Category: Essentials of Economics: Ch 09

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Falling flat

According to the first estimate by the Office for National Statistics, the UK economy shrank by 0.3% in the final three months of 2012. This means that over the whole year growth was flat.

The biggest contributor to the fall in GDP in Q4 was the production industries, which include manufacturing. Output of the production sector fell by 1.8% in Q4. Construction sector output, by contrast, was estimated to have increased by 0.3%. Service sector output was flat. The chart below shows quarterly and annual growth in the UK from 2007 to 2012. (Click here for a PowerPoint.)

Latest estimates by the IMF are that the UK economy will grow by 1.0% in 2013 – well below the long-term growth in potential output (see also the last blog, High hopes in the Alps). But some forecasters are predicting that real GDP will continue to fall for at least one more quarter, which means that the economy would then be in a ‘triple-dip recession’.

Not surprisingly politicians have interpreted the statistics very differently, as have economists. The government, while recognising that the UK faces a ‘very difficult economic situation’, argues that now is not the time to change course and that by continuing with policies to reduce the deficit the economy will be placed on a firmer footing for sustained long-term growth

The opposition claims that the latest figures prove that the government’s policies are not working and that continuing attempts to bear down on the deficit are depressing aggregate demand and thereby keeping the economy depressed.

The following webcasts, podcasts and articles expand on these arguments. Try to be dispassionate in using economic analysis and evidence to assess the arguments.

Webcasts and podcasts
Video Summary: Gross Domestic Product Preliminary Estimate, Q4 2012 Media Briefing (Click here for the following Q&A) ONS (25/1/13)
Triple dip on the menu? Channel 4 News, Siobhan Kennedy and Faisal Islam (25/1/13)
Getting and spending – the key to recovery Channel 4 News, Cathy Newman (25/1/13)
UK economy shrinks by 0.3% in the last three months of 2012 BBC News, Hugh Pym (25/1/13)
Danny Alexander on GDP figures and economic plans BBC Daily Politics (25/1/13)
Osborne defends government’s deficit reduction plan BBC News (25/1/13)
Ed Balls: UK economy urgently needs a ‘Plan B’ BBC News (25/1/13)
UK heads for triple dip as GDP contracts 0.3pc The Telegraph, Philip Aldrick (25/1/13)
Economist: Government may need to rethink its fiscal policy The Telegraph, Jim O’Neill (25/1/13)
Has austerity really been tried in Britain? BBC Today Programme, Jonathan Portes and Andrew Lilico (29/1/13)

Articles
UK GDP: Economy shrank at end of 2012 BBC News (25/1/13)
UK GDP shrinks by 0.3% in fourth quarter: what the economists say The Guardian (25/1/13)
New Bank of England head Mark Carney hints at big shift in policy The Guardian (26/1/13)
The Bank of England, the chancellor, and the target BBC News. Stephanie Flanders (29/1/13)
The Entire World Of Economics Is Secretly Thankful To The UK Right Now Business Insider, Joe Weisenthal (26/1/13)

Data
Gross Domestic Product: Preliminary Estimate, Q4 2012 ONS (25/1/13)
Video Summary: Gross Domestic Product Preliminary Estimate, Q4 2012 ONS (25/1/13)
Preliminary Estimate of GDP – Time Series Dataset 2012 Q4 ONS (25/1/13)
Business and Consumer Surveys DG ECFIN

Questions

  1. What are the reasons for the decline in GDP in 2012 Q4??
  2. Examine how likely it is that the UK will experience a triple-dip recession.
  3. What measures could be adopted to increase consumer and business confidence?
  4. If there is substantial spare capacity, is expansionary fiscal policy the best means of achieving economic growth?
  5. What additional monetary policy measures could be adopted to stimulate economic growth?
  6. Find out what has happened to the UK’s public-sector deficit and debt over the past three years. Explain what has happened.
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High hopes in the Alps

Each year world political and business leaders meet at the World Economic Forum in the Swiss resort of Davos. The aim is to assess the progress of the global economy and to look at challenges ahead and what can be done about them.

Cynics claim that the round of presentations, discussions, Champagne receptions and fine dining rarely leads to anything concrete. Those who are less cynical argue that the Forum gives a unique opportunity for considering policy options and helping to shape a global consensus.

This year the mood was more optimistic. Many believe that the worst of the financial crisis is behind us. Stock markets are buoyant; the banking system seems more secure; the eurozone has not collapsed; growth prospects seem a little brighter.

But perhaps ‘optimistic’ is an overstatement. ‘Less pessimistic’ might be a better description. As Christine Lagarde, head of the IMF, pointed out in her speech:

The recovery is still weak, and uncertainty is still high. As the IMF announced just a few hours ago in our World Economic Outlook, we expect global growth of only 3½ percent this year, not much higher than last year. The short-term pressures might have alleviated, but the longer-term pressures are still with us. (Click here for transcript).

