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?
Today’s title is inspired from the British Special Air Service (SAS) famous catchphrase, ‘Who Dares Wins’ – similar variations of which have been adopted by several elite army units around the world. The motto is often credited to the founder of the SAS, Sir David Stirling (although similar phrases can be traced back to ancient Rome – including ‘qui audet adipiscitur’, which is Latin for ‘who dares wins’). The motto was used to inspire and remind soldiers that to successfully accomplish difficult missions, one has to take risks (Geraghty, 1980).
In the world of economics and finance, the concept of risk is endemic to investments and to making decisions in an uncertain world. The ‘no free lunch’ principle in finance, for instance, asserts that it is not possible to achieve exceptional returns over the long term without accepting substantial risk (Schachermayer, 2008).
Undoubtedly, one of the riskiest investment instruments you can currently get your hands on is cryptocurrencies. The most well-known of them is Bitcoin (BTC), and its price has varied spectacularly over the past ten years – more than any other asset I have laid my eyes on in my lifetime.
The first published exchange rate of BTC against the US dollar dates back to 5 October 2009 and it shows $1 to be exchangeable for 1309.03 BTC. On 15 December 2017, 1 BTC was traded for $17,900. But then, a year later the exchange rate was down to just over $1 = $3,500. Now, if this is not volatility I don’t know what is!
In such a market, wouldn’t it be wonderful if you could somehow predict changes in market sentiment and volatility trends? In a hot-off-the press article, Shen et al (2019) assert that it may be possible to predict changes in trading volumes and realised volatility of BTC by using the number of BTC-related tweets as a measure of attention. The authors source Twitter data on Bitcoin from BitInfoCharts.com and tick data from Bitstamp, one of the most popular and liquid BTC exchanges, over the period 4/9/2014 to 31/8/2018.
According to the authors:
This measure of investor attention should be more informed than that of Google Trends and therefore may reflect the attention Bitcoin is receiving from more informed investors. We find that the volume of tweets are significant drivers of realised [price] volatility (RV) and trading volume, which is supported by linear and nonlinear Granger causality tests.
They find that, according to Granger causality tests, for the period from 4/9/2014 to 8/10/2017, past days’ tweeting activity influences (or at least forecasts) trading volume. While from 9/10/2017 to 31/8/2018, previous tweets are significant drivers/forecasters of not only trading volume but also realised price volatility.
And before you reach out for your smartphone, let me clarify that, although previous days’ tweets are found in this paper to be good predictors of realised price volatility and trading volume, they have no significant effect on the returns of Bitcoin.
- Explain how the number of tweets can be used to gauge investors’ intentions and how it can be linked to changes in trading volume.
- Using Google Scholar, make a list of articles that have used Twitter and Google Trends to predict returns, volatility and trading volume in financial markets. Present and discuss your findings.
- Would you invest in Bitcoin? Why yes? Why no?
Late January sees the annual global World Economic Forum meeting of politicians, businesspeople and the great and the good at Davos in Switzerland. Global economic, political, social and environmental issues are discussed and, sometimes, agreements are reached between world leaders. The 2019 meeting was somewhat subdued as worries persist about a global slowdown, Brexit and the trade war between the USA and China. Donald Trump, Xi Jinping, Vladimir Putin and Theresa May were all absent, each having more pressing issues to attend to at home.
There was, however, a feeling that the world economic order is changing, with the rise in populism and with less certainty about the continuance of the model of freer trade and a model of capitalism modified by market intervention. There was also concern about the roles of the three major international institutions set up at the end of World War II: the IMF, the World Bank and the WTO (formerly the GATT). In a key speech, Angela Merkel urged countries not to abandon the world economic order that such institutions help to maintain. The world can only resolve disputes and promote development, she argued, by co-operating and respecting the role of such institutions.
But the role of these institutions has been a topic of controversy for many years and their role has changed somewhat. Originally, the IMF’s role was to support an adjustable peg exchange rate system (the ‘Bretton Woods‘ system) with the US dollar as the international reserve currency. It would lend to countries in balance of payments deficit to allow them to maintain their rate pegged to the dollar unless it was perceived to be a fundamental deficit, in which case they were expected to devalue their currency. The system collapsed in 1971, but the IMF continued to provide short-term, and sometimes longer-term, finance to countries in balance of payments difficulties.
