Figures released by the Bank of England show that in the third quarter of 2009 UK households increased their housing equity (i.e. repaid mortgage debt) by £4.9 billion, equivalent to 2% of their disposable income. This was the sixth consecutive quarter in which saving in housing exceeded net mortgage lending. Interestingly, during each of these six quarters the UK economy contracted.
Saving in housing (or ‘negative housing equity withdrawal’ (HEW)) will reduce aggregate demand if it is funded out of income that would otherwise have been spent on consumer goods and services. Since the proportion of income saved, as measured by the saving ratio, climbed from an historic low of 0.9% in the third quarter of 2008 to 8.6% in the same quarter of 2009, increased saving in housing equity has been depressing spending levels. Indeed, across the six quarters in which HEW has been negative, households have increased their stock of housing equity by £33.9 billion, equivalent to 2.3% of disposable income – money which could otherwise have been spent.
Increased saving in housing by households is an example of the household sector’s attempt to repair its balance sheets. Another example has been the fall in the sector’s outstanding stock of unsecured debt (e.g. outstanding personal loans and credit-card debt). Elsewhere in the economy, banks too have been looking to repair their badly damaged balance sheets and, of course, there is the considerable interest in how the UK government will reduce its budget deficit. We can expect these repairs to balance sheets to have some impact on the pace of economic recovery. What is less certain is the size and duration of these balance sheet effects.
Home loan repayments ‘a priority’ BBC News (29/12/09)
Homeowners pay off £5bn of mortgage debt Financial Times, Vanessa Houlder (30/12/09)
Homeowners stop cashing in on the value of their homes Telegraph, Myra Butterworth (29/12/09)
Mortgages paid off at the fastest rate for 40 years Guardian, Larry Elliott (30/12/09)
Homeowners rush to repay mortgages thisismoney, Rosamund Urwin (29/12/09)
Questions
- What factors might explain why UK households have been increasing their saving in housing equity during 2009?
- Why might increasing amounts of HEW, such as those in the mid 2000s, not necessarily result in higher levels of consumer spending?
- What do you understand by the ‘household balance sheets’? What do you think is likely to be the most significant item on the sector’s balance sheets?
The health of an economy is generally measured in terms of the growth rate in GDP. A healthy economy is portrayed as one that is growing. Declining GDP, by contrast, is seen as a sign of economic malaise; not surprisingly, people don’t want rising unemployment and falling consumption. The recession of 2008/9 has generally been seen as bad news.
But is GDP a good indicator of human well-being? The problem is that GDP measures the production of goods and services for exchange. True, such goods and services are a vital ingredient in determining human well-being. But they are not the only one. Our lives are not just about consumption. What is more, many of our objectives may go beyond human well-being. For example, the state of the environment – the flora and fauna and the planet itself.
Then there is the question of the capital required to produce goods and maintain a healthy and sustainable environment. Capital production is included in GDP and the depreciation of capital is deducted from GDP to arrive at a net measure. But again, things are left out of these calculations. We include manufactured capital, such as factories and machinery, but ignore natural capital, such as rain forests, coral reefs and sustainable ecosystems generally. But the state of the natural environment has a crucial impact on the well-being, not only of the current generation, but of future generations too.
In the video podcast below, Professor Sir Partha Dasgupta, from the Faculty of Economics at the University of Cambridge and also from the University of Manchester, argues that the well-being of future generations requires an increase in the stock of capital per head, and that, in measuring this capital stock, we must take into account natural capital. In the paper to which the podcast refers, he argues “that a country’s comprehensive wealth per capita can decline even while gross domestic product (GDP) per capita increases and the UN Human Development Index records an improvement.”
Nature’s role in sustaining economic development (video podcast) The Royal Society, Partha Dasgupta
Nature’s role in sustaining economic development Philisophical Transactions of the Royal Society B, vol 365, no. 1537, pp 5–11, Partha Dasgupta (12/1/10)
GDP is misleading measure of wealth, says top economist University of Manchester news item (21/12/09)
Economics and the environment: Down to earth index Guardian (28/12/09)
Questions
- Why might a rise in GDP result in a decline in human well-being?
- In what sense is nature ‘over exploited’?
- What is meant by ‘comprehensive wealth’ and why might comprehensive wealth per capita decline even though the stocks of both manufactured capital and human capital are increasing?