In both her speech and her press conference, she went on to outline the policies the IMF feels should be adopted to achieve sustained global growth.

The articles below summarise the outcomes of the Forum and some of the views expressed.

Articles

Too soon for sighs of relief Deutsche Welle, Andreas Becker (27/1/13)
Davos 2013: The icy economic chill begins to thaw The Telegraph, Louise Armitstead (26/1/13)
IMF Projects Modest Pick-up in Economic Growth in 2013 IMF videos, Olivier Blanchard, IMF Chief Economist (23/1/13)
Managing Director’s New Year Press Briefing IMF videos, Christine Lagarde, IMF Managing Director
Mark Carney in Davos: what’s up next for the global economy Maclean’s (Canada), Erica Alini (26/1/13)
World Economic Forum ends on warning note over ‘complacency’ The Guardian, Graeme Wearden (26/1/13)
Angela Merkel tells Davos austerity must continue The Guardian, Graeme Wearden and Larry Elliott (24/1/13)
Davos 2013: A ‘sigh of relief’ at the World Economic Forum BBC News, Stephanie Flanders (27/1/13)
Happy talk The Economist (27/1/13)
Davos Man and his defects The Economist, Schumpeter (26/1/13)
Davos: are the captains of capitalism finally paying attention? The Observer (27/1/13)

Official site
The Global Agenda 2013 The World Economic Forum

IMF projections
Modest Growth Pickup in 2013, Projects IMF IMF Survey Magazine: In the News (23/1/13)
World Economic Outlook Update IMF (23/1/13)

Questions

  1. Why was the mood at the WEF less pessimistic than in 2012?
  2. What threats remain to sustained global recovery?
  3. What policies are being recommended by Christine Lagarde of the IMF? Explain the reasoning behind the recommendations.
  4. What disagreements are there between global leaders on the scope for fiscal and monetary policies to stimulate economic growth?
  5. In her press conference, Christine Lagarde stated that “the teams here have concluded that the fiscal multipliers were higher in the context of that unbelievable international crisis”. Do you agree with this statement? Explain.
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The new cooler UK housing market?

The housing market is an incredibly fascinating market to monitor and to research. The market was at the centre of the financial crisis with some lenders accused of over-aggressively expanding their mortgage books and relaxing their lending criteria. The UK housing market of today looks very different to the market before the financial crisis. Nationally, house prices are stagnant while transaction numbers are less than half their pre-crisis level. The UK housing market appears almost as ‘cold’ as the recent weather!

As the first chart shows, the annual rate of house price inflation across the UK has been consistently close to or even below zero over the past couple of years. The latest figures from the Nationwide Building Society point to the average UK house price in the final quarter of 2012 being 1.1 per cent lower than in the final quarter of 2011. The figures from the Halifax concur with their estimate showing UK house prices 0.3 per cent lower year-on-year in the final quarter of 2012. This is a very different picture from that during the 2000s. As recently as 2007, the annual rate of house price inflation was in excess of 10 per cent.

Another indicator of the changing face of the UK housing market is the level of activity. The second chart shows the number of transactions per quarter across England and Wales since 1996. The figures from the Department of Communities and Local Government show that since the start of 2010 England and Wales has seen an average of 159,000 transactions per quarter. This compares with an average of 294,000 transactions over the period from 1996 to the end of 2007. Hence, the number of purchases today is roughly half the level prior to the financial crisis.

A further indicator of today’s very different housing market is the numbers of approvals by lenders for mortgages for house purchases. The latest Bank of England figures show that across the UK, the number of approvals each month in the first eleven months of 2012 averaged 51,000. Since 2010, the average monthly number of approvals has been 49,000. However, over the period from 1996 to the end of 2007 there were over 102,000 mortgages being approved each month.

A trawl through some of the key indicators of the UK housing market helps to paint a picture of a market that is markedly different to that before the financial crisis. It would be a big surprise in today’s financial and economic climate if there were to be any significant change in the path of these indicators for some time.