The World Bank was primarily set up to provide development finance to poorer countries. The General Agreement on Tariffs and Trade (GATT) and then the WTO were set up to encourage freer trade and to resolve trade disputes.
However, the institutions were perceived with suspicion by many developing countries and by more left-leaning developed countries, who saw them as part of the ‘Washington consensus’. Loans from the IMF and World Bank were normally contingent on countries pursuing policies of market liberalisation, financial deregulation and privatisation.
Although there has been some movement, especially by the IMF, towards acknowledging market failures and supporting a more broadly-based development, there are still many economists and commentators calling for more radical reform of these institutions. They advocate that the World Bank and IMF should directly support investment – public as well as private – and support the Green New Deal.
- What was the Bretton Woods system that was adopted at the end of World War II?
- What did Keynes propose as an alternative to the system that was actually adopted?
- Explain the roles of (a) the IMF, (b) the World Bank, (c) the WTO (formerly the GATT).
- What is meant by an adjustable exchange rate system?
- Why did the Bretton Woods system collapse in 1971?
- How have the roles of the IMF, World Bank and WTO/GATT evolved since they were founded?
- What reforms would you suggest to each of the three institutions and why?
- What threats are there currently to the international economic order?
- Summarise the arguments about the world economic order made by Angela Merkel in her address to the World Economic Forum.
It is impossible to make both precise and accurate forecasts of a country’s rate of economic growth, even a year ahead. And the same goes for other macroeconomic variables, such as the rate of unemployment or the balance of trade. The reason is that there are so many determinants of these variables, such as political decisions or events, which themselves are unpredictable. Economics examines the effects of human interactions – it is a social science, not a natural science. And human behaviour is hard to forecast.
Nevertheless, economists do make forecasts. These are best estimates, taking into account a number of determinants that can be currently measured, such as tax or interest rate changes. These determinants, or ‘leading indicators’, have been found to be related to future outcomes. For example, surveys of consumer and business confidence give a good indication of future consumer expenditure and investment – key components of GDP.
Leading indicators do not have to be directly causal. They could, instead, be a symptom of underlying changes that are themselves likely to affect the economy in the future. For example, changes in stock market prices may reflect changes in confidence or changes in liquidity. It is these changes that are likely to have a direct or indirect causal effect on future output, employment, prices, etc.
Macroeconomic models show the relationships between variables. They show how changes in one variable (e.g. increased investment) affect other variables (e.g. real GDP or productivity). So when an indicator changes, such as a rise in interest rates, economists use these models to estimate the likely effect, assuming other things remain constant (ceteris paribus). The problem is that other things don’t remain constant. The economy is buffeted around by a huge range of events that can affect the outcome of the change in the indicator or the variable(s) it reflects.
Forecasting can never therefore be 100% accurate (except by chance). Nevertheless, by carefully studying leading indicators, economists can get a good idea of the likely course of the economy.
Leading indicators of the US economy
At the start of 2019, several leading indicators are suggesting the US economy is likely to slow and might even go into recession. The following are some of the main examples.
Political events. This is the most obvious leading indicator. If decisions are made that are likely to have an adverse effect on growth, a recession may follow. For example, decisions in the UK Parliament over Brexit will directly impact on UK growth.
As far as the USA is concerned, President Trump’s decision to put tariffs on steel and aluminium imports from a range of countries, including China, the EU and Canada, led these countries to retaliate with tariffs on US imports. A tariff war has a negative effect on growth. It is a negative sum game. Of course, there may be a settlement, with countries agreeing to reduce or eliminate these new tariffs, but the danger is that the trade war may continue long enough to do serious damage to global economic growth.
