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.
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.
Are the components of the balance sheet stocks or flows. Explain your answer. What about disposable income?
List those factors that might affect the value of each component of the household balance sheet.
Again considering the balance sheet, try drawing up a list of ways in which the components of the balance sheet could affect spending.
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?
If the real value of disposable income increases in 2013 shouldn’t this be enough to see real value of consumption increase?
How would the balance sheet of a household that rents differ from a household that is an owner-occupier?
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.
While the Western world has struggled with economic growth for the past 6 years, emerging economies such as China, Brazil and India have recorded some very high rates of growth. Throughout 2012, there were signs that these economies were not going to be the saviour of the global economy that we all thought. But, as we enter 2013, is it these economies that still hold the hope of the West for more positive figures and better economic times?
The article below from BBC News, in particular, considers the year ahead for the Asian economies and what it might mean for the Western world. Although these countries are by no means safeguarded against the impending approach of the US economy to their fiscal cliff or the ongoing eurozone crisis, they have seemed to be more insulated than the rest of the world. A crucial question to consider is whether this will continue. Furthermore, are the growth levels and policies of a country such as China sustainable? Can it continue to record such high growth rates in the face of the global economic situation?
The Japanese economy has been in serious trouble for a couple of decades, but measures to boost growth for this economy are expected. If these do occur, then western economies may feel some of their positive effects. At present, there is a degree of optimism as we enter the New Year, but how long this will last is anybody’s guess. The following articles consider the year ahead.
Why have the Asian economies been more insulated to the global economic conditions over the past few years, in comparison with the Western world?
What challenges will the global economy be facing over the coming year?
What challenges are the Asian economies facing? How different are they from the challenges you identified in question 3?
Why is the rate of exchange an important factor for an economy such as Japan?
What does a low exchange rate for the yen mean for European countries? Is it likely to be seen as a good or bad thing? What about for South Korea? Use a diagram to help you answer this question.
Why is the economic situation in countries such as China and India so important for the rest of the global economy? Use a diagram to illustrate this.
The Autumn Statement, delivered annually by the Chancellor of the Exchequer in late November or early December, is rather like a second Budget. In his statement, the Chancellor presents new forecasts for the UK economy by the Office for Budget Responsibility (OBR) and announces various policy changes in the light of the forecasts.
So what does this OBR say? Its headline reads, “Government borrowing revised higher as weaker economy hits revenues” and this is followed by the statement:
The OBR has revised up its forecasts for public-sector borrowing over the next five years, as a weaker outlook for the economy reduces tax revenues. As a result, the Government no longer seems likely to achieve its target of reducing public-sector net debt in 2015–16.
The chart shows OBR forecasts for public-sector net borrowing made in June 2010 (its first forecast after the OBR was formed by the Coalition government), in March 2012 and in December 2012. The current forecast clearly shows borrowing set to decline more slowly than in the earlier forecasts. Click here for a PowerPoint of the chart. (Note that the effects of transferring the pension assets of the Royal Mail to the Treasury and the effects of not paying interest to the Bank of England on government bonds purchased under quantitative easing programmes have not been included in order to make the three forecasts consistent.)
So with a weaker economy and slower recovery than previously forecast, what are George Osborne’s options? He and his colleagues, along with various economists, argue for sticking to Plan A. This means continuing with austerity measures in order to get the public-sector deficit down. But with government borrowing having fallen more slowly than forecast, this means further government expenditure cuts, such as reductions in benefits, cuts in grants to local authorities and reductions in pensions relief. Even so, achieving his two targets – (1) eliminating the cyclically adjusted current (as opposed to capital) budget deficit by 2015/16 (the so-called ‘fiscal mandate’), and (2) public-sector debt falling as a proportion of GDP by 2015/16 – will both be missed. They were extended by a year in the Budget last March. They have now been extended by a further year to 2017/18.
The opposition and many other economists argue that Plan A has failed. Austerity has prevented the economy from growing and has thus meant a slower reduction in the deficit as tax revenues have not grown nearly as much as hoped for. A more expansionary policy would allow the deficit to be reduced more quickly, especially if extra government expenditure were focused on infrastructure and other capital spending.
It could be argued that George Osborne’s Autumn Statement moves some way in this direction – a Plan A+. He is making deeper cuts in welfare and government departmental spending in order to divert monies into capital spending. For example, there will be £1bn of extra expenditure on roads; £1bn extra on schools; £270m on FE colleges; and £600m extra for scientific research. Also, by extending the period of austerity to 2017/18, this has meant that he has not had to make even deeper cuts. What is more, he is increasing income tax allowances and cutting the rate of corporation tax by 1% more than originally planned and scrapping the planned 3p per litre rise in road fuel duty. He hopes to make up any lost tax revenue from these measures by HMRC clamping down on tax evasion.
But by sticking to his broad austerity strategy, and with many parts of the global economy having weakened, it looks as if the UK economy is in for several more years of sluggish growth. Winter is going to be long.
Distinguish between ‘stocks’ and ‘flows’. Define (a) public-sector net borrowing (PSNB) and (b) the public-sector net debt (PSND) and explain whether each one is a stock or a flow.
Summarise the measures announced by George Osborne in his Autumn Statement.
What are his arguments for not adopting a more expansionary fiscal policy?
Assess his arguments.
What is meant by the ‘output gap’? What are the OBR’s forecasts about the output gap and what are the implications?
How has quantitative easing affected PSNB and PSND?
Distinguish between the cyclical and structural deficit. What implications does this distinction have for fiscal policy?
In a previous blog, Anyone got a crystal ball?, we reported on the Bank of England’s and other agencies’ difficulty in making forecasts. As the Governor, Mervyn King, said, “There is just enormous uncertainty out there.”
The Bank of England has just published its November Inflation Report. This quarterly publication gives forecasts of inflation, GDP and other indicators. It is clear that forecasting hasn’t become any easier. In his opening remarks, Dr. King says:
Continuing the recent zig-zag pattern, output growth is likely to fall back sharply in Q4 as the boost from the Olympics in the summer is reversed – indeed output may shrink a little this quarter. It is difficult to discern the underlying picture. It is probably neither as good as the zigs suggest nor as bad as the zags imply.
The Inflation Report looks at the various factors affecting aggregate demand, inflation, unemployment and aggregate supply. It is quite clear on reading the report why there is so much uncertainty.
A salutary lesson is to look back at previous forecasts and see just how wrong they have been. The chart above shows the forecasts for GDP made in the Inflation Reports of Nov 2012 and Aug 2011. You can see that they are significantly different and yet just 15 months apart. You might also like to compare the forecasts made a year ago (or even two!) about 2012 with the actual situation today. A good source for this is the Treasury’s Forecasts for the UK economy. This collates the forecasts from a range of independent forecasters.
The inaccuracy of forecasting is an inevitable consequence of a highly interdependent world economy that is subject to a range of economic shocks and where confidence (or lack of it) is a major determinant of aggregate demand. But when firms, governments, individuals and central banks have to make plans, it is still necessary to project into the future and try to forecast as accurately as possible – even though it might mean keeping your fingers firmly crossed.
What was being forecast for economic growth and inflation for 2012 (a) one year ago; (b) two years ago?
What are the main reasons for the inaccuracy of forecasts?
How might forecasting be made more reliable?
If sentiment is a key determinant of economic activity, how might politicians increase the confidence of firms and consumers? What are the political constraints on doing this?
Explain the following statement from the Guardian article: “The problem … is that last decade’s tailwind has become this decade’s headwind.” Why is it difficult to forecast the strength of this ‘headwind’?
How useful is it to use past trends as a guide to the future course of the economy?
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.
