Disagreements are hardly an uncommon occurrence during Prime Minister’s Questions and today the key issue up for debate was UK unemployment. Figures released show that in the 3 months to November 2011, UK unemployment rose to 2.685 million – an increase of 118,000. The ONS said that unemployment now stands at 8.4% – the highest figure in well over a decade.
However, the increase in unemployment is not as high as it was in the 3 months previous to that, which is possibly an indication that the labour market is slowly beginning to recover and the government’s labour market policies are starting to take effect. The government claimed that cuts in the public sector will be compensated by growth in private sector jobs, but the evidence from the ONS did little to back this up.
The labour market is crucial for the recovery of the UK. Jobs mean income and income means consumer spending. If the job market remains uncertain and more people enter unemployment, consumer spending is likely to remain weak for some time. Chris Williamson, the chief economist at Markit:
The increase in unemployment, plus job security worries and low pay growth for those in work, means consumer spending may remain very subdued this year, despite lower inflation alleviating the squeeze on real incomes that caused so much distress to households in 2011.
One area of specific criticism leveled at the Coalition was the extent of youth unemployment, which reached 22.3%. Ed Miliband said the government had cut ‘too far and too fast’ and that it will be remembered for standing aside and doing nothing ‘as thousands of people find themselves unemployed’. The figures are clearly concerning, but the Coalition maintains that policies designed to tackle the labour market are beginning to take effect and over the coming months, the economy will begin to see a decline in the unemployment rate. The following articles look at the unemployment crisis.
What type of unemployment is being referred to in the above articles?
Explain the mechanism by which a recession will lead to higher unemployment.
Using a diagram to help your explanation, analyse the impact of a fall in aggregate demand on the equilibrium unemployment rate and wage rate. What happens to unemployment if wages are sticky downwards?
What can explain such different stories of unemployment between Scotland, England and Wales?
What policies have the Coalition implemented to tackle the rising problem of unemployment? On what factors will their effectiveness depend?
Why is the UK’s job market so important for the future economic recovery of the UK?
A key determinant of our economy’s rate of growth over the year ahead is likely to be the behaviour of households and, in particular, the rate of growth in consumer (or household) spending. In other words, your appetite for spending will help to determine how quickly the economy grows. The importance of household spending for the economy is straightforward to understand given that it accounts for roughly two-thirds of the total demand for firms’ goods and services, i.e. two-thirds of aggregate demand. In its November 2011 Economic and Fiscal Outlook the Office for Budget Responsibility presents it forecasts for economic growth and household spending. The following table summarises these forecasts.
The OBR are forecasting that household spending will fall in real terms in 2011 by 1.1 per cent and grow by only 0.2 per cent in 2012. This is not good news for retailers nor, of course, for the economy. The drag on consumer spending growth is largely attributed to expected falls in real disposable (after-tax) incomes in both 2011 and 2012. In 2011, the household sector’s real income is forecast to decline by 2.3 per cent and then by a further 0.3 per cent in 2012.
The OBR’s figures on spending growth critically depend on the ability of households to absorb the negative shock to their real income. Empirical evidence tends to show that household spending growth is less variable than that in income and that households try and smooth, if they can, their spending. This means that the marginal propensity of households to consume out of changes to their income is below 1 in the short-run. In fact, the shorter the period of time over which we analyse income and consumption changes the smaller the consumption responses become. This is consistent with the idea that households are consumption-smoothers disliking excessively volatile spending patterns. In other words, the size of our monthly shop will usually vary less than any changes in our real income.
Of course, consumption-smoothing cannot be taken for granted. Households need the means to be able to smooth their spending given volatile and, in the current context, declining real incomes. Some economic theorists point to the importance of the financial system in enabling households to smooth their spending. In effect, households move their resources across time so that their current spending is not constrained solely by the income available to them in the current time period. This could mean in the face of falling real income perhaps borrowing against future incomes (moving forward in time expected incomes) or drawing down past savings.
The ability of households to move future incomes forward to the present has probably been impaired by the financial crisis. Banks are inevitably less cautious in their lending and therefore households are unable to borrow as much and so consume large amounts of future income today. In other words, households are credit-constrained. Furthermore, it is likely that households are somewhat uneasy about borrowing in the current climate, certainly any substantial amounts. Uncertainty tends to increase the stock of net worth a household would like to hold. A household’s net worth is the value of its stock of physical assets (largely housing wealth) and financial assets (savings) less its financial liabilities (debt). If households feel the need for a larger buffer stock of wealth to act as a sort of security blanket, they will not rush to acquire more debt (even if they could) or to draw down their savings.
