The consumer prices index (CPI) is used by the government and the Bank of England for measuring the rate of inflation, and in the 12 months to March 2010 it rose by 3.4%. This figure was above the expected rate of 3.1% and well above the Bank of England’s target of 2%. The other major measure of consumer prices, the retail prices index (RPI) rose by even more – by 4.4%.
In order to recover from the recession, the UK economy needs to grow, but as demand begins to rise, this could put further upward pressure on inflation. There are a number of influencing factors that have caused the recent rise in inflation (see Too much of a push from costs but no pull from demand). Large rises in housing, fuel, transport, many household services and food were contributing factors. Many of these factors, however, are thought to be temporary, so it may not be too much of a problem.
And anyway, at least if inflation does continue to rise, it won’t be unexpected!
Articles
UK inflation rate rises to 3.4% BBC News (21/4/10)
A surprise? Definitely. A problem? Possibly. BBC News blogs, Stephanomics, Stephanie Flanders (20/4/10)
Transport costs push UK inflation above 3pc Telegraph, Edmund Conway (21/4/10)
Data
Latest Inflation data National Statistics Online
Consumer Price Indices portal National Statistics Online
Consumer Price Indices, Statistical Bulletin Office for National Statistics
Consumer Price Indices, time series data National Statistics Online
Retail Prices Index: 1948–2010 National Statistics Online
Questions
- Why might the Monetary Policy Committee have to restrict growth to keep inflation manageable?
- What are some of the causes of rising inflation? Why are expectations so important?
- How is the CPI calculated to measure inflation?
- Normally, during a recession, we would expect economic growth to be poor, but inflation to be low and stable. How can we explain both poor growth and rising inflation?
- “Investors know that the UK government has more to gain from an unexpected bout of inflation than almost any other economy.” Why is this?
’The steepest and longest recession of any developed country since World War II.’ This has been the case for Ireland, which has seen national income fall by 20% since 2007. Many countries across the globe have experienced pretty bad recessions, but what makes Ireland stand out is how it has been dealt with.
In the UK, the government has continued spending in a bid to stimulate the economy and to use Gordon Brown’s phrase from 2008, we have aimed to ‘spend our way out of recession’. Ireland, however, did not have that option. With too much borrowing, Ireland was unable to stimulate the economy and needed to cut its debts in order to maintain its credibility in the eurozone. Last year, significant cuts in government spending were accompanied by tax rises equal to 5% of GDP. Similar action is to be expected in the UK following the election, where popular benefits may have to be reduced, as transfer payments do account for the majority of government spending. Whoever is in government following the election will have some hard decisions to make and everyone will be affected. Read the article below and listen to the interview and think about what the UK can learn from Ireland.
Irish lessons for the UK (including interview) BBC Stephanomics (9/4/10)
Questions
- In the interview, Brian Lenihan said that the UK was expecting too much from the falling value of sterling. What was the UK expecting following significant depreciations in the value of sterling and why has that not happened?
- What is a deflationary spiral? Why has it caused Ireland’s public debt to rise so much?
- Why does Brian Lenihan argue that there are limits to how much taxes can be increased? What are diminishing returns to taxation?
- Would the UK be any better off had we joined the euro? What about other countries: would they have benefited had we joined the euro?
The OECD published its latest interim assessment of the world economy on April 7. This showed a world gradually bouncing back from recession, with growing GDP (albeit at variable speeds in different countries), rising industrial production, increasing business confidence, a stabilising of financial markets, an easing of credit conditions and yet continuing low inflation.
The UK is forecast to have an annualised rate of growth of GDP in quarter 2 of 3.1%. This is the second highest of the G7 countries, behind only Canada. This would seem like good news – an economic spring for the UK.
Despite continuing growth in the OECD countries, in most of them recovery is fragile. The OECD thus recommends caution in removing the stimulus measures adopted in most countries and hence caution in embarking on measures to cut public-sector deficits. As the report states:
Despite some encouraging signs on activity, the fragility of the recovery, a frail labour market and possible headwinds coming from financial markets underscore the need for caution in the removal of policy support. Central banks have already begun to rein in the exceptional liquidity stimulus injected during the recession. Further action in this area will need to be guided by financial conditions. The normalisation of policy interest rates should be carried out at a pace that will be contingent on the strength of the recovery in individual countries and the outlook for inflation beyond the near-term projection horizon. As for fiscal policy, the sharp increase in government indebtedness in the OECD area during the downturn calls for ambitious, clearly communicated medium-term consolidation programmes in many countries. Consolidation should start in 2011, or earlier where needed, and progress gradually so as not to undermine the incipient recovery.
The following webcast from the OECD presents the report.