Data

Statistical data set – Property transactions Department of Communities and Local Government
Nationwide house price index Nationwide Building Society
Halifax House Price Index Lloyds Banking Group
Lending to individuals – November 2012 Bank of England

Articles

UK house prices drop 1% Guardian, Hilary Osborne (3/1/13)
House prices on course to pass pre-crisis peak levels Telegraph, Roland Gribben (21/1/13)
House prices rise at highest rate in seven months Independent, Vicky Shaw (15/1/13)
UK mortgage market ‘now more robust’ BBC News, (21/1/13)
Bank of England report flags improving mortgage market Telegraph, Emma Rowley (21/1/13)

Questions

  1. Draw up a list factors that are likely to have affected each of our 3 indicators of the UK housing market (house price inflation, transactions and mortgage approvals) since the late 2000s.
  2. Using a demand-supply diagram, illustrate the forces that have affected house prices in the late 2000s and early 2010s.
  3. Draw up a list of issues surrounding the housing market that would be of interest to a microeconomist. Now repeat the exercise for a macroeconomist.
  4. Why are house prices so notoriously volatile? Can you think of any other markets where prices are similarly volatile? Do these markets share any common traits?
  5. If you were a commentator on the UK housing market what would you be forecasting for prices and activity in 2013?
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7.04 trillion reasons to spend?

Consumer spending is crucial to an economy. In the UK total consumer spending is equivalent to almost two-thirds of the value of country’s GDP. Understanding its determinants is therefore crucial in attempting to forecast the short-term path of the economy. In other words, the growth of the economy in 2013 will depend on our inclination to spend.

While the amount of disposable income (post-tax income) will be one factor influencing our spending, other factors matter too. Amongst these ‘other factors’ is the stock of wealth of households. Here we look at the latest available figures on the net worth of the UK household sector. Will our stock of wealth help to underpin spending or will it act to constrain spending?

The household sector’s net worth is the sum of its net financial wealth and non-financial (physical) wealth. Net financial wealth is the balance of financial assets over financial liabilities. Financial assets include funds in savings accounts, shares and pension funds. Financial liabilities include debts secured against property, largely residential mortgages, and unsecured debts, such as overdrafts and unpaid balances on credit cards. Non-financial wealth largely includes the value of the sector’s holdings of property and buildings.

The following table summarises the net worth of the UK household sector at the end of 2011 and 2010. The figures are taken from the Office for National Statistics release, National Balance Sheet. They show that at the end of 2011, the household sector had a net worth of £7.04 trillion. This was up just 0.1 per cent up 2010. At the end of 2011, the stock of net worth of the household sector was 7 times the amount of disposable income earned by the sector in 2011.

The Household Sector Balance Sheet

Component 2010 (£bn) 2011 (£bn)
Financial assets 4,302.8 4,283.7
Financial liabilities 1,540.7 1,541.3
Net financial wealth 2,762.1 2,742.4
Non-financial (physical) wealth 4,272.2 4,302.1
Net worth 7,034.3 7,044.5

Source: National Balance Sheet, 2012 Dataset (Office for National Statistics)
Note: Figures include non-profit institutions serving households

We can also see from the table the significance of the value of non-financial assets to net worth. The value of households’ physical wealth is slightly larger than the value of its financial assets, though in 2011 both equate to around 4¼ times the annual flow of disposable income.

2011 saw the value of the stock of non-financial wealth grow by 0.7 per cent while the value of the sector’s stock of financial assets fell by 0.4 per cent. Meanwhile, the value of the stock of financial liabilities was virtually unchanged at a little over £1½ trillion. In 2011, the sector’s financial liabilities were equivalent to around 1½ times its annual disposable income. While this is down from the 2007 peak of 1¾ times income, it is considerably higher than during the period from 1987 to 1999 when the financial liabilities to income ratio remained consistently close to 1. The 2000s saw a rapid expansion of the sector’s liabilities relative to its income and, hence, today there remains what economists call a debt overhang.

Despite the very small overall increase in net worth in 2011, the stock of net wealth was up by 18 per cent on 2008. During 2008, net worth fell by 12 per cent. This was on the back of a fall in non-financial wealth of 9.4 per cent, a fall in the value of financial assets of 10.1 per cent and an increase in the value of financial liabilities of 1.9 per cent.

Chart 1 gives an historical picture of net worth. It shows the two principal balances that comprise net worth: net financial wealth and physical wealth. Each is shown relative to annual disposable income. Again, we can see the importance of physical wealth to overall net worth. The growth in house prices from the late 1990s through to the economic downturn of the late 2000s helps to explain its rising relative importance in net worth. We can also see from the chart that the relative level of net worth is roughly on a par with its value at the end of the 1990s. However, the composition is different. Today, relatively more of the sector’s net worth comes from non-financial wealth compared with that from net financial wealth.

A crucial question for spending in the months ahead is how inclined the household sector feels to consolidate its balance sheets further. Chart 2 includes more recently available data on financial assets and liabilities from United Kingdom Economic Accounts, Q3 2012. From it we can see the declining stock of financial liabilities relative to disposable income. This has been driven by an actual fall in the stock of unsecured financial liabilities. In the 12-month period up to the end of Q3 2012, the stock of unsecured financial liabilities fell by 6.4 per cent (the stock of secured debt rose by 1.8 per cent). This consolidation of unsecured debt suggests that households remain understandably cautious given the uncertain economic environment. Hence, the household balance sheet will most probably continue to constrain consumption growth in the short-term.