But just how damaging it is likely to be is impossible to predict. That depends on future political decisions, not just those of the recent past. Will there be a global rise in protectionism or will countries pull back from such a destructive scenario? On 29 December, President Trump tweeted, ‘Just had a long and very good call with President Xi of China. Deal is moving along very well. If made, it will be very comprehensive, covering all subjects, areas and points of dispute. Big progress being made!’ China said that it was willing to work with the USA over reaching a consensus on trade.
Rises in interest rates. If these are in response to a situation of excess demand, they can be seen as a means of bringing inflation down to the target level or of closing a positive output gap, where real national income is above its potential level. They would not signify an impending recession. But many commentators have interpreted rises in interest rates in the USA as being different from this.
The Fed is keen to raise interest rates above the historic low rates that were seen as an ’emergency’ response to the financial crisis of 2007–8. It is also keen to reverse the policy of quantitative easing and has begun what might be described as ‘quantitative tightening’: not buying new bonds when existing ones that it purchased during rounds of QE mature. It refers to this interest rate and money supply policy as ‘policy normalization‘. The Fed maintains that such policy is ‘consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term’.
However, many commentators, including President Trump, have accused the Fed of going too fast in this process and of excessively dampening the economy. It has already raised the Federal Funds Rate nine times by 0.25 percentage points each time since December 2015 (click here for a PowerPoint file of the chart). What is more, announcing that the policy will continue makes such announcements themselves a leading indicator of future rises in interest rates, which are a leading indicator of subsequent effects on aggregate demand. The Fed has stated that it expects to make two more 0.25 percentage point rises during 2019.
Surveys of consumer and business confidence. These are some of the most significant leading indicators as consumer confidence affects consumer spending and business confidence affects investment. According to the Duke CFO Global Business Outlook, an influential survey of Chief Financial Officers, ‘Nearly half (48.6 per cent) of US CFOs believe that the US will be in recession by the end of 2019, and 82 per cent believe that a recession will have begun by the end of 2020’. Such surveys can become self-fulfilling, as a reported decline in confidence can itself undermine confidence as both firms and consumers ‘catch’ the mood of pessimism.
Stock market volatility. When stock markets exhibit large falls and rises, this is often a symptom of uncertainty; and uncertainty can undermine investment. Stock market volatility can thus be a leading indicator of an impending recession. One indicator of such volatility is the VIX index. This is a measure of ’30-day expected volatility of the US stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. On a global basis, it is one of the most recognized measures of volatility – widely reported by financial media and closely followed by a variety of market participants as a daily market indicator.’ The higher the index, the greater the volatility. Since 2004, it has averaged 18.4; from 17 to 28 December 2018, it averaged 28.8. From 13 to 24 December, the DOW Jones Industrial Average share index fell by 11.4 per cent, only to rise by 6.2 per cent by 27 December. On 26 December, the S&P 500 index rallied 5 per cent, its best gain since March 2009.
Not all cases of market volatility, however, signify an impending recession, but high levels of volatility are one more sign of investor nervousness.
Oil prices. When oil prices fall, this can be explained by changes on the demand and/or supply side of the oil market. Oil prices have fallen significantly over the past two months. Until October 2018, oil prices had been rising, with Brent Crude reaching $86 per barrel by early October. By the end of the year the price had fallen to just over $50 per barrel – a fall of 41 per cent. (Click here for a PowerPoint file of the chart.) Part of the explanation is a rise in supply, with shale oil production increasing and also increased output from Russia and Saudi Arabia, despite a commitment by the two countries to reduce supply. But the main reason is a fall in demand. This reflects both a fall in current demand and in anticipated future demand, with fears of oversupply causing oil companies to run down stocks.
Falling oil prices resulting from falling demand are thus an indicator of lack of confidence in the growth of future demand – a leading indicator of a slowing economy.
The yield curve. This depicts the yields on government debt with different lengths to maturity at a given point in time. Generally, the curve slopes upwards, showing higher rates of return on bonds with longer to maturity. This is illustrated by the blue line in the chart. (Click here for a PowerPoint file of the chart.) This is as you would expect, with people requiring a higher rate of return on long-term lending, where there is normally greater uncertainty. But, as the Bloomberg article, ‘Don’t take your eyes off the yield curve‘ states:
Occasionally, the curve flips, with yields on short-term debt exceeding those on longer bonds. That’s normally a sign investors believe economic growth will slow and interest rates will eventually fall. Research by the Federal Reserve Bank of San Francisco has shown that an inversion has preceded every US recession for the past 60 years.
