One of the interesting things about the recent recession was the dilemma that it posed for governments. As aggregate demand fell, unemployment rose, incomes fell, which reduced demand further and so national output began to decline. Obviously there were many other factors contributing to this decline, in particular the housing market, but the long and the short of it is, aggregate demand was falling. With the AD curve shifting inwards, we would expect the average price level to fall at the same time: i.e. inflation doesn’t tend to be much of a problem during a recession. It is this fact that posed something of a dilemma. In the recession, not only was aggregate demand low, but inflation was rising. The explanation for this: in large part due to rising commodity prices – a supply-side shock. Governments had to deal with low national output and inflation: this combination made policy changes much more complex.
While prices for many goods and commodities did fall significantly after their peak in 2008, there has been a gradual rise again and there seems to be no end in sight. Headline food prices, in particular, have increased almost to their 2008 levels, although in real terms prices are still lower. Onions in India; cabbage, pork and mackerel in South Korea; chillies in Indonesia – the list goes on. The rapidly rising prices of these basic foodstuffs has, in many cases, led to emergency government intervention. However, there are fewer concerns this time round, as many hope that the causes of these higher prices are not just the increases in demand but crucially temporary supply shocks. Bloomberg’s Businessweek Assistant Managing Editor, Sheelah Kolhatkar, said:
There are a lot of reasons [for rising prices]. Weather is cited as a big one. There’s been sort of freak weather in different parts of the world. Russia experienced a drought. There are floods in Australia. There’s been sort of freezing weather in Florida. Our own Midwest experienced flooding earlier this year. And because the market for a lot of these food commodities is global, when something strange happens somewhere, that can affect a crop.
On the other hand, there are growing concerns at the timing of this inflation: the developed world has barely escaped from recession. How is it that inflation can already be a problem? Furthermore, with loose monetary policy in many countries, rising food and commodity prices could continue for some time.
An interesting question to consider is which countries will be affected the most? In Britain, like other developed countries, food consumption accounts for between 15 and 20 per cent of a household budget. However, in developing countries, food can take up between 50 and 75 per cent of a houshold budget, so any rise in food prices is disastrous.
What does it mean for the recovery? Well, if food (a necessity) is increasing in price, households have little choice but to pay the higher prices. This means they have less disposable income for other goods, hence aggregate demand may be adversely affected. The following articles will hopefully give you some ‘food for thought’!
Articles
Soaring food prices cast shadow over trading Financial Times, Dave Shellock (14/1/11)
Next shock will be high food prices Sydney Morning Herald (17/1/11)
Commodities can still shock BBC News blogs, Stephanomics, Stephanie Flanders (13/1/11)
Many countries face catastrophe as inflation creeps up the food chain Independent, Hamish McRae (16/1/11)
Soaring demand soaks food oil reserves Sydney Morning Herald, Luzi Ann Javier (17/1/11)
Government to subsidise essential food items Sunday Observer, Gammi Warushamana (16/1/11)
Brace for higher food prices Jamaica Observer, Julia Richardson (16/1/11)
Jordanians protest against soaring food prices Guardian, Johnny McDevitt (15/1/11)
Inflation, the old enemy, is back. But this is no time to be frightened Guardian, Larry Elliott (16/1/11)
Global effort to calm food prices Washington Post, Steve Mufson (15/1/11)
The link between commodity prices and Monetary Policy Seeking Alpha (14/1/11)
Australian floods bost commodity prices, shares and funds Telegraph, Ian Cowie (13/1/11)
Soaring cost of oil and food will result in turmoil Belfast Telegraph Hamish McRae (18/1/11)
Q&A: Why food prices and fuel costs are going up BBC News (14/1/11)
Data
Commodity Prices Index Mundi
Questions
- What is the difference between headline food prices and real prices?
- What are the demand-side factors causing food prices to increase?
- What factors have affected the supply-side of the food market? Use a diagram to illustrate both the demand and supply-side factors.
- Can you identify some of the key differences between the causes of the rising food prices in 2008 and the rising food prices we’re seeing at the moment?
- Who are the winners and losers of rising food prices?
- What methods of government intervention are available to stabilise prices? Are they likely to be efficient and equitable?
