A weekly expense for most families is filling up their car(s) with petrol, but this activity is becoming increasingly expensive and is putting added pressure on lower and middle income families in particular. For those families on lower incomes, a tank of petrol represents a much larger percentage of their income than it does for a higher income household. Assuming that petrol for a month costs you £70 and your monthly income is £500, as a percentage of your income, a tank of petrol costs you 14%. Whereas, if your income is £900, the percentage falls to 7.7% and with a monthly take-home pay of £2000, the cost of a month’s petrol as a percentage of your income is just 3.5%. This is a stark indication of why those on lower incomes feel the burden of higher petrol prices (and indeed, higher prices for any essential items) more than other families.
The price of petrol will today be debated by MPs, following an e-petition signed by more than 100,000 people and having the support of more than 100 MPs. When in power, the Labour government proposed automatic fuel-tax increases, but these were scrapped by the Coalition. However, in January, the government plans to increase fuel duty by 3p a litre and further increases in prices are expected in August in line with inflation. This could mean that the price of unleaded petrol rises to over 1.40p per litre.
And it’s not just households that are feeling the squeeze. The situation described in the first paragraph is just as relevant to firms. The smaller firms, with lower turnover and profits are feeling the squeeze of higher petrol prices more than their larger counterparts. Any businesses that have to transport goods, whether to customers or from wholesalers to retailers etc, are seeing their costs rise, as a tank of petrol is requiring more and more money. To maintain profit margins, firms must pass these cost increases on to their customers in the form of higher prices. Alternatively, they keep prices as they were and take a hit on profitability. If prices rise, they lose customers and if prices are maintained, profitability suffers, which for some companies, already struggling due to the recession, may not be an option.
Mr. Halfon, the Tory MP whose motion launched the e-petition said that fuel prices were causing ‘immense difficulties’ and the Shadow Treasury Minister Owen Smith has said:
‘With our economic recovery choked off well before the recent eurozone crisis, we need action.’
With inflation at 5.2% (I’m writing an hour or so before new inflation data is released on 15/11/11), higher prices for many goods is putting pressure on households. This is possibly contributing towards sluggish growth, as households have less and less disposable income to spend on other goods, after they have purchased their essential items, such as groceries and petrol. A criticism leveled at oil companies is that they quickly pass on price rises, as the world price of oil increases, but do not pass on cuts in oil prices. The issues raised in the debate and how George Osborne and David Cameron respond, together with inflation data for the coming months, may play a crucial role in determining just how much a tank of petrol will cost in the new year.
MPs to debate motion calling for half in petrol prices BBC News (15/11/11)
Petrol price rise: David Cameron faces Commons revolt after No10 e-petition Guardian, Cherry Wilson (15/11/11)
David Cameron faces backbench rebellion over fuel price hike Telegraph, Rowena Mason (14/11/11)
Petrol prices may be slashed by Rs 2 per litre on November 16 The Economic Times (15/11/11)
Paying the price as fuel costs rise BBC News (15/11/10)
Oil barons the big winners from soaring pump prices, ONS figures reveal Daily Mirror, Graham Hiscott (15/11/11)
Scrap rise in petrol duty: 100 MPs demand Osborne abandon planned 3p increase Mail Online, Ray Massey and Tim Shipman (15/11/11)
Questions
- As the price of petrol rises, why do people continue to buy it? What does it suggest about the elasticity of this product?
- Why do higher prices affect lower income families more than higher income families?
- What are the arguments (a) for and (b) against George Osborne’s planned 3p rise in petrol duty?
- Do you think that higher prices are contributing towards sluggish growth? Why?
- What type of tax is imposed on petrol? Is it equitable? Is it efficient?
- Why can the oil companies pass price rises on to petrol stations, but delay passing on any price reductions? Is there a need for better regulation and more pressure on oil companies to change their behaviour?
The UK and US governments face a conundrum. To achieve economic recovery, aggregate demand needs to expand. This means that one or more of consumption, government expenditure, exports and investment must rise. But the government is trying to reduce government expenditure in order to reduce the size of the public-sector deficit and debt; exports are being held back by the slow recovery, or even return to recession, in the eurozone and the USA; and investment is being dampened by business pessimism. This leaves consumer expenditure. For recovery, High Street spending needs to rise.
