In our blog How sustainable is UK consumer spending? we considered concerns of some commentators that consumer spending was growing unduly quickly given the absence of any sustained growth in disposable income. The Second Estimate of GDP, Q2 2013 reports that the economy grew by 0.7 per cent in the second quarter of the year, with household expenditure growing by 0.4 per cent.
Because household spending makes up about two-thirds of aggregate demand in the UK it is important to keep an eye on it. The latest figures show that the real value of consumer spending by British households has risen in each quarter since 2011 Q4. In other words, the volume of household purchases has risen for seven consecutive quarters. Over the period, the growth in real consumer spending has averaged 0.4 per cent per quarter.
The chart helps to demonstrate the stark turnaround in the growth in consumer spending. Over the period from 2008 Q1 to 2011 Q3, real consumer spending typically fell by 0.4 per cent each quarter. As we noted in our previous blog, this was a period when the global financial system was in distress, with the availability of credit severely dampened, but also a period when households were concerned about their own financial balances and the future prospects for growth. Over the same period, real GDP typically fell by a little under 0.3 per cent each quarter. (Click here to download a PowerPoint of the chart.)
The real value of consumer spending has yet to return to its 2007 Q4 peak (£242 billion at 2010 prices). In 2013 Q2 the real value of consumer spending is estimated still to be 3 per cent below this level (£235 billion at 2010 prices). These figures are mirrored by the economy at large. Real GDP peaked in 2008 Q1 (£393 billion at 2010 prices). Despite the back-to-back quarterly increases in real GDP of 0.3 per cent in Q1 and 0.7 per cent in Q2, output in 2013 Q2 (£380 billion at 2010 prices) remains 3.2 per cent below the 2008 Q1 peak.
While real consumption values are below their 2007 Q4 peak, the concern is whether current rates of growth in consumer spending are sustainable. In particular, should this growth cause the household sector financial distress there would be real pain for the economy further down the line. Some commentators argue that the latest GDP figures are consistent with a more balanced recovery. In Q2 economic growth was supported too by other parts of the economy. For instance, we saw a 3.6 per cent rise in export volumes and a 1.7 per cent rise in gross fixed capital formation (i.e. investment expenditure).
Nonetheless, it is the protracted period over which consumer spending has been growing robustly that concerns some economists. Hence, we will need to continue to monitor the growth in all components of aggregate demand and, in particular, changes in household consumption, income, saving and borrowing.
Data
Second Estimate of GDP, Q2 2013 Dataset Office for National Statistics
Articles
New articles
UK economic growth revised up to 0.7% BBC News, (23/8/13)
UK GDP revised up to 0.7pc in second quarter: reaction Telegraph, (23/8/13)
UK rallying faster than thought as exports leap boosts GDP Independent, Russell Lynch and Ben Chu (24/8/13)
UK economy expanding faster than first thought, GDP revision shows Guardian, Heather Stewart (23/8/13)
Growth upgrade points to ‘sustainable’ recovery Telegraph, Philip Aldrick (23/8/13)
Previous articles
UK wages decline among worst in Europe BBC News, (11/8/13)
Squeezing the hourglass The Economist, (10/8/13)
UK first-quarter growth unchanged BBC News, (28/5/13)
Summer heatwave triggers shopping spree in ‘Wongaland’ economy Telegraph, Steve Hawkes and Steven Swinford (15/8/13)
Retail sales data better than expected as UK economy enjoys summer bounce Guardian, Heather Stewart (15/8/13)
Mark Carney is banking on you to keep spending Telegraph, Philip Aldrick (10/8/13)
NIESR upgrades UK economy but warns on consumer spending Telegraph, Philip Aldrick (2/8/13)
Consumers ‘expect better economy’ Belfast Telegraph, (4/8/13)
Questions
- Explain what you understand by a ‘sustainable’ economic recovery.
- What are the expenditure components that make up Aggregate Demand?
- Explain what you understand by consumption smoothing.
- Why would we would typically expect consumption growth to be less variable than that in disposable income?