- How is the exchange rate affecting food prices?
- Why could a loose monetary policy make food price inflation even worse?
- What are the main consequences of rising food and commodity prices? Think about the impact on different groups within society.
I have something of an admission to make: I love data. I suppose it goes back to my time working as a civil servant. My job was to brief on the latest data releases relevant to the household sector and to try to interpret what the latest numbers might be telling us. It meant that on one day I might be briefing about the latest household spending numbers and the next on house prices. It was not only great fun but it also helped my understanding of economics and, importantly, my understanding of the issues and topics that economists wrestle with. Data help to give context perhaps by placing current outcomes, such as the latest high street sales figures, in an historical context or by enabling international comparisons, such as comparing UK consumer behaviour to that across the Channel in France. These days I spend my time teaching, but I retain my passion for data and I do all that I can to convey this to those I teach. So, what I thought we would do here is to look at a few numbers relating to UK households, show that we need not be frightened by them, and show how they can help to paint a picture of the current economic behaviour of the UK consumer.
My first teaching week back this academic term began by talking to students about consumer spending. I think it’s important that those new to economics and learning about household spending behaviour have a sense of how much UK households spend, how this varies, and why how much the sector spends is important. Let’s begin with the household spending figure for 2009 – the 2010 figure will not be available for a couple of months. By going to the latest release of the Quarterly National Accounts we discover that UK households spent £874 billion in 2009. Though a big enough figure in its own right, it is actually 2% less than the £892 billion in 2008. But, more than this, remember that these are nominal values reflecting the prices of 2008 and 2009. The average price of household consumption goods and services rose by 1.3% between these two years which, if we eliminate, means that the volume of consumer spending fell by 3.3%.
To convince anyone that patterns in household spending do matter is pretty straightforward. One way of doing this is to consider household spending relative to GDP, i.e. the value of our country’s output. If we return to latest Quarterly National Accounts we discover that GDP in 2009 is estimated at £1.39 trillion. So with household spending of £874 billion and total output of £1.39 trillion we can readily see the value of households as purchasers of this output. To be more specific, household spending in 2009 was equivalent to some 63% of GDP. This is one of the reasons why economists pay so much attention to trying to interpret the spending patterns of households – one of my old jobs – and, of course, trying to predict the future path of household spending.
You might be wondering about more recent patterns in household consumption since, after all, 2009 now seems quite a while ago. Well, in the third quarter of 2010 household spending was estimated at £232.3 billion and if we add to this the revised figures for the previous three quarters we get a 4-quarter total of £910.4 billion. For many analysts though the key numbers relate to the growth in the volume of household spending. In Q3 2009 real household spending grew by 0.3%. Whilst the first quarter of 2010 saw spending volumes decline by 0.1%, Q3 was the second consecutive quarter in which spending volumes increased. The concern, however, was that the 0.3% growth in Q3 was down on the 0.8% growth in Q2. We wait with much interest the Q4 figure.
When I talk to students about the determinants of household spending many, quite naturally, will point to the importance of disposable income. Again let’s return to the Quarterly National Accounts. In 2009 the disposable income, i.e. post-tax income, of the household sector was estimated at £942.2 billion. That’s another big number. Let’s put that alongside our spending number for households of £874.4 billion and we have an average propensity to consume (APC) out of disposable income of 0.92 which compares with 0.97 in 2008 and 0.98 in 2007. This suggests that households were inclined to do other things with their income in 2009 than just merely spend it. We observe this too if we take note of the real changes in consumption and income in 2009. After removing the impact of price changes, we find that while consumption volumes fell by 3.3%, the spending power of the sector’s disposable income actually rose by 1.1%.
But, what of more recent patterns in disposable income? Well, disposable income in Q3 2010 is estimated to have been £244.3 billion which with consumption of £232.3 billion equates to an average propensity to come out of disposable income of 0.95. If we again add the Q3 disposable income number to those from the previous three quarters we have a 4-quarter disposable income figure of £964.4 billion which gives us an average propensity to consume over this period of 0.94 and, hence, a tad higher than 2009, albeit not at the levels of 2007 and 2008. Meanwhile, real disposable income rose by 1.1% in Q3 following a 2% decline in Q2. The quarterly disposable income series is a notoriously volatile series and the recent past has seen no change in that. Perhaps the key fact though is that the real value of the household sector’s disposable income in Q3 2010 was 1.5% lower than it was a year earlier. Hence, while real disposable income grew across 2009, it is likely to have fallen across 2010.
