The second estimate of UK output for Q1 2010 from the Office for National Statistics reports that the economy grew by 0.3%. The first estimate, based on limited data, put growth in Q1 at 0.2%. But, it appears that more recently available data picked up evidence of stronger growth in the latter stages of the quarter, particularly in the production industries, such as manufacturing, as well as in capital spending by firms.
When analysed in terms of the composition of demand for our firms’ goods and services, there has been something of a rebound in investment expenditure. This follows a marked collapse during 2008 and the first half of 2009. In 2010 Q1 investment volumes increased by 4.2% on the back of a 2.4% rise in the last quarter of 2009.
This rebound in the investment figures across the last two quarters has partly been driven by firms running down their stockpiles of finished goods at a considerably slower rate. When firms build up their stocks of inventories for sales in future periods they are deemed to be engaging in investment. When firms then ‘tap into’ these inventories, as they have been since Q4 2008, they are disinvesting. It is now the case that the pace of disinvestment through running down inventories is slowing. This reflects a pick up in the demand for firms’ goods and services and, hopefully, an expectation of stronger future demand.
More encouragingly, the rebound in investment volumes in Q1 also reflected an increase in gross fixed capital formation, i.e. an increase in the purchase of non-financial fixed assets used in production, such as machinery. Gross fixed capital formation increased in Q1 by 1.5%. This was the first quarter since Q2 2008 in which there has been an increase in the volume of capital purchases by firms. Again, this is likely to reflect increased optimism about future demand since these assets are purchased to do one thing – to produce goods and services!
The improvement in the investment numbers is such that the volume of investment in Q1 2010 was 0.6% higher than it was in Q1 2009. This is largely the impact of a slower rate of disinvestment by firms through running down inventories since despite the rise in gross capital formation in Q1 2010 it still came in 5.7% lower than in Q1 2009. Nonetheless, it will be interesting to see whether the recent improvement in the UK’s investment numbers is maintained as we go forward.
Of particular concern is whether the volume of capital purchases can continue to grow. Can these purchases help to both boost growth now and our economy’s potential output in the medium term? Some of the key issues in determining the answer to this are likely to include: (i) the extent to which aggregate demand grows; (ii) the impact of fiscal consolidation measures on both firms and consumers; (iii) sentiment (confidence) across firms – especially of their own medium-term prospects; and (iv) the ability of firms to access credit from financial institutions. One can undoubtedly add many other issues to this list. One thing is for sure, these are very uncertain times indeed!
Articles
The economy: GDP growth revised up The Times, Grainne Gilmore (26/5/10)
Manufacturing pushes up economic growth The Independent, Sarah Arnott (26/5/10)
UK economic growth revised up to 0.3% BBC News (25/5/10) )
Economy tracker: GDP BBC News (25/5/10)
Boost for UK as GDP growth revised up Telegraph, Edmund Conway (25/5/10)
UK GDP growth revised upwards to 0.3% Financial Times, Daniel Pimlott (25/5/10)
UK first-quarter GDP revised higher Wall Street Journal, Natasha Brereton (25/5/10)
Data
Latest on GDP growth Office for National Statistics (25/5/10)
UK output, income and expenditure, Statistical Bulletin, 1st Quarter 2010 Office for National Statistics (25/5/10)
UK Output, Income and Expenditure, 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
- Why do the National Accounts record a positive change in inventories as investment and a negative change in inventories as disinvestment?
- What factors might explain the running down of inventories across firms in the UK since Q4 2008? Why didn’t this start in Q2 2008 when the UK economy went into recession?
- In Q1 2010 the running down of inventories was worth, at 2005 prices, some £1.347 billion. This was considerably less than the £4.883 billion in Q3 2009 and the £2.596 billion in Q4 2009 (again at 2005 prices). Why might the pace of disinvestment be slowing?
- Of what importance do you think, firstly, the change in inventories and, secondly, gross capital fixed formation are for an economy’s potential output?
- What arguments do you think there are for distinguishing between different types of investment goods and services when considering our future economic growth?
With the Conservatives and Liberal Democrats now in power in the UK and with the Labour Party, having lost the election, being now in the midst of a leadership campaign, politicians from across the political spectrum are balming Gordon Brown for the ‘mess the country’s in’. The UK has a record budget deficit and debt, and is just emerging from a deep recession, when only a few years ago, Gordon Brown was claiming the end of boom and bust. But is the condition of the UK economy Mr Brown’s fault? Would it have been any better if others had been in charge, or if there had been even greater independence for the Bank of England of if there had been an Office of Budget Responsibility (see)?
The following podcast by Martin Wolf, chief economics commentator of the Financial Times, considers this question. He argues that:
Everybody would like to blame Gordon Brown for the financial crisis. But he was only acting in line with the national consensus on economic policy.
The economic legacy of Mr Brown FT podcasts, Martin Wolf (13/5/10)
The economic legacy of Mr Brown Financial Times, Martin Wolf (13/5/10)
Questions
- Explain what is meant by ‘the great moderation’.
