To what extent does history repeat itself? Minsky’s Financial Instability Hypothesis infers that credit cycles are fairly inevitable. We have seem them in the past and we will see them in the future. Human beings are subject to emotion, to irrational exuberance and to a large dose of forgetfulness! To what extent do the latest UK credit numbers suggest that we might be embarking on another credit binge? Are the credit data consistent with evidence of another credit cycle?
Chart 1 shows the stocks of debt acquired by households and private non-financial corporations from MFIs (Monetary Financial Institutions). The scale of debt accumulation in the late 1980s and again from the mid 1990s up to the financial crisis of the late 2000s is stark. At the start of 1985 the UK household sector had debts to MFIs of around £140 billion. By the start of 2009 this had hit £1.29 trillion. Meanwhile, private non-financial corporations saw their debts to MFIs rise from around £45 billion to over £500 billion. (Click here to download a PowerPoint of the chart.)
The path of debt at the start of the 2010s is consistent with a story of consolidation. Financially-distressed households, private non-financial corporations and, of course, MFIs themselves meant that corrective action was needed to repair their balance sheets. The demand for and supply of additional credit waned. Debt accumulation largely ceased and, in fact, debt numbers fell. This trend continues today for private non-financial corporations. But, for households debt accumulation resumed in the middle of 2013. At the end of the third quarter of 2015 the household sector had debt obligations to MFIs of £1.246 trillion.
Chart 2 focuses on flows rather stocks. It allows us to see the accumulation of new credit (i.e. less repayments of debt). What is even more apparent from this chart is the evidence of cycles in credit. The growth in new credit during the 2000s is stark as is the subsequent squeeze on credit that followed.
The question that follows is what path are we now on? Clearly flows of credit to households are again on the rise. In part, this is driven by the rebound in the UK housing market. But, in fact there is a more rapid increase in consumer credit, i.e. unsecured debt. (Click here to download a PowerPoint of the chart.)
Chart 3 shows the flows of consumer credit from MFIs and other credit providers. Again, we see the marked evidence of cycles. In the year to the end of Q1 of 2015 net consumer credit flows amounted to £22.8 billion, the highest figure since the 12-month period up to the end of Q3 of 2005. Click here to download a PowerPoint of the chart.)
While it might be a little early to say that another Minsky cycle is well under way, policymakers will be keeping a keen eye on credit patterns. Is history repeating itself?
Articles
Average UK mortgage debt rises to £85,000 The Guardian, Phillip Inman (15/12/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Recovery ‘too reliant on consumer debt’ as BCC downgrades forecast The Guardian, Heather Stewart (9/12/15)
BCC: UK Growth Too Reliant On Consumer Debt Sky News (9/12/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
IMF: UK’s economic performance ‘very strong’, but risks remain BBC News (11/12/15)
Data
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England
Questions
- How can the financial system affect the economy’s business cycle?
- What does it mean if households or firms are financially distressed? What responses might they take to this distress and what might the economic consequences be?
- How would you measure the net worth (or wealth) of an individual or a firm? What factors might affect their net worth?
- How might uncertainty affect spending and saving by households and businesses?
- What does it mean if bank lending is pro-cyclical?
- Why might lending be pro-cyclical?
- Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?
George Osborne in his recent Autumn Statement, once again stressed that ‘the government is committed to strong, sustainable and balanced growth’. But while he plans to reduce government debt as a percentage of GDP, consumer debt is rising, both absolutely and as a percentage of household disposable income. The rise in household borrowing, and the resulting rise in consumer expenditure, has been the main factor driving economic growth. It has not been exports nor, until recently, investment, as the Chancellor had hoped. Indeed, investment in new housing is falling.
The Office for Budget Responsibility in its latest Economic and Fiscal Outlook forecasts that gross household debt will reach 163 per cent of household disposable income by 2021, up from 146% at the end of 2015.