- Would we expect consumption growth to always be less variable than that in disposable income? Explain your answer.
- What impact do you think the financial crisis has had on consumer behaviour?
- To what extent do you think the current growth in consumer spending is sustainable?
- How important are expectations in determining consumer behaviour?
Household spending makes up about two-thirds of aggregate demand in the UK. Understanding its determinants is therefore important to understanding short-term economic growth. The real value of consumer spending by British households has risen in each quarter since 2011 Q4. Over the same period real disposable income has flat-lined. This suggests that the British household sector has stepped up attempts to smooth their longer-term spending profile despite the current absence of growth in their real incomes.
When viewed over many years, disposable income and consumer spending grow at very similar rates. After stripping out inflation we find that over the past 50 years both have grown at about 2½ per cent per annum. However, if we measure growth from one quarter of the year to the next we tend to find that consumption growth is less variable than disposable income. This is known as consumption smoothing.
Chart 1 shows the quarterly percentage change in consumption and disposable income since 1998. (Click here to download a PowerPoint of the chart).The variability in the disposable income series is generally greater than that in consumption so helping to illustrate consumption smoothing.
Consumption smoothing is facilitated by the financial system enabling us to either borrow to supplement our spending or to save to enjoy more spending in the future. The financial system can help households to avoid large variations in their spending over short periods.
Consumption smoothing does not prohibit falls in consumption nor periods when it is more variable than income. Over the period from 2008 Q1 to 2011 Q3, real consumption typically fell by 0.4 per cent each quarter while disposable income was flat. This was a period when the global financial system was in distress. Sharp contractions in credit meant that the financial system was no longer able to support economic activity as it had previously. Furthermore, households too looked to repair their balance sheets with economic uncertainty acting as an incentive to do so.
What is interesting is the extent to which British households are spending again. Since 2011 Q4 the real value of spending has typically expanded by 0.4 per cent each quarter while income growth remains largely absent. One might argue that this just demonstrates a willingness for households to engage in consumption smoothing. With credit conditions still tight, the growth in spending has been aided by a decline in the saving ratio. 
This can be seen from Chart 2.
In 2009 Q2 the proportion of income saved hit 8.6 per cent having been as low as 0.2 per cent in 2008 Q1. In 2013 Q1 the saving ratio had fallen back to 4.2 per cent. (Click here to download a PowerPoint of the chart.)
It is of course all too easy to over-interpret data. Nonetheless, there be will concern if households look to maintain consumption growth at rates substantially greater than those in disposable income for too long a period of time. Consumption smoothing could become a real problem for future economic activity if it was to result in a financially distressed household sector. Hence, an important question is the extent to which current rates of consumption growth are sustainable. Future consumption and income trends will therefore be analysed with enormous interest.
Data
Quarterly National Accounts, Q1 2013 Dataset Office for National Statistics
Articles
UK wages decline among worst in Europe BBC News, (11/8/13)
Squeezing the hourglass The Economist, (10/8/13)
UK first-quarter growth unchanged BBC News, (28/5/13)
Summer heatwave triggers shopping spree in ‘Wongaland’ economy Telegraph, Steve Hawkes and Steven Swinford (15/8/13)
Retail sales data better than expected as UK economy enjoys summer bounce Guardian, Heather Stewart (15/8/13)
Mark Carney is banking on you to keep spending Telegraph, Philip Aldrick (10/8/13)
NIESR upgrades UK economy but warns on consumer spending Telegraph, Philip Aldrick (2/8/13)
Consumers ‘expect better economy’ Belfast Telegraph, (4/8/13)
Questions
- Explain what you understand by consumption smoothing.
- Why would we would typically expect consumption growth to be less variable than that in disposable income?
- Would we expect consumption growth to always be less variable than that in disposable income? Explain your answer.
- What impact do you think the financial crisis has had on consumer behaviour?
- To what extent do you think the current growth in consumer spending is sustainable?
- How important are expectations in determining consumer behaviour?