- Should regulation of the banks be handed back to the Bank of England?
- Why may controlling inflation not necessarily result in stable economic growth? Is this a case of Goodhart’s Law?
- Why was the UK economy especially fragile during the banking crisis and its aftermath?
- What, according to Martin Wolf, was Mr Brown’s biggest mistake?
- Could a mistake be now being made by following the conventional wisdom that cutting the deficit is the solution to achieving sustained recovery?
Research from the Halifax estimates that the total wealth of UK households at the end of 2009 was £6.316 trillion. Putting this into context, it means that the average UK household has a stock of wealth of £236,998. In real terms, so stripping out the effects of consumer price inflation, the total wealth of households has grown five-fold since 1959 while the average wealth per household has grown three-fold while. The growth in wealth per household is a little less because of the increase in the number of households from 6.6 million to 26.6 million. For those that like their numbers, total household wealth in 1959 was estimated at £1.251 trillion (at 2009 prices) while the average amount per household was £72,719 (at 2009 prices).
But, do changes in household wealth matter? Well, yes, but not necessarily in a consistent and predictable manner. That’s why so many of us love economics! For now, consider the prices of two possible types of assets: share prices and house prices. The prices of both these assets are notoriously volatile and it is this volatility that has the potential to affect the growth of consumer spending.
It might be, for instance, that you are someone who keeps a keen eye on the FTSE-100 because you use shares as a vehicle for saving. A fall in share prices, by reducing the value of the stock of financial assets, may make some people less inclined to spend. Housing too can be used as a vehicle for saving. Changes in house prices will, of course, affect the capital that can be realised from selling property, but also affect the collateral that can be used to support additional borrowing and, more generally, affect how wealthy or secure we feel.
The Halifax estimates that the household sector’s stock of housing wealth was £3.755 trillion at the end of 2009 while its stock of financial assets (such as savings, pensions and shares) was £4.024 trillion. In real terms, housing wealth has grown on average by 5% per year since 1959 while financial assets have grown by 2.8% per year. Of course, while households can have financial and housing assets they are likely to have financial liabilities too! We would expect households’ exposure to these liabilities – and their perception of this exposure – to offer another mechanism by which household spending could be affected. For instance, changes in interest rates impact on variable rate mortgages rates, affecting the costs of servicing debt and, in turn, disposable incomes.
The Halifax reports that the stock of mortgage loans was £1.235 trillion at the end of 2009, which, when subtracted from residential housing wealth, means that the UK household sector had net housing equity of £2.519 trillion. It estimates that the stock of mortgage loans has increased on average by 6.5% per year in real terms since 1959 while net housing equity has grown by 4.5%. The stock of households’ unsecured debt, also known as consumer credit, was £227 billon at the end of 2009. In real terms it has grown by 5.3% per year since 1959.
The recent patterns in household wealth are particularly interesting. Between 2007 and 2008 downward trends in share prices and house prices contributed to a 15% real fall in household wealth. The Halifax note that some of this was ‘recouped’ in 2009 as a result of a rebound in both share prices and house prices. More precisely, household wealth increased by 9% in real terms in 2009, but, nonetheless, was still 8% below its 2007 peak.
Given the recent patterns in household wealth, including the volatility in the components that go to comprise this stock of wealth, we shouldn’t be overly surprised by the 3.2% real fall that occurred in household spending last year. Further, we must not forget that 2009 was also the year, amongst other things, that the economy shrunk by 4.9%, that unemployment rose from 1.8 million to 2.5 million and that growing concerns about the size of the government’s deficit highlighted the need for fiscal consolidation at some point in the future. All of these ingredients created a sense of uncertainty. This is an uncertainty that probably remains today and that is likely to continue to moderate consumer spending in 2010. So, it’s unlikely to be a time for care-free shopping, more a time for window shopping!
Halifax Press Release
UK household wealth increases five-fold in the past 50 years Halifax (part of the Lloyds Banking Group) (15/5/10)
Articles
Household wealth ‘up five-fold’ UK Press Association (15/5/10)
We’ve never had it so good: Families five times richer than in 1959 Daily Mail, Steve Doughty (15/5/10)
Household wealth grows five-fold in past 50 years BBC News (16/5/10)
Average household wealth jumps £150,000 Telegraph, Myra Butterworth (15/5/10)
Questions
- Draw up a list of the ways in which you think consumer spending may be affected by: (i) the stock of household wealth; and (ii) the composition of household wealth.
- What factors do you think lie behind the annual 5% real term increase in the value of residential properties since 1959?.
- How might the sensitivity of consumer spending to changes in interest rates be affected by the types of mortgage product available?
- Why do you think consumer spending fell by 3.2% in real terms in 2009 despite real disposable income increasing by 3.2%?
- What would you predict for consumption growth in 2010? Explain your answer.
According to political business cycle theory, incoming governments tend to take harsh measures at first, when they can blame the cuts on the ‘mess they’ve inherited’ from their predecessors. And then two or three years later, as an election looms, they can start spending more and/or cutting taxes, hoping that the good will this creates will help them win the election.
