Growth in the UK for the final quarter of 2010 was originally at -0.5%. However, the latest data has revised that figure to -0.6% and not all of this was down to the snow. Analysts say that the snow effect is still believed to explain the 0.5% contraction, but the economy therefore declined by 0.1% because of other reasons and retailers have seen the effects. Primark has reported a ‘noticeable’ slowdown in demand since the beginning of 2011. With increasing VAT and rising cotton prices, clothing retailers are feeling the squeeze. The same is true of UK consumers. With an increase in VAT and high inflation, consumers’ purchasing power has simply fallen and so they are spending less. Despite this slowdown, Primark’s revenues are still significantly ahead of the same time last year.
The parent company, Associated British Foods (ABF) commented on the disappointing trading of 2011 so far, saying:
“Since the New Year, the performance in all our operations in Continental Europe has been very encouraging but there has been a noticeable slowing down of UK consumer demand.”
However, despite disappointing figures for Primark, UK retail sales did pick up in January, although analysts are warning against taking this information as a sign of recovery. As Hetal Mehta from Daiwa said:
“While we expected there to be some clawback from December’s dismal, snow-hit retail sales, today’s jump is a welcome surprise. But is still far too early to conclude that consumers are weathering the storm … and with the past week’s unemployment figures highlighting the fragility of the labour market, the housing market continuing to weaken and real earnings being hit hard by high inflation, it seems inconceivable that consumer spending will act as the driving force of the economy over the near term.”
There are many opinions about what to expect from the economy in 2011, but for any concrete information, we really have to wait for at least another month. Perhaps by Easter, we’ll have a better idea about the state of the UK. For now, there are a few articles considering the retail sector.
Primark owner warns of slowing sales in UK Guardian, Graeme Wearden (28/2/11)
Primark warns of ‘noticeable’ slowdown in UK demand BBC News (28/2/11)
Growth in UK retail sales slows sharply Wall Street Journal, Alex Brittain and Art Patnaude (24/2/11)
UK retail sales rebound: reaction Telegraph (28/2/11)
UK GDP figure revised down further BBC News (25/2/11)
Questions
- Why has higher VAT and cotton prices impacted retailers such as Primark?
- Why was Primark less affected by declining sales in the run up to Christmas?
- What do we mean by purchasing power?
- Why is it hard to draw any conclusions about the performance of the UK at the moment?
- What does a slowing down of retail sales mean for the UK’s recovery? Will it influence the Chancellor’s Budget?
Every quarter, the Bank of England publishes its Inflation Report. This analyses developments in the macroeconomy and gives forecasts for inflation and GDP growth over the following 12 quarters. It is on the forecast for inflation in 8 quarters’ time that the Bank of England’s Monetary Policy Committee primarily bases its interest rate decision.
According to the February 2011 Inflation Report forecast, CPI inflation is expected to be at or slightly below its 2% target in two year’s time, but there is considerable uncertainty about this, as shown in the fan diagram in Chart 3 of the Overview. What is more, inflation is likely to rise considerably before it falls back. As the Report states:
CPI inflation is likely to pick up to between 4% and 5% in the near term and to remain well above the 2% target over the next year or so, reflecting in part the recent increase in VAT. The near-term profile is markedly higher than in November, largely reflecting further rises in commodity and import prices since then. Further ahead, inflation is likely to fall back, as those effects diminish and downward pressure from spare capacity persists. But both the timing and extent of that decline in inflation are uncertain.
It is interesting to look back at the Inflation Reports of a year ago and two years ago to see what was being forecast then and to compare them with what has actually happened. It’s not too difficult to explain why the forecasts have turned out to be wrong. Hindsight is a wonderful thing. Unfortunately, foresight is less wonderful.
Articles
BoE forecasts pave way to rate rise, but King cautious Reuters, Matt Falloon and Fiona Shaikh (16/2/11)
Inflation report: what the economists say Guardian (16/2/11)
Inflation will rise sharply, says Mervyn King BBC News (16/2/11)
The unrepentant governor BBC News blogs: Stephanomics, Stephanie Flanders (16/2/11)
Inflation: Mervyn and me BBC News blogs: Idle Scrawl, Paul Mason (16/2/11)
What would Milton do? The Economist, Buttonwood (16/2/11)
Why inflation hawks are still grounded Fortune, Colin Barr (16/2/11)
Podcast and Webcast
Bank of England Press conference: Podcast (16/2/11)
Bank of England Press conference: Webcast (16/2/11)
Inflation Report
Inflation Report, portal page for latest report and sections, Bank of England
Inflation Report, February 2011: full report, Bank of England
Data
Forecasts for the UK economy: a comparison of independent forecasts, HM Treasury
Prospects for the UK economy, National Institute of Economic and Social Research press release (1/2/11)
Output, Prices and Jobs, The Economist (10/2/11)
Questions
- Examine the forecasts for UK inflation and GDP for 2010 made in the February 2009 and February 2010 Bank of England Inflation Reports. How accurate were they?