UK unemployment fell by 4000 to 2.51 million in second quarter of this year. But this was too small to have any significant effect on the unemployment rate, which remained at 7.8%.
According to the forward guidance issued by the Bank of England, Bank Rate will stay at 0.5%, barring serious unforeseen circumstances, until unemployment reaches 7%. So will this be soon?
There are good reasons to suggest that the answer is no. Reasons include the following:
(a) Many firms may choose to employ their part-time workers for more hours, rather than taking on extra staff, if the economy picks up.
(b) The recovery is being fuelled by a rise in consumption, which, in turn, is being financed by people drawing on savings or borrowing more. The household saving ratio fell from 7.4% in 2012 Q1 to 4.2% in 2013 Q1. This trend will be unsustainable over the long run, especially as the Bank of England may see a rapid rise in borrowing/decline in saving as serious enough to raise interest rates before the unemployment rate has fallen to 7%.
(c) Despite the modest recovery, people’s average real incomes are well below the levels prior to the deep recession of 2008/9.
The articles consider the outlook for the economy and unemployment
Articles
UK unemployment holds steady at 7.8pc The Telegraph, Rebecca Clancy (14/8/13)
Unemployment rate is unlikely to fall sharply The Guardian, Larry Elliott (14/8/13)
UK unemployment falls by 4,000 to 2.51 million BBC News (14/8/13)
UK wages decline among worst in Europe BBC News (11/8/13)
Squeezing the hourglass The Economist (10/8/13)
More people in work than ever before as unemployment falls Channel 4 News, Faisal Islam (14/8/13)
Data
Labour Market Statistics, August 2013 ONS
United Kingdom National Accounts, The Blue Book, 2013: Chapter 06: Households and Non-profit Institutions Serving Households (NPISH) ONS
Questions
- What factors determine the rate of unemployment?
- With reference to the ONS data in Labour Market Statistics, August 2013 above, what has happened to (a) the long-term unemployment rate; (b) the unemployment rate for 18–24 year olds?
- How would you define ‘living standards’?
- How is labour productivity relevant to the question of whether unemployment is likely to fall?
- How much have living standards fallen since 2008?
- Under what circumstances might the Bank of England raise interest rates before the rate of unemployment has fallen to 7%?
- Property prices are beginning to rise. Consider the effects of this and whether, on balance, a rise in property prices is beneficial.
The Preliminary Estimate of the UK Q2 GDP figures by the Office for National Statistics show that the UK economy grew by 0.6% in the second quarter of 2013: double the growth rate of the first quarter and almost back to the long-run average growth rate prior to 2008.
At first sight, this would seem to be good news – certainly from the government’s point of view. What is more, unlike the previous quarter, growth is spread relatively evenly across the three main sectors: the production (manufacturing, mining, water supply, etc.) and services sectors both grew by 0.6% and the construction sector by 0.9% (this sector fell by 1.8% in the previous quarter). (Click here for a PowerPoint of the chart below.)
But while growth in the latest quarter may be balanced between the broad sectors, the rise in aggregate demand is not balanced between its components. As an earlier news item (A balancing act) showed, the rise in aggregate demand has been driven largely by a rise in consumption, and a corresponding fall in saving. Exports are rising only slowly and investment is some 25% lower than in the boom years prior to 2008.
So will the latest growth be sustainable? Will investment now begin to pick up and what constraints are there on investment? The following articles consider some of the issues.
Articles
Economy firing on all cylinders as growth hits 0.6pc The Telegraph, Philip Aldrick (25/7/13)
The good, the bad or the ugly? How the UK economy stands up. The Telegraph, Philip Aldrick (25/7/13)
George Osborne’s 0.6% growth is good but unspectacular The Guardian, Larry Elliott (25/7/13)
The (not-so) green shoots of recovery The Economist, John Van Reenen (23/7/13)
Economic recovery slow to take root for some in UK Reuters, William Schomberg and Max De Haldevang (25/7/13)
GDP figures offer hard evidence for political narrative BBC News, Paul Mason (25/7/13)
Ignore the hype: Britain’s ‘recovery’ is a fantasy that hides our weakness The Observer, Will Hutton (21/7/13)
UK economy: Half-speed ahead BBC News, Stephanie Flanders (25/7/13)
BoE guidance can help sustain the UK recovery The Economist, Kevin Daly (22/7/13)
George Osborne’s description of the economy is near-Orwellian The Guardian, Ha-Joon Chang (26/7/13)
Economic growth: more must be done to encourage investment The Guardian, Phillip Inman (1/8/13)
Data
Gross Domestic Product: Preliminary Estimate, Q2 2013 ONS (25/7/13)
Questions
- Compare the macroeconomic situation today with that prior to the financial crisis of 2007/8 and subsequent recession.