Consumer gross debt includes both secured debt and unsecured debt. Secured debt is essentially debt secured on property (i.e. mortgages), while unsecured debt is largely in the form of credit card debt, overdrafts and personal loans.
The chart shows that from 2008 to 2013, gross debt fell as a percentage of personal disposable income. Following the financial crisis, banks were more cautious about lending as they sought to increase their capital and liquidity ratios. And consumers were more cautious about borrowing as the uncertainty made many people keen to reduce their debts. This decline in credit reversed the massive growth in household debt from 2000 to 2008: one of the contributing factors to the financial crisis. (Click here for a PowerPoint of the chart.)
But since late 2013, household debt – both secured and unsecured – has been rising. In absolute (nominal) terms, individuals’ debt is now £1.43 trillion, slightly above the previous high in 2008. And as the chart shows, the OBR forecasts that it will continue rising. This makes consumers more vulnerable to adverse economic shocks, such as a downturn in emerging markets, another crisis in the eurozone or financial crises in other parts of the world.
And as consumer debt has been rising, the personal saving ratio (the ratio of saving to personal disposable incomes) has been falling and is now lower than before the financial crisis.
The rise in consumer borrowing has been of some concern to the Bank of England. Andy Haldane, the Bank’s Chief Economist, appearing before the Treasury Select Committee, warned that consumer credit, and in particular personal loans, had been ‘picking up at a rate of knots. That ultimately might be an issue that the Financial Policy Committee might want to look at fairly carefully.’
Articles
The UK economy may be growing, but in a highly unbalanced way The Guardian, Phillip Inman (27/11/15)
UK growth hit by biggest drag from net trade on record The Telegraph, Szu Ping Chan (27/11/15)
Surge in consumer lending could prompt Bank of England intervention The Guardian, Patrick Collinson and Jill Treanor (30/11/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Between Debt and the Devil by Adair Turner review – should the government start printing money? The Guardian, Tom Clark (25/11/15)
Lending rises as Bank of England ponders new curbs Financial Times, Ferdinando Giugliano (30/11/15)
Carney indicates BoE’s willingness to rein in credit Financial TImes, Chris Giles (5/11/15)
FCA sounds alarm at rising credit card debt Financial Times, Emma Dunkley (3/11/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
Seven years after the crisis, Britain is still addicted to the drug of debt Independent, James Moore (1/12/15)
Vince Cable: Former Business Secretary warns that ‘severe economic storms’ are on the way Independent, Ben Chu (14/11/15)
The risks stalking the UK economy BBC News, Kamal Ahmed (1/12/15)
OBR publications
Economic and fiscal outlook Office for Budget Responsibility (25/11/15)
Economic and fiscal outlook charts and tables (Excel file) Office for Budget Responsibility (25/11/15)
Questions
- Does it matter if economic growth is driven by a rise in consumer demand, in turn driven by a risen in consumer credit?
- Is there an inflation risk from growth being driven by a rise in consumer credit?
- What is the precise relationship between the household saving ratio and the household debt ratio? (Which of these ratios is a stock and which is a flow?)
- What might cause a fall in consumer borrowing? Would this be a good thing?
- Why did consumer borrowing fall following the financial crisis of 2007–8?
- What could the Bank of England’s Financial Policy Committee do to curb consumer borrowing?
- If banks were forced to hold more reserves, how could aggregate demand be maintained? Would ‘helicopter money’ be a good idea?
- What are ‘countercyclical buffers for banks’? What are the arguments for raising them at the current time?
Jim Slater, who has just died at the age of 86, was a tycoon of the 1970s, probably unknown to most reader of this blog. But his legacy lives on and many will question whether the actions of the banking sector and big business today is a reflection of the lessons that were not learnt 40 years ago.