Webcast
Interim Assessment OECD, Pier Carlo Padoan, OECD Chief Economist (7/4/10)
Report
Portal to report and webcast OECD
What is the economic outlook for OECD countries? An interim assessment OECD, Pier Carlo Padoan (7/4/10)
Articles
Economy set to speed up and beat UK’s rivals, says OECD Independent, Sean O’Grady (8/4/10)
Economy poised for rapid expansion Financial Times, Norma Cohen and Daniel Pimlot (8/4/10)
OECD sees slower growth in US, Europe, Japan Sydney Morning Herald (8/4/10)
UK business confidence ‘hits four-year high’ BBC News (12/4/10)
British companies confident of recovery but need investment, BDO warns Telegraph, Angela Monaghan (12/4/10)
Questions
- What are the main findings in the report?
- What are the policy implications of the findings?
- What are the implications of developments in financial markets? What are the possible ‘headwinds’?
- What factors could threaten the recovery of the UK economy?
Housing Equity Withdrawal, or HEW for short, is new borrowing that is secured against property which is not reinvested in the housing market. In other words, it is borrowed money that is not used by households to purchase property or to undertake major refurbishments, such as extensions to existing residential properties. The latest HEW statistical release from the Bank of England shows that HEW in Q4 2009 was again negative, making it the seventh consecutive quarter of negative HEW. But, what does a negative HEW figure mean?
Negative HEW occurs when the total saving by households in housing (either by paying back mortgages or by purchasing property directly without borrowing) is greater than new borrowing secured against housing. It results in an increase in housing equity held by the household sector. In the fourth quarter of 2009, the Bank’s seasonally-adjusted figures show that negative HEW was just over £4.3 billion, equivalent to 1.6% of disposable income.
But why might the household sector have wanted to save through housing and how might this impact on consumer spending? In truth there is no single reason, but one potentially important reason is likely to be the sector’s desire to rebuild its balance sheets. In times of uncertainty, such as those that we face now, a perfectly understandable response by households is to try to reduce their exposure to debt. During the seven quarters in which HEW has been negative, households have used housing as a vehicle for saving to the tune of £36.5 billion, equivalent to 2.2% of the sector’s disposable income. To some extent the fact that, as a result of the banking crisis, house-buyers have had to put down larger deposits when purchasing housing helps to reduce their exposure to debt. But, the extent of the negativity of HEW means that households more generally have been actively looking to repay some of their outstanding mortgage debt.
So what of the impact of HEW on consumer spending? Negative sums of HEW mean that consumers are either reducing consumer spending, reducing holdings of financial assets, increasing levels of unsecured debt (e.g. personal loans or credit card debt) or, of course, undertaking some combination of these. Given that the stock of unsecured debt has actually declined by £7.9 billion to £224.8 billion in the 12 months to February, the impact would seem to be falling on consumer spending.
Some commentators are pointing to the weakening pace with which households are saving through housing. The current level of saving through housing is, as we said earlier, equivalent to 1.6% of disposable income, down from the 3.0% recorded in both Q4 2008 and Q1 2009. But, this would seem to simply highlight the extent of the precautionary behaviour by households in the midst of the economic downturn. It would be a surprise to see any significant end soon to the UK household sector’s precautionary behaviour.
Articles
Britons plough cash into repaying debt The Times, James Charles (6/4/10)
The great mortgage payback Reuters, Harry Wallop (6/4/10)
Home owners’ housing equity still increasing BBC News (6/4/10) )
Brits pay off £4bn of mortgage debt Press Association (6/4/10)
UK Q4 housing injection smallest since Q2 2008 – BOE MarketNews.com (6/4/10)
Data
Housing equity withdrawal (HEW) statistical releases Bank of England
Questions
- Explain what are meant by positive and negative values of HEW.
- What implications might additions to housing equity have for consumer spending?
- What factors do you think lie behind the seven consecutive quarters of negative HEW?
- If house price inflation were to start picking up in the near future, would you expect to see positive values of HEW and, if so, how strongly positive?
- Other than through HEW, how might the housing and mortgage markets impact on consumer spending?
Public finances aren’t in a great state – that’s no secret. However, what is remaining a secret is exactly how and when the main political parties intend to reduce the budget deficit. The UK’s credit-rating is under pressure and with the election approaching, we can expect government finances to come under increasing scrutiny. Whichever party forms the government will face the unenviable task of having to pull Britain out of a recession, while trying to reduce: 1) a forecast budget deficit for 2009/10 of £167 billion (about 13% of GDP), 2) a government debt of 68.6% of GDP, with 3) £73.8 billion alone going on interest payments and 4) a trade deficit of £8 billion. Who would be a politician?!
Phoney deficit wars BBC News, Stephanomics (26/3/10)
Questions
- What is the structural deficit?
- A fall in government spending may improve public finances, but why may it adversely affect the UK’s recovery?
- Outline the main proposals by the Labour, Conservative and Liberal Democrat Parties to tackle public finances. Are any of their proposals viable?
- Why is the UK’s credit-rating under pressure? If the UK is down-graded, what could this mean?