So why did household spending fall so markedly in 2009 despite the rise in disposable income. It is likely that the impact of the financial crisis, the subsequent recession and a sense of uncertainty amongst households will have been contributory factors. One way in which these factors seems to have affected UK households is in their desire to reduce their exposure to debt. So we end with a few numbers, some a little eye-watering, which relate to household debt and demonstrate the attempt by households to improve their financial positions.
Figures from the Bank of England contained within Table 3 of their statistical release lending to individuals show that at the end of November 2010 households had a stock of debt of £1.454 trillion, not too dissimilar a number to that for GDP! But, this is £5.6 billion less than at the end of November 2009. The main reason for this is the sector’s repayment of unsecured debt, such as credit card debt and overdrafts. Unsecured debt fell by £13.4 billion over the year to stand at £214.1 billion.
The remaining £1.24 trillion of household debt is secured debt and so debt secured against property. This has risen by £7.7 billion over the 12 months to November. But, it would be a mistake to believe that because the overall stock of mortgage debt hasn’t fallen that households are not trying to paying it off. How can this be, you might ask? The answer lies in the growth of housing investment relative to that of mortgage debt. Housing investment relates, in the main, to the purchase of brand new homes and to major home improvements. As our population grows and the housing stock expands and as we spend more on improving our existing housing stock we acquire more mortgage debt. However, the Bank of England figures shows that housing investment has been greater than new secured lending. In other words, the additions to the stock of lending have been less than housing investment.
In Q3 the Bank of England estimates an increase of housing equity of £6.1 billion. Negative housing equity withdrawal (HEW), an injection of housing equity, has become something of a new norm dating back to when the UK economy went into recession in Q2 2008. Since then, the UK household sector has injected some £49.7 billion of housing equity. This, of course, comes at a potential cost for the economy because by increasing equity in property households are using money that cannot be used to fund current consumption or to purchase financial assets. The extent of this negative HEW over the past 10 quarters has been the equivalent to 2.1% of disposable income.
So that ends my tour of the household sector through numbers. Hopefully, the numbers have helped to paint a picture of the importance of the household sector for the economy and to make you think about some of the variables that affect the sector’s behaviour. Given these interesting economic times, painting by economic numbers has never been so much fun!
Articles
Mortgage debt falls for the 10th quarter in a row BBC News (29/12/10)
Homeowners make record mortgage repayments Independent, Hugo Young (30/12/10)
Homeowners reduce their mortgages by £6bn in just three months Telegraph, Louise Armistead (30/12/10)
Homeowners paying off mortgages at faster rate Guardian, Jill Insley (29/12/10)
Homeowners paying back mortgages at rapid rate Daily Mail (29/12/10)
Christmas trading hit by snow, says BRC Financial Times, Chris Giles (11/1/11)
Festive freeze hits sales across the high street Independent, James Thompson (11/1/11)
Shoppers hit hard by inflation Independent (12/11/10)
Families warned by Bank of England of even more painful year ahead Daily Mail, Lucy Farndon (28/12/10)
Shop inflation accelerated in December on commodities, retailers say Bloomberg, Svenja O’Donnell
Data
Lending to individuals statistical release Bank of England
Housing equity withdrawal (HEW) statistical release Bank of England
Latest on GDP growth Office for National Statistics (22/12/10)
Quarterly National Accounts, 3rd Quarter 2010 Office for National Statistics (22/12/10)
UK Economic Accounts, 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
- What factors do you think affect consumer spending in the short-term, say over a three-month period? Would the same factors be important if we were looking at spending patterns over a longer period of time?
- Consumers are sometimes described as consumption-smoothers which means that they look to smooth their profile of spending in the face of volatile incomes. What factors do you think affect their ability to do this?
- Would you expect the relationship between consumption and income to be consistent and predictable? Explain your answer.
- Why do you think real spending values fell in 2009 despite real disposable income rising? Does this mean that households are not in fact consumption-smoothers?