- Explain the difference between the forecasts and the outturn.
- Why is it particularly difficult to forecast inflation and GDP growth at the present time for two years hence?
- What are the advantages of the Bank of England using a forward-looking rule as opposed to basing interest rate decisions solely on current circumstances?
- Explain whether or not it is desirable for interest rates to be adjusted in response to external shocks, such as commodity price increases?
- What do you understand by the term ‘core’ inflation? Is this the same thing as demand-pull inflation?
- How is the Bank of England’s policy on interest rates likely to affect expectations? What expectations are particularly important here?
- Explain whether or not it is desirable for interest rates to be adjusted in response to external shocks, such as commodity price increases?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. And there it has remained for almost 2 years and as yet, no change is in sight. In the February 2011 meeting of the Monetary Policy Committee (who are responsible for setting interest rates to keep inflation on target), the decision was to keep interest rates at 0.5% rather than raise them to tackle high and rising UK inflation. Those in favour of keeping interest rates at this record low argue that any increase could damage the UK’s ability to recover and may lead to the dreaded double-dip recession. This is of particular concern given the economy’s performance in the last quarter of 2010.
However, one group that will certainly not be happy is the savers. With instant-access savings accounts paying on average just 0.84% before tax and with inflation at 3.7%, savers aren’t just not gaining much interest, but are actually seeing the value of their money in real terms fall. Howard Archer of HIS Global Insight said:
“For now, we retain our view that the Bank of England will hold off from raising interest rates until the latter months of the year. Even if interest rates do rise in the near term, the likelihood is still that they will rise only gradually and remain very low compared to past norms.
Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2pc by the end of 2012.”
Following some speculation that the Bank of England may succumb to the pressure of inflation and hike up interest rates (markets had priced in a 20% chance of a rate rise), sterling did take a hit, but after the decision to keep rates at 0.5%, sterling recovered against the dollar. There is a belief amongst some traders that rates will rise in May, but others believe rates may remain at 0.5% until much later in 2011, as the country aims to avoid plunging back into recession. Of 49 economists that responsed to a poll by Reuters, three quarters of them said that rates would rise by the end of 2011, with median forecasts predicting a rise around November. This is certainly a space to watch, as it has implications for everyone in the UK and for many in countries around the world.
BOE leaves bank rate unchanged at 0.5% at Feb meeting Automated Trader (10/2/11)
Economists predict interest rates will rise in November Telegraph, Szu Ping Chan (11/2/11)
UK May rate hike view holds firm after BOE Reuters, Kirsten Donovan (10/2/11)
Interest rates: What the economists say Guardian (10/2/11)
Fixed rate mortgages becoming more expensive BBC News (10/2/11)
Bank rate: savers’ celebrations on hold Telegraph, Richard Evans (10/2/11)
Inflation fears turn up heat ahead of bank rate decision City AM, Julian Harris (10/2/11)
Sterling takes BOE in its stride, higher rate talk aids Reuters, Anirban Nag (10/2/11)
Bank of England holds interest rates of 0.5% Telegraph, Emma Rowley (10/2/11)
Questions
- Why are interest rates such an important tool of monetary policy? Think about which variables of aggregate demand will be affected by the Bank of England’s decision.
- What is the relationship between interest rates and inflation?
- What explanation is there for the fall in the value of sterling following speculation that interest rates may rise? Why did sterling recover after the Bank of England’s decision?
- How has the recent speculation affected fixed rate mortgages?
- What does the Telegraph article about “savers’ celebrations on hold” mean about the ‘real value’ of money and savings?
- What are (a) the arguments for keeping interest rates at 0.5% and (b) the arguments for raising interest rates? Who wins and loses in each case?
- Are there any other government policies that could be used to combat inflation, without creating the possibility of a double-dip recession? Why haven’t they been used?
With the UK economy borrowing 11% of GDP, it is undeniable that spending cuts are needed. Of course, the big question is should they be occurring now or delayed until the recovery is more stable. However, another question is now being asked. Should taxes be cut to help the worse off? David Cameron says that this is out of the question. While he is a ‘tax-cutting Tory’ who ‘believes in tax cuts’, any significant cuts in taxes specifically aimed at the poor would simply make matters worse, especially as the Coalition government is already helping to move thousands of families out of taxation altogether, albeit by increasing taxes on the better off.