The impairment of the financial system and the need for a buffer stock are two impediments to households smoothing their spending. They tend to make consumption more sensitive to income changes and so with falling incomes make it more likely that consumption will fall too. There are other related concerns too about the ability and willingness of consumers to smooth spending. Uncertainty arising from the volatility of the financial markets imposes liquidity constraints because households become less sure about the value of those savings products linked to the performance of equity markets. Consequently, they become less certain about the money (liquidity) that could be raised by cashing-in such products and so are more cautious about spending. Similarly, the falls in house prices have reduced the ability of households to extract housing equity to support spending. Indeed, with fewer transactions in the housing market the household sector is extracting less housing equity because it has been quite common, at least in the past, for households to over-borrow when moving and use the excess money borrowed to fund spending.
In short, there are many reasons to be cautious about the prospects for household spending. The expected decline in real income again in 2012 will ‘hit’ consumer spending. The question is how big this ‘hit’ will be and crucially on the extent to which households will be able to absorb it and keep spending.
What do you understand by a consumption function? What variables would you include in such a function?
Using the figures in the table in the text above, calculate ‘rough’ estimates of the income elasticity of consumption for each year. Why are these estimates only ‘rough’ approximations of the income elasticity of consumer spending?
Draw up a list of factors that are likely to affect the strength of consumer spending in 2012. Explain how similar or different these factors are likely to have been to those that may affect spending during periods of strong economic growth.
Explain what you understand by the term consumption-smoothing. Explore how households can smooth their spending and the factors that are likely to both help and prevent them from doing so.
What do you understand by the net worth of housholds? Try drawing up a list of factors that could affect the net worth of households and then analyse how they might affect consumer spending.
With all the doom and gloom of recent economic data, including rising inflation and higher unemployment, there’s finally a small speck of light and that’s in the form UK retail sales. The latest data from the ONS suggests that sales in the UK in September were higher than previously forecast and reversed the 0.4% decline we saw in August. A big contributing factor to this positive data was a boost to online sales, but this small glimmer of hope is unlikely to be sufficient to keep the economy going – unless sales keep rising, we are unlikely to see any significant increase in economic growth.
The data, while positive, is still unlikely to have any impact on economic policy. The minutes from the Monetary Policy Committee showed that there was unanimous support for further quantitative easing, as the threat of weak growth and financial instability and uncertainty remains. An economist from Barclays Capital said:
‘We don’t think the recent strong growth in monthly sales is likely to be sustained…The environment for retailers is likely to remain challenging as consumer spending remains depressed driven by low confidence and slow earnings growth.’
The data from September is positive, but it does little to offset the decline in sales seen in August. It was revised down from 0.2% to 0.4% – some blame the hot weather, which discouraged consumers from hitting the high streets in preparation for the winter. The key data to look out for will be sales figures for the next few months. Only then will we have more of an indication about exactly which direction the economy is moving in. The following articles consider this latest economic data.
We have learnt a lot this week about the appetite of households for spending. And, it appears that they are not particularly hungry. On Monday, the Quarterly National Accounts for Q1 revealed that, in real terms, household sector spending fell by 0.1% in the quarter despite disposable income growing by 2.1%. Today, we have learnt that households have continued to increase the amount of equity in their homes. The Housing Equity Withdrawal (HEW) figures for Q1 show that households increased their stake in housing by some £3.2 billion.
Housing Equity Withdrawal occurs when lending secured on dwellings increases by more than the investment in the housing stock. Housing investment relates largely to the purchase of brand new homes and to major home improvements, but also includes housing moving costs such as legal fees. What the Bank of England does is to compare these levels of housing investment with the amount of additional secured lending. If the Bank of England finds that additional secured lending is equal to the amount of housing investment then HEW is zero. If it is positive, then additional secured lending is greater than the levels of housing investment. This would show that the household sector was extracting equity from the housing stock and using mortgage lending to fund consumption, to purchase financial assets or to pay off unsecured debts, like credit cards.
But, the point here is that HEW is actually negative and has been so since the second quarter of 2008. Negative HEW means that housing investment levels are greater than the levels of new secured borrowing. In other words, household are increasing their housing equity. But, there is a cost to this choice because by doing so households are using money that could otherwise be assigned for spending or purchasing financial assets. One way of measuring the potential extent of foregone consumption is to note that the Bank estimates that the level of equity injected into housing in Q1 was equivalent to 1.3% of disposable income. Since Q2 2008 households have injected equity into housing to the tune of £38.34 billion, which is equivalent to 1.97% of disposable income, some of which might have otherwise been used to fund spending.
The negativity of HEW is not that surprising. In difficult economic times many of us might be tempted, if we can, to reduce our exposure to debt. Low interest rates may also be inducing households to pay off debt either because the interest rates on saving products are low and unattractive or because the size of mortgage payments for those on now lower variable rate mortgages gives them income with which to pay debt off. The bottom line is that after many years happily spending, households appear to be dining off a different menu.