The US economy is 37 quarters into what may prove to be its longest expansion on record. Analysts surveyed by Bloomberg expect gross domestic product growth to come in at 2.9 percent this year, up from 2.2 percent last year. Wages are rising as unfilled vacancies hover near all-time highs.
With times this good, the biggest betting game on Wall Street is when they’ll go bad. Barclays Plc, Goldman Sachs Group Inc., and other banks are predicting inversion will happen sometime in 2019. The conventional wisdom: Afterward it’s only a matter of time – anywhere from 6 to 24 months – before a recession starts.
As you can see from the chart, the yield curve on 24 December 2018 was still slightly upward sloping (expect between 6-month and 1-year bonds) – but possibly ready to ‘flip’.
However, despite the power of an ‘inverted’ yield in predicting previous recessions, it may be less reliable now. The Fed, as we saw above, has already signalled that it expects to increase short-term rates in 2019, probably at least twice. That alone could make the yield curve flatter or even downward sloping. Nevertheless, it is still generally thought that a downward sloping yield curve would signal belief in a likely slowdown, if not outright recession.
So, is the USA heading for recession?
The trouble with indicators is that they suggest what is likely – not what will definitely happen. Governments and central banks are powerful agents. If they believed that a recession was likely, then fiscal and monetary policy could be adjusted. For example, the Fed could halt its interest rate rises and quantitative tightening, or even reverse them. Also, worries about protectionism may subside if the USA strikes new trade deals with various countries, as it did with Canada and Mexico in USMCA.
- A jarring new survey shows CEOs think a recession could strike as soon as year-end 2019
Business Insider, Joe Ciolli (17/12/18)
- 4 Recession Indicators to Watch Now
Barron’s, Campbell Harvey (20/12/18)
- 9 Reasons the US Will Have a Recession Next Year
24/7 Wall St, Douglas A. McIntyre (26/12/18)
- The global economy is living dangerously – but don’t expect superpowers to follow the 2008 script
Independent, Ben Chu (3/1/19)
- Could a recession be just around the corner?
The Conversation, Amitrajeet A Batabyal (6/12/18)
- The US is on the edge of the economic precipice – Trump may push it over
The Guardian, Robert Reich (23/12/18)
- US prepares to hit the wall as reckless Trump undoes years of hard work
The Guardian, (Business Leader) (23/12/18)
- The first signs of the next recession
New Statesman, Helen Thompson (23/11/18)
- Is a Recession Coming? CFOs Predict 2019 Recession, Majority Expect Pre-2020 Market Crash
Newsweek, Benjamin Fearnow (12/12/18)
- Trade slowdown coming at worst time for world economy, markets
Reuters, Jamie McGeever (19/12/18)
- How to spot the next recession
The Week, Jeff Spross (27/11/18)
- What Is a Recession, and Why Are People Talking About the Next One?
New York Times, Niraj Chokshi (17/12/180
- For the American Economy, Storm Clouds on the Horizon
New York Times, Binyamin Appelbaum (28/11/18)
- Don’t Take Your Eyes Off the Yield Curve
Bloomberg Businessweek, Liz McCormick and Jeanna Smialek (16/11/18)
- What to expect from 2019’s ‘post-peak’ economy
CNN, Larry Hatheway (19/12/18)
- Worried about the next recession? Here’s what to watch instead of the yield curve
Quartz, Gwynn Guilford (17/12/18)
- Leading Economic Indicators and How to Use Them
The Balance, Kimberly Amadeo (10/9/18)
Surveys and Data
- Define the term ‘recession’.
- Are periods of above-trend expansion necessarily followed by a recession?
- Give some examples of leading indicators other than those given above and discuss their likely reliability in predicting a recession.
- Find out what has been happening to confidence levels in the EU over the past 12 months. Does this provide evidence of an impending recession in the EU?