So are we seeing the start of a new political business cycle with the start of the new Coalition government? The following two articles look at the issue.
Coalition will inflict cuts now and spend later to win a second term Guardian, Larry Elliott (17/5/10)
If you get all the bad news out at once, the only way left to go will be up. Or will it? Independent, Sean O’Grady (18/5/10)
Questions
- Explain what is meant by the ‘political business cycle’.
- Would the existence of a political dimension to the business cycle amplify or dampen the cycle, or could it do either depending on the circumstances? Explain.
- Does the existence of an independent central bank eliminate the political business cycle?
- Will the new Office for Budget Responsibility (see Nipping it in the Budd: Enhancing fiscal credibility?) help to eliminate the political business cycle? Explain your answer.
Each month the Bank of England reports on the amount of net lending by households. This is the amount that households have borrowed from financial institutions (gross lending) less any repayments households have made to financial institutions. In March, net lending to households was £643 million, down from £2.43 billion in February. Of the £643 million, £318 million was net secured lending (i.e. mortgage lending) and £325 million net unsecured lending (i.e. lending through credit cards, overdrafts and general loans).
Now, you might think that net lending of £643 million means that the stock of debt owed by households grew by £643 million. Well, not quite; some debt is ‘written off’ by financial institutions. When bad debts are taken into consideration we find that the stock of debt actually fell in March by £2.682 billion to stand at £1.460 trillion. Of this stock of debt, £1.239 trillion is secured debt and £221.65 billion is unsecured debt. Put another way, 84% of household debt is secured debt and 16% unsecured debt.
One of the interesting developments of late has been the decline in the household sector’s stock of unsecured debt. It has now fallen for 10 months in a row and in 16 of the last 18 months. Interestingly, in only 7 of these months was net unsecured lending actually negative. However, historically low sums of net unsecured lending combined with the writing-off of unsecured debt has meant that the stock of unsecured debt has fallen by £14.975 billion over the past 18 months. Over the same period the total stock of debt increased by £2.379 billion.
Patterns in net lending by households and in the growth of the stock of household debt reflect, on one hand, the willingness and ability of lenders to supply credit and, on the other hand, the demand by households for credit. On the supply-side, the financial crisis continues to restrict lending by financial institutions. But demand has been affected too because households as well as banks are looking to rebuild their balance sheets. Furthermore, the economic downturn, lower asset prices, including, until of late, lower house prices, as well as a sense of economic uncertainty have all contributed to a more precautionary mind-set amongst households.
This precautionary mind-set has impacted on the housing market. Housing market activity can, at best, be described as ‘thin’. Even though the seasonally-adjusted number of mortgage approvals for house purchase rose by 4.3% in March to 48,901, this is almost half the 94,043 seen on average each month over the past ten years. A further demonstration of the household sector’s precautionary behaviour is the sector using housing as a vehicle for saving. We observed in our blog article Saving through housing: households build firmer foundations that since the second quarter of 2008 additional housing investment (i.e. money spent on moving costs, including stamp duty, the purchase of newly built properties or expenditure on major home improvements) has been greater than net secured lending. This is known as negative housing equity withdrawal (HEW). In other words, the household sector’s stock of secured borrowing has increased by less than we would have expected.
In the 12 months to the end of March, the stock of secured debt rose by only 0.9% compared with an average annual growth rate of 9.8% over the past 10 years. Of course this doesn’t mean that households have simply been using some of their own money to fund housing investment, but that they have also been paying-off some of their existing secured debt. This, coupled with the 4.3% decline in the stock of unsecured debt, demonstrates the extent to which the household sector has been looking to consolidate. It would be something of a surprise if this consolidation was to stop any time soon.
Articles
Weak mortgage lending set to undermine house prices Independent, David Prosser (5/5/10)
Mortgage lending down almost 90% from 2007 peak Guardian, Katie Allen (4/5/10)
Mortgage approvals still sluggish, figures show BBC News (4/5/10)
Mortgage lending stalls this year Telegraph, Harry Wallop (4/5/10)
Lending dip fuels house price fall fears Press Association (4/5/10)
Data
Lending to individuals Bank of England
Monetary and Financial Statistics (Bankstats) Bank of England (See Tables A5.1 to A5.7, in particular)
Housing equity withdrawal (HEW) statistical releases Bank of England
Questions
- What do you understand by the term net lending? What would a negative net lending figure indicate?
- Illustrate with examples what you understand by secured and unsecured debt.
- What factors might explain why the household sector’s net secured lending has been less than the amount of its housing investment (e.g. the household sector’s purchase of new houses or its spending on major refurbishments)? Does this mean that stock of secured lending has been falling?
- What factors might explain the recent historically low levels of net unsecured lending?
- Does net lending have to be negative for the stock of debt to fall? Explain your answer.
- As well as the household sector, which other sectors might need to rebuild their balance sheets? How might such behaviour be expected to impact on the economy?