Slater was a businessman: perhaps the businessman in the 1970s, building up a company that in today’s money and the height of its success, would have been worth billions. Buying and selling companies, asset stripping and investing created Slater Walker, which shot to success and then crumbled to failure, taking with it a bailout from the Bank of England of £110 million. You might look at that figure and compare it with the bail outs of more recent times and think – peanuts. But think about how prices have changed and convert £110 million into today’s money and that’s a hefty bail out. A key question is whether the willingness of the government and Bank of England to bail out key banks and financial sector businesses has encouraged the irresponsible lending that led to the credit crunch. Was there a moral hazard? Had Slater Walker been left to fail, would the world look a slightly different place?
Perhaps a little extreme, but I wonder, if we were to look back over the past 50 to 60 years, whether we would find other cases of key businesses being bailed out, which set a precedent for other companies to grow, without necessarily taking full responsibility for it. Jim Slater will certainly leave a legacy behind him .
Jim Slater and the warning from the 1970s that we ignored BBC News, Jonty Bloom (20/11/15)
Questions
- What is meant by asset stripping?
- If a company like Slater Walker had not been bailed out, do you think the economy would have suffered?
- If Slater Walker had been left to fail, would that have changed the business model of some of our largest banks and reduced the chance of a financial crisis 40 years later?
- Do you think the concept of moral hazard is relevant here?
First the IMF in its World Economic Outlook, then the European Commission in its Economic Forecasts (see also) and now the OECD in its Economic Outlook (see also) – all three organisations in the latest issues of their 6-monthly publications are predicting slower global economic growth than they did 6 months previously. This applies both to the current year and to 2016. The OECD’s forecast for global growth this year is now 2.9%, down from the 3.7% it was forecasting a year ago. Its latest growth forecast for 2016 is 3.3%, down from the 3.9% it was forecasting a year ago.
Various reasons are given for the gloomier outlook. These include: a dramatic slowdown in global trade growth; slowing economic growth in China and fears over structural weaknesses in China; falling commodity prices (linked to slowing demand but also as a result of increased supply); austerity policies as governments attempt to deal with the hangover of debt from the financial crisis of 2007/8; low investment leading to low rates of productivity growth despite technological progress; and general fears about low growth leading to low spending as people become more cautious about their future incomes.
The slowdown in trade growth (forecast to be just 2% in 2015) is perhaps the most worrying for future global growth. As Angel Gurría, OECD Secretary-General, states in his remarks at the launch of the latest OECD Economic Outlook:
‘Global trade, which was already growing slowly over the past few years, appears to have stagnated and even declined since late 2014, with the weakness centering increasingly on emerging markets, particularly China. This is deeply concerning as robust trade and global growth go hand in hand. In 2015 global trade is expected to grow by a disappointing 2%. Over the past five decades there have been only five other years in which trade growth has been 2% or less, all of which coincided with a marked downturn of global growth.’
So what policies should governments pursue to stimulate economic growth? According to Angel Gurría:
‘Short-term demand needs to be supported and structural reforms to be pursued with greater ambition than is currently the case. Three specific actions are key:
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First, we need to resist and turn back rising protectionism. Trade strengthens competition and investment and revs up the “diffusion machine” – the spread of new technologies throughout the economy – which will ultimately lift productivity. |
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Second, we need to step up structural reform efforts, which have weakened in recent years. And here, I mean the whole range of structural reforms – education, innovation, competition, labour and product market regulation, R&D, taxes, etc. |
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Third, there is scope to adjust public spending towards investment. If done collectively by all countries, if the sector and projects chosen have high multipliers, and if combined with serious structural reforms, stronger public investment can give a boost to growth and employment and not increase the relative debt burden.’ |
On this third point, the OECD Economic Outlook argues that ‘the rationale for such investments is that they could help to push economies onto a higher growth path than might otherwise be the case, at a time when private investment growth remains modest.’
‘Collective action to increase public investment can be expected to boost the initial domestic multiplier effects from the stimulus, since private investment and exports in each economy will benefit from stronger demand in other economies. …the multiplier effects from an investment-led stimulus are likely to be a little larger than from other forms of fiscal stimulus, since the former also has small, but positive, supply-side effects.