- The financial system enables households to accumulate financial assets, financial liabilities and to acquire housing wealth. How might these three variables impact on household spending?
- Illustrate with examples what is meant by secured and unsecured debt. Does the long-term accumulation of stocks of these debts have any consequences for household spending?
- What do you understand by the term housing equity withdrawal? What is meant by negative HEW and which the UK has observed for the past ten quarters?
- What factors might help to explain the ten consecutive quarters of negative HEW? Would you expect things to change in the near future? Explain your answer.
- What is the opportunity cost of positive housing equity withdrawal (HEW)? What about the opportunity cost of negative HEW?
- To what extent do you think household spending affects economic growth? Is household spending a long-term driver of economic growth?
Bank rate in the UK has been at the historically low level of 0.5% since March 2009 and the MPC decision on 13 January was to leave the rate unchanged (see also). But inflation has been well above the Bank of England’s target of 2% since December 2009 and it could well rise further as international commodity prices are soaring. Some economists are thus arguing that Bank rate should rise. This is crucial, they say, to dampen inflationary expectations.
Other economists, however, argue that aggregate demand is likely to remain depressed and that the economy is operating with a large negative output gap. What is more, house prices are falling, as are real wages (see Bosses gain – workers’ pain)
In the following extract from BBC Radio 4’s Today Programme, two economists, Charles Goodhart and Willem Buiter, both former members of the MPC, debate the issue.
Podcast
Should interest rates rise? BBC Today Programme (13/1/11)
Data
Economic and Labour Market Review, Office for National Statistics (For inflation data see Tables Chapter 3, Table 3.01; for interest rates see Tables Chapter 5, Table 5.08)
Monetary Policy Committee Decisions Bank of England
Questions
- What are the arguments for a rise in Bank rate at the current time?
- What are the arguments against a rise in Bank rate at the current time?
- What information would you require to decide which of the arguments was the more powerful?
- Why is it difficult to decide the size of the output gap?
- To what extent do the arguments for and against a rise in Bank rate depend on the factors determining expectations, and what expectations are important here?
- To what extent are exchange rates relevant to the effectiveness of interest rate policy?
Two reports on business confidence in the UK have just been published. The first, by Lloyds TSB Commercial, is its twice-yearly Business in Britain Report. The second is the Quarterly Economic Survey by the British Chambers of Commerce. Both reports paint a mixed picture about business confidence.
First the good news: the export sector is booming. Demand for exports is being boosted by (a) the depreciation of the pound, with the sterling exchange rate index some 20% lower now compared with the start of 2008 and (b) rapid economic growth in China, India and many other developing countries. Not surprisingly many exporting companies are looking to a bright future and are willing to invest.
Now the bad news. Domestic demand for many products is declining, especially services. This is not surprising given the rise in VAT, cuts in public spending and consumers cautious about their employment and income prospects in the coming year. With rapid cost-push inflation from higher oil and commodity prices, real incomes are set to fall and with it the level of real consumer demand (see Bosses gain – workers’ pain).
So where is the economy heading? The mixed picture painted by the two reports mean that the economy is likely to remain on the cusp. But with the export sector being much smaller than the domestic market, worries are likely to persist that economic growth may well slow significantly and the economy might return to recession. The main hope is that the restocking and replacement investment that follow a recession may be enough to provide just enough extra demand to avoid the ‘double dip’.
Articles
UK Business Confidence Hit By Domestic Demand Fears-Survey NASDAQ, Emma Haslett (4/1/11)
More doom and gloom as business confidence falls? Management Today, Nicholas Winning (5/1/11)
Smaller businesses do not share optimism Financial Times, Brian Groom (5/1/11)
New Year business confidence hit by domestic demand fears The Telegraph, James Hurley (5/1/11)
UK’s fragile services sector risks undermining recovery, BCC warns The Telegraph, Philip Aldrick (11/1/11)
Companies fear double-dip recession Oxford Mail, Andrew Smith (10/1/11)
Firms ‘planning investment freezes’ Press Association (4/1/11)
Surveys paint bleak picture for British economy Reuters, David Milliken (11/1/11)
Kern Says U.K. Services Industry Growth Is `Mediocre’ Bloomberg, Watch Video, David Kern (11/1/11)
UK economic growth rate slowing, BCC says BBC News (11/1/11)
Reports
Business in Britain, December 2010 Lloyds TSB Commercial (January 2011)
Quarterly Economic Survey, Q4 2010: Summary British Chambers of Commerce (January 2011)
Quarterly Economic Survey, Q4 2010: Tables British Chambers of Commerce (January 2011)
Data
Interest Rates and Exchange Rates Bank of England (for sterling effective exchange rates)
Economic and Labour Market Review Office for National Statistics (see Tables Chapter 1, worksheets in Table 1.03 for components of aggregate demand)
Business and Consumer Surveys European Commission, Economic and Financial Affairs (see latest ESI – Economic Sentiment Indicator, Table 1)
Questions
- Summarise the findings of the two reports.