But herein lies the dilemma. For consumer spending to rise, people need to save less and/or borrow more. But UK and US saving rates are already much lower than in many other countries. You can see this by examining Table 23 in OECD Economic Outlook. Also, household debt is much higher in the UK and USA. This has been largely the result of the ready availability of credit through credit cards and other means. The government is keen to encourage people to save more and to reduce their reliance on debt – in other words, to start paying off their credit-card and other debt. That way, the government hopes, the economy will become ‘rebalanced’. But this rebalancing, in the short run at least, will dampen aggregate demand. And that will hardly help recovery!
In the following podcast, Sheldon Garon discusses his new book Beyond Our Means. He describes the decline of saving in the USA and UK and examines why other countries have had much higher saving rates.
‘He also seeks to explain why high interest rates didn’t encourage saving in the boom years and why current levels of relatively high inflation haven’t stopped savings rates shooting up again in Britain.’
Living beyond our means Guardian: the Business Podcast, Sheldon Garon talks to Tom Clark (2/11/11)
Questions
- Why have saving rates in the UK and USA been much lower than those in many other countries? How significant has been the availability of credit in determining savings rates?
- Why have saving rates increased in the UK and USA since 2008/9 despite negative real interest rates in many months?
- Explain what is meant by the “paradox of thrift”. What are the implications of this paradox for government policy at the present time?
- Why may it be difficult to have a consumer-led recovery in the UK and US economies?
- What is the life-cycle theory of consumption and saving? How well does it explain saving rates?
- Can people be given a “nudge” to spend more or to save more? If so, what nudges might be appropriate in the current situation?
- Why do countries with a more equal distribution of income have higher saving rates?
- What is the relationship between the saving rate and (a) the rate of inflation and (b) the real rate of interest? Why is this the case?
Economic growth in developed countries, like the UK, exhibits two important characteristics. First, growth is positive over the long run such that the volume of output increases over time. Second, growth in the short-term is highly variable with patterns in the volume of output creating business cycles. With increased global interdependence through trade and integrated financial systems, domestic business cycles often resemble a global or international business cycle. This was certainly the case during the late 2000s. Recent releases from the Office for National Statistics provide an opportunity to look again at the characteristics of UK economic growth. In particular, they show the importance of differentiating between nominal and real values. Furthermore, revisions to the data have somewhat revised our view of economic growth before and after the economic crisis of the late 2000s.
The value of goods and services produced in the UK in 2010, as measured by GDP, is estimated at £1.46 trillion. This is the nominal GDP estimate because it measures the economy’s output for 2010 using the prices of 2010. Back in 1948, GDP measured at 1948 prices was £11.97 billion. Based on these nominal estimates the size of the UK economy would appear to have grown some 122 times which is the equivalent of growing by 8.1 per cent each year. However, some of this increase relates not to the volume of output but to the prices of the goods and services produced. It is for this reason that when analysing economic growth we ordinarily look at constant-price or real estimates of GDP. Such estimates effectively show what GDP would have been if prices had remained at the levels of a chosen year known as the base year. The base year now being used in the UK is 2008.
GDP at constant 2008 prices in 2010 is estimated at £1.40 trillion as compared with £314.5 billion in 1948. The real GDP figures reveal that the volume of UK output increased not by a factor of 122 but by a factor of 4.44; this is the equivalent to growth of 2.4 per cent each year.
The nominal GDP estimates for each year from 1948 up to 2010 rise with only one exception: 2009. In 2009, nominal GDP fell by 2.8 per cent. However, over the same period, real GDP fell during seven of the years. What this tells us, is that in six of the seven years, price increases were enough to offset falls in the volume of output such that nominal GDP increased. However, in 2009, the average price of the economy’s output, which is measured by the GDP deflator, rose by a just a little under 1.7 per cent, while the volume of output and, hence, real GDP, fell by almost 4.4 per cent.
The real annual GDP numbers estimate that the volume of UK output declined both in 2008 and 2009. In 2008 output is thought to have fallen by 1.1 per cent, while in 2009, as we have just seen, it fell by 4.4 per cent. The last time the UK experienced two consecutive annual (yearly) falls in output was in 1980 and 1981 when output fell by 2.1 per cent and 1.3 per cent respectively.