In other words, the OECD is calling for a relaxation of austerity policies, with public investment being used to provide a stimulus to growth. The higher growth will then lead to increased potential output, as well as actual output, and an increase in tax revenues.
These policy recommendations are very much in line with those of the IMF.
Videos and Webcasts
OECD warns of global trade slowdown, trims growth outlook again Reuters (9/11/15)
OECD returns to revisionism with growth downgrade Euronews, Robert Hackwill (9/11/15)
OECD: Weak China Import Growth Leads Trade Slowdown Bloomberg, Catherine L Mann, OECD Chief Economist (9/11/15)
OECD Economic Outlook: Moving forward in difficult times OECD PowerPoint presentation, Catherine L Mann, OECD Chief Economist (9/11/15)
Press Conference OECD, Angel Gurría and Álvaro Pereira (9/11/15)
Articles
OECD cuts world growth forecast Financial Times, Ferdinando Giugliano (9/11/15)
OECD rings alarm bell over threat of global growth recession thanks to China slowdown Independent, Ben Chu (10/11/15)
OECD cuts global growth forecasts amid ‘deep concern’ over slowdown BBC News (9/11/15)
OECD fears slowdown in global trade amid China woes The Guardian, Katie Allen (9/11/15)
The global economy is slowing down. But is it recession – or protectionism? The Observer, Heather Stewart and Fergus Ryan (14/11/15)
Global growth is struggling, but it is not all bad news The Telegraph, Andrew Sentance (13/11/15)
OECD Publications
Economic Outlook Annex Tables OCED (9/11/15)
Press Release: Emerging market slowdown and drop in trade clouding global outlook OCED (9/11/15)
Data handout for press OECD (9/11/15)
OECD Economic Outlook, Chapter 3: Lifting Investment for Higher Sustainable Growth OCED (9/11/15)
OECD Economic Outlook: Full Report OECD (9/11/15)
Questions
- Is a slowdown in international trade a cause of slower economic growth or simply an indicator of slower economic growth? Examine the causal connections between trade and growth.
- How worried should we be about disappointing growth in the global economy?
- What determines the size of the multiplier effects of an increase in public investment?
- Why are the multiplier effects of an increase in public-sector investment likely to be larger in the USA and Japan than in the UK, the eurozone and Canada?
- How can monetary policy be supportive of fiscal policy to stimulate economic growth?
- Under what circumstances would public-sector investment (a) stimulate and (b) crowd out private-sector investment?
- How would a Keynesian economist respond to the recommendations of the OECD?
- How would a neoclassical/neoliberal economist respond to the recommendations?
- Are the OECD’s recommendations in line with the Japanese government’s ‘three arrows‘?
- What structural reforms are recommended by the OECD? Are these ‘market orientated’ or ‘interventionist’ reforms, or both? Explain.
Interest rates in the UK have been at a record low since 2009, recorded at just 0.5%. In July, the forward guidance from Mark Carney seemed to indicate that a rate rise would be likely towards the start of 2016. However, with the recovery of the British economy slowing, together with continuing problems in Europe and slowdowns in China, a rate rise has become less likely. Forward guidance hasn’t been particularly ‘guiding’, as a rate rise now seems most likely well into 2016 or even in 2017 and this is still very speculative.
Interest rates are a key tool of monetary policy and one of the government’s demand management policies. Low interest rates have remained in the UK as a means of stimulating economic growth, via influencing aggregate demand. Interest rates affect many of the components of aggregate demand, such as consumption – through affecting the incentive to save and spend and by affecting mortgage rates and disposable income. They affect investment by influencing the cost of borrowing and net exports through changing the exchange rate and hence the competitiveness of exports.
Low interest rates therefore help to boost all components of aggregate demand and this then should stimulate economic growth. While they have helped to do their job, circumstances across the global economy have acted in the opposite direction and so their effectiveness has been reduced.