- What is meant by ‘shadow prices’ in the context of natural capital?
- How might economists go about measuring the shadow prices of capital?
- What factors should determine the rate of discount chosen for projects that impact on the future state of the environment?
Should economists have foreseen the credit crunch? A few were warning of an overheated world economy with excessive credit and risk taking. Most economists prior to 2007/8, however, were predicting a continuation of steady economic growth. Inflation targeting, fiscal rules and increasingly flexible markets were the ingredients of this continuing prosperity. And then the crash happened!
So why did so few people see the downturn coming? Were the models used by economists fundamentally flawed, or was it simply a question of poor assumptions or poor data? Do we need a new way of modelling the economy, or is it simply a question of updating theories from the past? Should, for example, models become much more Keynesian? Should we abandon the new classical approach of assuming that markets are essentially good at pricing in risk and that herd behaviour will not be seriously destabilising?
The following podcast looks at these issues. “Aditya Chakrabortty’s joined in the studio by the Guardian’s economics editor Larry Elliott, as well as Roger Bootle, the managing director of Capital Economics, and political economist and John Maynard Keynes biographer Robert Skidelsky. Also in the podcast, we hear from Nobel prize-winning economist, Elinor Ostrom, Freakonomics author Steven Levitt, and UN advisor and developmental economist Daniel Gay.”
The Business: A crisis of economics Guardian podcast (25/11/09)
See also the following news items from the Sloman Economics news site:
Keynes is dead; long live Keynes (3/10/09)
Learning from history (3/10/09)
Macroeconomics – Crisis or what? (6/8/09)
The changing battle grounds of economics (27/7/09)
Repeat of the Great Depression – or learning the lessons from the past? (23/6/09)
Animal spirits (30/4/09)
Keynes – do we need him more than ever? (26/10/08)
Questions
- Why did most economists fail to predict the credit crunch and subsequent recession? Was it a problem with the models that were used or the data that was put into these models, or both?
- What was the Washington consensus? To what extent did this consensus contribute to the current recession?
- What is meant by systemic risk? How does this influence the usefulness of ‘micro’ financial models?
- What particular market failures were responsible for the credit crunch?
- What is meant by ‘rational behaviour’? Is it reasonable to assume that people are rational?
- Is macroeconomics too theoretical or too mathematical (or both)? If you think it is, how can macroeconomics be reformed to improve its explanatory and predictive power?
- Does a ‘really good economist’ need to have a good grounding in a range of social sciences and in economic history?
The problem with banks and the financial sector is that we need them. Who knows what might have happened if the government hadn’t stepped in to bail out the banks. And that’s one of the key arguments for continuing to pay bankers’ bonuses. If they left their jobs and the banks ceased to exist, we’d be looking at a very bleak future.
The truth is: ‘we need them’ and, what’s worse, they know it. As Frank Skinner said in a Times article: ‘during the crisis bankers will be thinking, “Don’t panic. The public have got short memories. Show them the slightest hint of recovery and most of them will forget their moral indignation and we can start where we left off – making the biggest splashes we can and not worrying about the ripples” ‘.
Despite the argument for continuing to pay out bonuses, a large proportion of the public are understandably angry that bankers are still receiving enormous bonuses. Not only are banks and the financial sector largely responsible for the current recession, but it is taxpayers who have bailed them out and who now pay their bonuses. However, things could be about to change.
The FSA is set to get powers, allowing it to ‘tear up’ bankers’ bonus contracts, especially for those taking reckless risks that threaten the stability of the financial sector. The new regulations will be found in the Financial Services Bill, which, if approved by Parliament, will apply to all British banks, as well as the British subsidiaries of overseas banks operating in the UK. Multi-million pound payments will be able to be blocked and fines will be imposed on banks who offer unjustified ‘mega-bucks pay-outs’.
Despite this impending regulation, not everyone thinks it will be successful. Sir George Mathewson, the former Chairman of RBS, has said that interfering with bankers’ contracts is a ‘dangerous route to go down’. Read the following articles that consider this contentious issue.