If we want to identify recessions then yearly GDP numbers will not do, rather, we need to use quarterly GDP numbers. This is because we are looking for two consecutive quarters where real GDP (output) declined. The revised GDP data show that the UK experienced five consecutive quarterly falls in real GDP in the late 2000s. We went into recession in Q2 of 2008 and came out in Q3 of 2009. As a result, real GDP was 7 per cent lower than before the UK economy entered recession. The previous recession, from Q3 of 1990 to Q3 of 1991 (5 quarters), saw UK output fall by 2.5 per cent. Between these two recessions the UK experienced 66 consecutive quarters of economic growth during which time the revised estimates show that the average annual rate of growth was 3 per cent. Compared with the recession of 2008/09, the next deepest recession in recent times occurred between Q1 of 1980 and Q1 of 1981 (5 quarters) when output fell by 4.7 per cent. In other words, these figures help to illustrate the extraordinary depth of the 2008/9 recession.
Articles
QE plus Economist (8/10/11)
Cameron steadfast as economy halts Sky News Australia, Matt Falloon and Christina Fincher (6/10/11)
Recession was deeper and recovery slower than expected Telegraph, Philip Aldrick (31/10/11) )
Mr Cameron, GDP and the hole in the recovery BBC News, Stephanie Flanders, (5/10/11)
UK economy grinds to virtual halt AFP (5/10/11) )
Recession concern as economy fails to grown Herald Scotland, Ian McConnell (5/10/11)
Data
Quarterly National Accounts, Q2 2011 Office for National Statistics (5/10/11)
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
- Explain what you understand by the terms nominal GDP and real GDP. Can you think of other examples of where economists might distinguish between nominal and real variables?
- Explain under what circumstances nominal GDP could rise despite the output of the economy falling.
- The average annual change in nominal GDP since 1948 is 8.2% while that for real GDP is 2.4%. What do you think we can learn from each of these figures about long-term economic growth in the UK?
- What do you understand to be the difference between short-term and long-run economic growth?
- What is meant by the concept of a business cycle? In what ways can the characteristics of business cycles differ across time? What about across countries?
- How might the position within the business cycle impact on an economy’s potential output?
- What factors might influence a country’s long-term rate of economic growth?
At its meeting on 26 October, the eurozone countries agreed on a deal to tackle the three problems identified in Part A of this blog:
1. Making the Greek debt burden sustainable
2. Increasing the size of the eurozone bailout fund to persuade markets that there would be sufficient funding to support other eurozone countries which were having difficulties in servicing their debt.
3. Recapitalising various European banks to shield them against possible losses from haircuts and defaults.
The following were agreed:
1. Banks would be required to take a loss of 50% in converting existing Greek bonds into new ones. This swap will take place in January 2012. Note that Greek debt to other countries and the ECB would be unaffected and thus total Greek debt would be cut by considerably less than 50%.
2. The bailout fund (EFSF) would increase to between €1 trillion and €1.4 trillion, although this would be achieved not by direct contributions by Member States or the ECB, but by encouraging non-eurozone countries (such as China, Russia, India and Brazil) to buy eurozone debt in return for risk insurance. These purchases would the form the base on which the size of the fund could be multiplied (leveraged). There would also be backing from the IMF. Details would be firmed up in November.
3. Recapitalising various European banks to shield them against possible losses from haircuts and defaults. About 70 banks will be required to raise an additional €106.4 billion by increasing their Tier 1 capital ratio by 9% by June 2012 (this compares with the Basel III requirement of 6% Tier 1 by 2015).
On the longer-term issue of closer fiscal union, the agreement was in favour of achieving this, along with tight constraints on the levels of government deficits and debt – a return to something akin to the Stability and Growth Pact.
On the issue of economic growth, whilst constraining sovereign debt may be an important element of a long-term growth strategy, the agreement has not got to grips with the short-term problem of a lack of aggregate demand – unless, of course, the relief in markets at seeing a solution to the debt problem may boost business and consumer confidence. This, in turn, may provide the boost to aggregate demand that has been sadly lacking over the past few months.