Although the latest news on interest rates may suggest some worrying times for the UK, the information contained in the Bank of England’s Inflation Report isn’t all bad. Despite its predictions that the growth rate of the world economy will slow and inflation will remain weak, the predictions from August remain largely the same. The suggestion that interest rates will remain at 0.5% and that any increases are likely to be at a slow pace will flatten the yield curve, and, with predictions that inflation will remain weak, there will be few concerns that continuing low rates will cause inflationary pressures in the coming months. Mark Carney said:
“The lower path for Bank Rate implied by market yields would provide more than adequate support to domestic demand to bring inflation to target even in the face of global weakness.”
However, there are many critics of keeping interest rates down, both in the UK and the USA, in particular because of the implications for asset prices, in particular the housing market and for the growth in borrowing and hence credit debt. The Institute of Directors Chief Economist, James Sproute said:
“There is genuine apprehension over asset prices, the misallocation of capital and consumer debt…Borrowing is comfortably below the unsustainable pre-crisis levels, but with debt once against rising there is a need for vigilance…The question is, will the Bank look back on this unprecedented period of extraordinary monetary policy and wish they had acted sooner? The path of inaction may seem easier today, but maintaining rates this low, for this long, could prove a much riskier decision tomorrow.”
hanges in the strength of the global economy will certainly have a role to play in forming the opinions of the Monetary Policy Committee and it will also be a key event when the Federal Reserve pushes up its interest rates. This is certainly an area to keep watching, as it’s not a question of if rates will rise, but when.
Articles
Bank of England dampens prospects of early UK rate rise BBC News (5/11/15)
Bank of England Governor gets his forward guidance on interest rates wrong Independent, Ben Chu (6/11/15)
Interest rates set to remain at rock-bottom right through 2016 as Bank of England cuts UK growth and inflation forecasts This is Money, Adrian Lowery (5/11/15)
Pound slides as Bank of England suggests interest rates will stay low for longer – as it happened 5 November 2015 The Telegraph, Peter Spence (5/11/15)
UK’s record low interest rates should be raised next Februrary says NIESE The Telegraph, Szu Ping Chan (4/11/15)
Fresh signs of slowdown will force interest rates rise to be put on hold The Guardian, Katie Allen (2/11/15)
The perils of keeping interest rates so low The Telegraph, Andrew Sentence (6/11/15)
Time to ask why we are still in the era of ultra-low rates Financial Times, Chris Giles (4/11/15)
No interest rate rise until 2017: Joy for homeowners as Bank of England delays hike in mortgage costs again Mail Online, Matt Chorley (5/11/15)
Pound tumbles after Carney warns its strength threatens recovery Bloomberg, Lucy Meakin (5/11/15)
Is Carney hurt by wrong rate steer? BBC News, Robert Peston (5/11/15)
Data and Reports
Inflation Report Bank of England (August 2015)
Inflation Report Bank of England (November 2015)
Historical Fan Chart Data Bank of England (2015)
Questions
- Use and AD/AS diagram, explain how low interest rates affect the key components of aggregate demand and in turn how this will affect economic growth.
- What is meant by the ‘yield curve’? How has it been affected by the latest release from the Monetary Policy Committee?
- Why has the value of the pound been affected following the decision to keep interest rates at 0.5%?
- How has the sterling exchange rate changed and how might this affect UK exports?
- What are the main concerns expressed by those who think that there is a danger from keeping interest rates low for too long?
- Why is the outlook of the global economy so important for the direction of interest rate changes?
To what extent does history repeat itself? Minsky’s Financial Instability Hypothesis infers that credit cycles are fairly inevitable. We have seem them in the past and we will see them in the future. Human beings are subject to emotion, to irrational exuberance and to a large dose of forgetfulness! To what extent do the latest UK credit numbers suggest that we might be embarking on another credit binge? Are the credit data consistent with evidence of another credit cycle?
