% and it is this figure which has largely contributed to the 0.8% figure. It was also helped by growth of 1% in France and incredibly of 0.8% in Greece, despite its huge debts. The growth in Greece is allegedly down to a better export market.

Why then wasn’t the figure higher? Whilst countries like Germany showed an acceleration in demand, growth remained sluggish in Spain and Italy at only 0.1% and 0.3% respectively and Portugal faced the second consecutive quarter of negative growth and so has officially gone back into recession. This situation may get even worse as the austerity measures put in place by the EU and IMF take effect. One of the key arguments against joining the eurozone is that the policies implemented are never going to be in the best interests of any one country. With some countries beginning to grow more quickly and others remaining sluggish, what should happen to macroeconomic policy? Should interest rates remain low in a bid to boost aggregate demand or should they rise as other countries see accelerating growth?

An interesting question here is why do countries, such as Italy, Spain and Portugal struggle, whilst France and Germany begin their recovery? One obvious explanation is that Germany and France are at the heart of the eurozone, where as Spain, Portugal and Italy remain on the periphery. Ken Wattret at BNP Paribas said:

“The periphery are getting the worst of both worlds. The core countries like Germany are doing really well and that’s keeping the euro strong, and it’s making the ECB [European Central Bank] more inclined to tighten policy.”

If the ECB do go ahead with a tightening of monetary policy, it could spell further trouble for those countries on the periphery of the Euro area that would benefit from interest rates remaining low and a weaker Euro. The following articles look at the conflicts within the 2-speed Eurozone.

Articles

Sterling lags euro on growth outlook; trails dollar Reuters (13/5/11)
Eurozone’s growth surprises as UK lags behind Telegraph, Emma Rowley (13/5/11)
Eurozone’s economic growth accelerates BBC News (13/5/11)
Solid finances help drive German economic revival Financial Times, Ralph Atkins (13/5/11)
UK’s economy in the slow lane as eurozone surges Scotsman, Scott Reid (14/5/11)
Euro growth eclipses rivals despite north-south divergences AFP, Roddy Thomson (13/5/11)
Eurozone economic growth data prompts political clash BBC News (13/5/11)
Fresh fears for UK economy as Germany and France power ahead Guardian, Larry Elliott (13/5/11)
Portugal’s GDP is set to shrink this year and next Wall Street Journal, Alex Macdonald and Patricia Kowsmann (14/5/11)

Data

UK GDP Growth National Statistics
Eurozone growth rates ECB
EU countries’ Growth rates of GDP in volume Eurostat News Release (13/5/11)
Real GDP growth rate for EU countries and applicant countries, EEA countries and USA and Japan Eurostat

Questions

  1. What has contributed to the German, French and Greek economies surging ahead?
  2. Why is there such a north-south divergence in growth within the eurozone?
  3. What is the most suitable monetary policy for those countries growing more strongly?
  4. What is the best direction for interest rates and hence the value of the euro for countries, such as Spain, Italy and Portugal?
  5. ’The UK economy would be in a worse position if it were a member of the eurozone’. What are the arguments (a) for and (b) against this statement?
  6. What is the relationship between interest rates, the exchange rate and growth?