“It’s no good saying we’re going to deal with the deficit by cutting spending, but then we’re going to make things worse again by cutting taxes. I’m afraid it doesn’t add up.”
Those in favour of cutting taxes include John Redwood, the head of the Tory’s economic affairs committee, who argues that they would help to boost the economy, by ‘encouraging the wealth creators and the private sector’. By reducing the burden on residents, disposable income will increase, helping to stimulate consumption and investment, which should in turn boost aggregate demand. This would be a much needed stimulus following the latest data which showed: a shrinking economy once again in the last quarter of 2010, consumer confidence at its lowest level in the past 20 years, the possibility of unstable markets should the government be seen to ‘twitch’ on the austerity drive and 57% in a YouGov poll saying that the cuts are ‘being imposed unfairly’. Public approval for the Coalition’s budget deficit reduction strategy has fallen from 53% in June 2010 to 38% in February 2010. Add to this rising inflation and unemployment and the last thing people want to hear is surely ‘No big tax cuts’.
However, the budget deficit must be tackled: now or later. Whenever it happens and whichever party is in power, spending must be cut and/or tax revenues must rise and everyone will have to play their part.
Cameron: ‘Tax cuts impossible right now’ Sky News (6/2/11)
David Cameron says major tax cuts not possible BBC News (6/2/11)
Cameron vows ‘No to big tax cuts’ The Press Association (6/2/11)
David Cameron: Sorry, but we can’t afford tax cuts Telegraph, Patrick Hennessy (5/2/11)
George Osborne faces Conservative pressure for tax cuts BBC News (1/2/11)
Nick Clegg’s tax cuts will cost £4.3 billion, says IFS Telegraph, James Kirkup (2/2/11)
Doubts mount over Cameron’s austerity drive Associated Press (6/2/11)
Sorry it is so complicated BBC 2, Daily Politics, Stephanie Flanders (14/6/10)
Questions
- What is government borrowing? Who does the government borrow from?
- Analyse the impact of tax cuts on the economy. Think about which groups will be affected the most and in what ways.
- Which components of aggregate demand will be affected by cuts in spending and rising taxes?
- ’Cuts in taxation would boost the economy.’ To what extent do you agree with this statement?
- What will be the impact of tas cuts on the government’s macroeconomic objectives, given your answer to question 3?
- What are the arguments (a) for cutting the budget deficit now and (b) for cutting the budget deficit later?
The recession caused a large rise in unemployment in many countries. In the USA the rise has been particularly steep, where unemployment now stands at 14.5 million, or 9.8% of the labour force. Unemployment has continued to rise despite renewed growth in the US economy, where the latest annual real GDP growth is 2.6% (measured in Q3 2010). The rise in unemployment has been blamed on ‘sticky wages’ – i.e. the reluctance of wage rates to fall.
But are wages genuinely sticky as far as the average worker is concerned? They may be in many specific jobs with specific employers, but many workers made redundant then find work in different jobs at lower rates of pay. For them, their wage has fallen, even if particular jobs are paying the same as before.
So what are the consequences of this? Does the willingness of workers to accept lower paid jobs mean that the labour market is flexible and that people will thus price themselves into work? If so, why is employment still rising? Or does a reduction in real wages for many people dampen spending and hence aggregate demand, thereby reducing the demand for labour? If so, why is GDP rising?
The following articles look at the apparent stickiness of wages and the implications for the labour market and the macroeconomy.
Articles
Downturn’s Ugly Trademark: Steep, Lasting Drop in Wages Wall Street Journal, Sudeep Reddy (11/1/11)
The Causes of Unemployment Seeking Alpha, Brad DeLong (13/1/11)
Sticky, sticky wages The Economist blogs: Free Exchange, R.A. (11/1/11)
The Causes of Unemployment New York Times blogs: Wonkish, Paul Krugman (16/1/11)
America’s union-bashing backlash Guardian, Paul Harris (5/1/11)
Data
Federal Reserve Economic Data: FRED Federal Reserve Bank of St. Louis (US macroeconomic datasets)
United States GDP Growth Rate Trading Economics
US unemployment statistics Bureau of Labor Statistics
Questions
- Why might nominal wages be sticky downwards in specific jobs in specific companies?
- Why might nominal average wages in the economy not be sticky downwards?
- Why is unemployment rising in the USA?
- Why might there be a problem of hysteresis in the USA that provides an explanation of the reluctance of unemployment to fall?
- Why might a fall in wages end up being contractionary?
- What lessons can be learned from the Great Depression about cures for unemployment?
- How might unemployment be brought down in the USA?
- Why may making wages somewhat more flexible, as opposed to perfectly flexible, not be a good thing?