Bankers bonuses’ ‘will soar to £6bn’ after government bailouts and rising profits Times Online, Katherine Griffiths (21/10/09)
Bonus crackdown plans dangerous BBC News (16/11/09)
Financial regulation ‘has broken down’ BBC Today Programme (16/11/09)
Roger Bootle: Bank reform hasn’t gone far enough (video) BBC News (25/12/09)
FSA to get powers to tear up’ bankers’ bonus contracts Citywire, Nicholas Paler (16/11/09)
It’ll be tough for bankers on a £200k bonus Times Online, Frank Skinner (13/11/09)
Prince Andrew defends bankers’ bonuses even as economy stays mired in recession Mail Online, Kate Loveys (24/10/09)
Curb on bankers’ bonuses to be unveiled in Queens’ speech Mail Online (13/11/09)
Bankers warn laws on pay and bonuses will scare off talent Telegraph Angela Monaghan (13/11/09)
Labour to overturn bonus deals at risk-taking banks Guardian Patrick Wintour (13/11/09)
Banking on the State Guardian (17/11/09)
Queen outlines new banking laws BBC News (18/11/09)
Queen’s Speech: what the Financial Bill really means for bankers’ bonuses Telegraph, Tracy Corrigan (18/11/09)
Brown Puts Deficit Curbs, Bonus Limits on U.K. Agenda Bloomberg, Gonzalo Vina and Thomas Penny (18/11/09)
Queen’s speech 2009: financial services bill Guardian, Jill Treanor (18/11/09)
Questions
- What is meant by ‘regulation’ and what forms does it take?
- Why are banks and the financial services largely blamed for the current recession? Will financial regulation of bonuses prevent a repeat of the current crisis?
- What are the arguments for and against further regulation? Why does the former Chairman of RBS argue that cracking down on bonuses could be ‘dangerous’? Do you agree?
- Why are bankers paid so much? How is the equilibrium wage rate determined in this sector?
- Should bankers receive bonuses? Think about the incentive effect; the effect on productivity. What are the possible consequences for those working in banking of bonuses being reduced and possibly removed if they are deemed to threaten financial stability?
A key determinant of the length of any phase of the business cycle is consumer confidence. If people have gloomy expectations and confidence of a recovery is low, then a recession that should have lasted 6 months ends up lasting for years. Companies don’t see an end to the recession and keep holding off on investment plans and the public don’t want to go out and start spending, because there’s no guarantee that the economy is on its way back up. The more you worry about your finances, the less likely you are to go out and start spending, even though that could be the stimulus that a shrinking economy needs.
According to the British Retail Consortium, consumer confidence in the UK is on its way back up and currently stands at an 18-month high – which doesn’t actually say much given the past 18-months!! Despite this, job worries still remain and this has been highlighted significantly in the past week, when Britain’s youngest person ever was made redundant: a 13-year old paper boy. Whilst consumer confidence is argued to be returning to the UK, consumer confidence has been going in the opposite direction in the USA, with further fears of job losses. US confidence had been improving but unexpectedly fell in October. Is that what the UK has to look forward to?
So, why is consumer confidence so important? How does it affect the length of recovery and what is expected to happen over the next few months? Read the articles below to find out more.
US consumer confidence takes hit BBC News (27/10/09)
Consumer confidence hits 18-month high The Independent, David Prosser (1/11/09)
Consumer confidence on the rise BBC News (2/11/09)
Confidence boost hints that worst of recession now over The Scotsman, Peter Ranscombe (2/11/09)
US Michigan Sentiment fell to 70.6 this month Bloomberg, Courtney Schlisserman (30/10/09)
Euro-zone Consumer confidence improves The Wall Street Journal, Ilona Billington and Roman Kessler (30/10/09)
Retailers set for a merry Christmas DIYWeek (2/11/09)
Job fears still remain despite biggest increase in consumer confidence in 18 months, says British Retail Consortium Liverpool Echo, Neil Hodgson (2/11/09)
Business and consumer surveys in each of the EU countries and in the EU as a whole can be found at:
Business and Consumer Surveys European Commission
Questions
- In what ways does consumer confidence affect economic growth?
- Are there likely to be any adverse consequences of consumer confidence returning to the market?
- What are some of the reasons for the unexpected fall in consumer confidence in the USA? Do you think a similar thing is likely to happen in the UK?
- Expectations are crucial in economics. What is the difference between adaptive and rational expectations? How do they affect adjustment to the short- and long-run equilibrium?
- Can anything be done to improve confidence or is it simply a case of leaving things as they are … and waiting?