- What factors will determine the sustainability of the UK economic recovery?
- What is meant by the ‘accelerator’ and what will determine the size of any accelerator effect from the latest rise in UK GDP?
- What supply-side constraints are likely to limit the rate and extent of recovery?
- Why do economies that are in recession ‘naturally bounce back’ without any government intervention? Have the macroeconomic policies of the UK government helped or hindered this bounce back? Explain.
- What monetary measures by the Bank of England are most appropriate in the current circumstances?
Each day many investors anxiously watch the stock market to see if their shares have gone up or down. They may also speculate: buying if they think share prices are likely to go up; selling if they think their shares will fall. But what drives these expectations?
To some extent, people will look at real factors, such as company sales and profits or macroeconomic indicators, such as the rate of economic growth or changes in public-sector borrowing. But to a large extent people are trying to predict what other people will do: how other people will react to changes in various indicators.
John Maynard Keynes observed this phenomenon in Chapter 12 of his General Theory of Employment, Interest and Money of 1936. He likened this process of anticipating what other people will do to a newspaper beauty contest, popular at the time. In fact, behaviour of this kind has become known as a Keynesian beauty contest (see also).
Keynes wrote that:
professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgement, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.
When investors focus on people’s likely reactions, it can make markets very unstable. A relatively minor piece of news can cause people to buy or sell in anticipation that others will do the same and that others will realise this and do the same themselves. Markets can overshoot, until, when prices have got out of line with fundamentals, buying can turn into selling, or vice versa. Prices can then move rapidly in the other direction, again driven by what people think other people will do. Sometimes, markets can react to very trivial news indeed. As the New York Times article below states:
On days without much news, the market is simply reacting to itself. And because anxiety is running high, investors make quick, sometimes impulsive, responses to relatively minor events.
The rise of the machine
In recent years there is a new factor to account for growing stock market volatility. The Keynesian beauty contest is increasingly being played by computers. They are programmed to buy and sell when certain conditions are met. The hundreds of human traders of the past who packed trading floors of stock markets, have been largely replaced by just a few programmers, trained to adjust the algorithms of the computers their finance companies use as trading conditions change.
And these computers react in milliseconds to what other computers are doing, which in turn react to what others are doing. Markets can, as a result, suddenly soar or plummet, until the algorithms kick the market into reverse as computers sell over-priced stock or buy under-priced stock, which triggers other computers to do the same.
Robot trading is here to stay. The articles and podcast consider the implications of the ‘games’ they are playing – for savers, companies and the economy.
Articles
Questions
- Give some other examples of human behaviour which is in the form of a Keynesian beauty contest.
- Why may playing a Keynesian beauty contest lead to an undesirable Nash equilibrium?
- Does robot trading do anything other than simply increase the speed at which markets adjust?
- Can destabilising speculation continue indefinitely? Explain.
- Explain what is meant by ‘overshooting’? Why is overshooting likely to occur in stock markets and foreign exchange markets?
- In what ways does robot trading (a) benefit and (b) damage the interests of savers?
In our blog How sustainable is UK consumer spending? we considered concerns of some commentators that consumer spending was growing unduly quickly given the absence of any sustained growth in disposable income. The Second Estimate of GDP, Q2 2013 reports that the economy grew by 0.7 per cent in the second quarter of the year, with household expenditure growing by 0.4 per cent. 