- Using the data in Table 1.03 of the Economic and Labour Market Review, calculate the percentage of UK GDP accounted for by each of the main elements of aggregate expenditure.
- Why is the manufacturing sector as a whole experiencing relatively strong economic growth?
- If the service sector shrank by x% and the manufacturing sector grew by x%, what would be likely to happen to the rate of economic growth in the economy? What else would you need to know to establish the precise rate of economic growth?
- The BCC said both the government and the Bank of England must “act forcefully to support growth”. What measures would this include?
- If real wages fall, what could cause real aggregate demand to rise in these circumstances?
- What is likely to drive the level of investment in the coming months?
For most people, buying a new car is a luxury and in times of hardship it is a luxury that many cannot afford. Sales of new cars did grow during 2010 by 1.8% compared to the previous year, although the end of the car scrappage scheme in March 2010 did see a fall in sales. Sales went from being 19.9 per cent up on 2009 in the first half of the year, to being 13.8 per cent down for the remainder of 2010. On top of this, they are predicted to fall by some 5% over the coming 12 months.
Part of the explanation of this trend is the VAT rise. While an extra 2.5% is hardly noticeable on many every day items (as we saw when VAT was reduced to 15%), it will have a much larger effect on more expensive items, such as cars.
It was expected that people thinking of buying a new car would try to beat the VAT rise and so car firms hoped for a surge in sales during December. However, this did not occur and with VAT at 20% during 2011, car prices will rise: a £15,000 car will cost an extra £320. Another contributing factor to the lower than expected sales in December was the snow. Retail sales in December collapsed by 37.5%, where as fleet sales, which are less likely to be affected by the adverse weather rose by 5.1%. Similar patterns were seen in Spain, Italy and France, but in Germany sales were up by 7% on the year from December 2009.
The good news for the UK car industry is that the second half of 2011 is expected to see growth, so there may be some recovery. Furthermore, UK-built cars have seen a rise in sales – up by 17%. Finally, as petrol prices continue to rise, it is hoped that this might encourage people to trade in their less efficient old cars for more fuel-efficient new cars. This will certainly be an industry to watch over the next few months.
Snow hits new car sales Telegraph, Graham Ruddick (8/1/11)
UK new car sales to fall in 2011, says industry BBC News (7/1/11)
Mixed end to the year for European car sales Independent (7/1/11)
Car sales set to stall? Daily Mirror, Clinton Manning (8/1/11)
UK new car sales rose 1.8pc in 2010 despite end of scrappage scheme Telegraph, Amy Wilson (7/1/11)
New car sales increased in 2010 Telegraph, Chris Knapman (7/1/11)
Car registrations fall 18% from year ago Financial Times, Norma Cohen (7/1/11)
Questions
- What type of tax is VAT? Illustrate the effect of such a tax on a diagram and explain why the higher the price of the good, the bigger the impact of the VAT rise. How might this impact inflation?
- Why are car sales expected to fall in the UK over the coming year? Given this expected trend, what might we expect to see in terms of car prices?
- What impact might rising petrol prices have on new car purchases? What figure would you expect to see for cross elasticity of demand?
- How might the expected decline in car sales affect the UK economy over the next 12 months?
- What type of market structure is the car industry? (Think about the characteristics of monopolistic competition and oligopoly.)
- How did the car scrappage scheme help car sales?
- What might explain the different trend seen in the German car industry?