- For what reasons may there be lags between a change in an indicator and a change in the variables for which it is an indicator?
- Why has the shape of the yield curve previously been a good predictor of the future course of the economy? Is it likely to be at present?
- What is the relationship between interest rates, government bond prices (‘Treasuries’ in the USA) and the yield on such bonds?
One of the key questions about Brexit is its effect on UK trade and cross-border investment. Once outside the customs union, will the freedom to negotiate trade deals lead to an increase in UK exports and GDP, as many who support Brexit claim; or will the increased frictions in trade with the EU, and the need to negotiate new trade deals with those non-EU countries which already have trade deals with the EU, lead to a fall in exports and in GDP?
Also, how will trade restrictions or new trade deals affect capital flows? Will there be an increase in inward investment or a flight of investment to the EU or elsewhere? Will many companies relocate away from the UK – or to it?
Although there has been a cost up to now from the Brexit vote, in terms of a depreciation in sterling and a fall in inward investment (see the first article below), the future effects have been hard to predict as the terms on which the UK will leave the EU have been unclear. However, with a draft withdrawal agreement between the EU and the UK government having been reached, the costs and benefits are becoming clearer. But there is still uncertainty about just what the effects on trade and investment will be.
- First, the 585-page draft withdrawal agreement is not a trade deal. It contains details of UK payments to the EU, commitments on the rights of EU and UK citizens and confirmation of the transition period – initially until 31 December 2020, but possibly extended with mutual agreement. During the transition agreement, the UK would remain a member of the customs union and single market and remain subject to rulings of the European Court of Justice. The withdrawal agreement also provides for a continuation of the customs union beyond the transition period, if no long-term trade agreement is in place. This is to prevent he need for a hard border between Ireland and Northern Ireland.
- Second, there is merely a 26-page ‘political declaration‘ about future trade relations. Negotiations on the details of these can only begin once the UK has left the EU, scheduled for 29 March 2019. So it’s still unclear about just how free trade in both goods and services will be between the UK and the EU and how freely capital and labour will move between them. But with the UK outside the single market, there will be some limitations on trade and factor movements – some frictions.
- Third, it is not clear whether the UK Parliament will agree to the withdrawal agreement. Currently, it seems as if a majority of MPs is in favour of rejecting it. If this happens, will the UK leave without an agreement, with trade based on WTO terms? Or will the EU be prepared to renegotiate it – something it currently says it will not do? Or will the issue be put back to the electorate in the form of a People’s vote (see also), which might contain the option of seeking to remain in the EU?
So, without knowing just what the UK’s future trade relations will be with (a) the EU, (b) non-EU countries which have negotiated trade deals with the EU, (c) other countries without trade deals with the EU, it is impossible to quantify the costs and benefits from the effects on trade and investment. However, the consensus among economists is still that there will be a net cost in terms of lost trade and inward investment.
Such as view is backed by a government analysis of various Brexit scenarios, released in time for the House of Commons vote on 11 December. This concludes that the UK will be worse off under all Brexit alternatives compared with staying in the EU. The main brake on growth will be frictions in trade from tariff and non-tariff barriers.
This analysis was supported by a Bank of England paper which modelled various scenarios based on assumptions about different types of Brexit deal. While recognising the inherent uncertainty in some of the empirical relationships, it still concluded that Brexit would be likely to have a net negative effect. The size of this negative effect would depend on the closeness of the new relationship between the UK and EU, the degree of preparedness across firms and critical infrastructure, and how other policies respond.
- Identify the main economic advantages and disadvantages for the UK from leaving the EU?
- How does the law of comparative advantage relate to the question of the relative trade gains from leaving and remaining in the EU?
- What is the difference between the following models of relationship with the EU: the Switzerland model; the Norway model; the Turkey model; the Canada (plus or plus, plus) model; trading on WTO terms?
- Why is the consensus among economists that there will be a net economic cost from leaving the EU, no matter on what terms?
- Is the UK likely to achieve more favourable trade deals with non-EU countries as an independent country or as a member of the EU benefiting from EU-negotiated trade deals with such countries?