Data

National Balance Sheet Dataset, 2012 dataset Office for National Statistics
Statistical Bulletin: The National Balance Sheet, 2012 Results Office for National Statistics
United Kingdom Economic Accounts, Q3 2012 dataset Office for National Statistics

Articles

UK mortgage approvals hit ten-month high Telegraph, Emma Rowley (4/1/13)
UK households reduce exposure to debt Guardian, Hilary Osborne (4/1/13)
The debt collector’s hammering at the front door. Will this be a wakeup call to Westminster? New Statesman, Rowenna Davis (7/1/13)
Mortgages soar thanks to Bank’s Funding for Lending Independent, Russell Lynch (3/1/13)
Consumer spending surveys give mixed messages BBC News (7/1/13)
House owners raise stakes in homes, Bank of England says BBC News (31/12/12)

Questions

  1. Are the components of the balance sheet stocks or flows. Explain your answer. What about disposable income?
  2. List those factors that might affect the value of each component of the household balance sheet.
  3. Again considering the balance sheet, try drawing up a list of ways in which the components of the balance sheet could affect spending.
  4. What do you think has been the motivating factor behind the declining stock of unsecured financial liabilities? What impact is this likely to have on consumer spending?
  5. If the real value of disposable income increases in 2013 shouldn’t this be enough to see real value of consumption increase?
  6. How would the balance sheet of a household that rents differ from a household that is an owner-occupier?
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The 2 Ds of British recessions

We know two things about economic growth in a developed economy like the UK: it is positive over the longer term, but highly volatile in the short term. We can refer to these two facts as the twin characteristics of growth. The volatility of growth sees occasional recessions, i.e. two or more consecutive quarters of declining output. Since 1973, the UK has experienced six recessions.

Here we consider in a little more detail the growth numbers for the UK from the latest Quarterly National Accounts, focusing on the depth and duration of these six recessions. How do they compare?

The latest figures on British economic growth show that the UK economy grew by 0.9 per cent in the third quarter of 2012. However, when compared with the third quarter of 2011, output was essentially unchanged. This means that the annual rate of growth was zero. Perhaps even more telling is that output (real GDP) in Q3 2012 was still 3.0 per cent below its Q1 2008 level.

The chart helps to put the recent output numbers into an historical context. It shows both the quarter-to-quarter changes in real GDP (right-hand axis) and the level of output as measured by GDP at constant 2009 prices (left-hand axis). It captures nicely the twin characteristics of growth. Since 1970, the average rate of growth each quarter has been 0.6 per cent. This is equivalent to an average rate of growth of 2.35 per cent per year. The chart also allows us to pin-point periods of recessions.

One way of comparing recessions is to compare their ‘2 Ds’: depth and duration. The table shows the number of quarters each of the six recessions since 1973 lasted. It also shows how much smaller the economy was by the end of each recession. In other words, it shows the depth of each recession as measured by the percentage reduction in output (real GDP).

British recessions

Duration (quarters) Depth (output lost, %)
1973Q3–74Q1 3 3.25
1975Q2–75Q3 2 1.76
1980Q1–81Q1 5 4.63
1990Q3–91Q3 5 2.93
2008Q2–09Q2 5 6.28
2011Q4–12Q2 3 0.90

We can see that three of the recessions lasted for five quarters. In the case of the recessions starting in 1975 and 2011 they occurred very shortly after a previous recession. Hence, we observe two so-called double-dip recessions.

The table reveals that the deepest recession by some distance was that in the late 2000s. As a result of this recession, UK output declined by 6.3 per cent. As the recent GDP numbers show, the UK has yet to recover the ‘lost output’ that followed the financial crisis.

Data

Quarterly National Accounts Time Series Dataset Q3 2012 Office for National Statistics
Statistical Bulletin: Quarterly National Accounts Q3 2012 Office for National Statistics

Articles

UK economic growth less than expected Sky News UK(21/12/12)
GDP growth revised down to 0.9% Financial Times, Claire Jones (21/12/12)
Uk borrowing higher than expected as GDP revised down BBC News (21/12/12)

Questions

  1. What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
  2. Looking at the chart above, summarise the key patterns in real GDP since the 1970s.
  3. What is a recession? What is a double-dip recession?
  4. Looking at the table, rank the recessions from 1973 by the amount of lost output.
  5. Can a recession occur if nominal GDP is actually rising? Explain your answer.
  6. What factors might result in economic growth being so variable?