Certainly if the reaction of stock markets around the world are anything to go by, the recovery in confidence may be under way. The day following the agreement, the German stock market index, the Dax, rose by 6.3% and the French Cac index rose by 5.4%.
Articles
Eurozone crisis explained BBC News (27/10/11)
Leaders agree eurozone debt plan in Brussels BBC News, Matthew Price (27/10/11)
Eurozone agreement – the detail BBC News, Hugh Pym (27/10/11)
10 key questions on the eurozone bailout Citywire Money, Caelainn Barr (27/10/11)
European debt crisis: ‘Europe is going to have a very tough winter’ – video analysis Guardian, Larry Elliott (27/10/11)
Eurozone crisis: banks agree 50% reduction on Greece’s debt Guardian, David Gow (27/10/11)
The euro deal: No big bazooka The Economist (29/10/11)
Europe’s rescue plan The Economist (29/10/11)
European banks given just eight months to raise €106bn The Telegraph, Louise Armitstead (26/10/11)
EU reaches agreement on Greek bonds Financial Times, Peter Spiegel, Stanley Pignal and Alex Barker (27/10/11)
Unlike politicians, the markets are seeing sense Independent, Hamish McRae (27/10/11)
Market view: Eurozone rescue deal buys time FT Adviser, Michael Trudeau (27/10/11)
Greece vows to build on EU deal, people sceptical Reuters, Renee Maltezou and Daniel Flynn (27/10/11)
Markets boosted by eurozone deal Independent, Peter Cripps, Jamie Grierson (27/10/11)
Has Germany been prudent or short-sighted? BBC News blogs, Robert Peston (27/10/11)
Germany’s Fiscal union with a capital F BBC News blogs, Stephanie Flanders (27/10/11)
Questions
- What are the key features of the deal reached in Brussels on 26 October?
- What details still need to be worked out?
- How will the EFSF be boosted some 4 or 5 times without extra contributions fron eurozone governments?
- Why, if banks are to take a 50% haircut on their holdings of Greek debt, will Greek debt fall only to 120% per cent by 2020 from just over 160% currently?
- On balance, is this a good deal?
With all the doom and gloom of recent economic data, including rising inflation and higher unemployment, there’s finally a small speck of light and that’s in the form UK retail sales. The latest data from the ONS suggests that sales in the UK in September were higher than previously forecast and reversed the 0.4% decline we saw in August. A big contributing factor to this positive data was a boost to online sales, but this small glimmer of hope is unlikely to be sufficient to keep the economy going – unless sales keep rising, we are unlikely to see any significant increase in economic growth.
The data, while positive, is still unlikely to have any impact on economic policy. The minutes from the Monetary Policy Committee showed that there was unanimous support for further quantitative easing, as the threat of weak growth and financial instability and uncertainty remains. An economist from Barclays Capital said:
‘We don’t think the recent strong growth in monthly sales is likely to be sustained…The environment for retailers is likely to remain challenging as consumer spending remains depressed driven by low confidence and slow earnings growth.’
The data from September is positive, but it does little to offset the decline in sales seen in August. It was revised down from 0.2% to 0.4% – some blame the hot weather, which discouraged consumers from hitting the high streets in preparation for the winter. The key data to look out for will be sales figures for the next few months. Only then will we have more of an indication about exactly which direction the economy is moving in. The following articles consider this latest economic data.
Retail sales in UK unexpectedly increase at fastest pace in five months Bloomberg, Scott Hamilton (20/10/11)
UK retail sales see stronger-than-expected rise BBC News (20/10/11)
Nothing expected from today’s UK retail sales figure FX-MM, Richard Driver (20/10/11)
Retail sales: what the economists say Guardian (20/10/11)
£1 in every £10 now spent online, says ONS Telegraph, Harry Wallop (20/10/11)
Retail sales rise more than expected Financial Times, Sarah O’Connor (20/10/11)
Retail sales up but good weather has a price Sky News (20/10/11)
Questions
- Which factors have contributed to the higher than expected sales figures for September?
- Why do economists not believe that the higher growth in sales means signs of recovery for the UK economy?
- How has higher inflation impacted UK households?
- To what extent do you think the warm weather held back retail sales?
- What could explain why there has been a significant growth in online sales?