The latest data in the Quarterly National Accounts show that UK households in 2015 spent £1.152 trillion, the equivalent of 62 per cent of the country’s Gross Domestic Product (GDP). In real terms, household spending rose by 2.8 per cent in 2015 in excess of the 2.3 per cent growth observed in GDP. In the final quarter of 2015 real household spending rose by 0.6 per – the same rate of growth as that recorded for the UK economy. This was the tenth consecutive quarter of positive consumption growth and the twelfth of economic growth.
It is the consistent growth seen over the recent past in real household spending that marks it out from the other components of aggregate demand. Consequently, household spending remains the bedrock of UK growth.
Chart 1 helps to evidence the close relationship between consumption and economic growth. It picks out nicely the stark turnaround both in economic growth and consumer spending following the financial crisis. Over the period from 2008 Q1 to 2011 Q2, real consumer spending typically fell by 0.4 per cent each quarter. This weakness in consumption was mirrored by economic growth. Real GDP contracted over this period by an average of 0.2 per cent each quarter. (Click here to download a PowerPoint of the chart.)
Since 2011 Q3 real consumption growth has averaged 0.6 per cent per quarter – the rate at which consumption grew in 2015 Q4 – while, real GDP growth has averaged 0.5 per cent per quarter. Over this same period the real disposable income (post-tax income) of the combined household and NPISH (non-profit institutions serving households), has typically grown by 0.4 per cent per quarter. (NPISHs are charities and voluntary organisations.)
The strength of consumption relative to income is evidenced by the decline in the saving ratio as can be observed in Chart 2. The ratio captures the percentage of disposable income that households (and NPISHs) choose to save. In 2010 Q3 the proportion of income saved hit 11.9 per cent having been as low as 4.5 per cent in 2008 Q1. By 2015 Q4 the saving ratio had fallen to 3.8 per cent, the lowest value since the series began in 1963 Q1. (Click here to download a PowerPoint.)
The historic low in the saving ratio in the final quarter of 2015 reflects the strength of consumption alongside a sharp fall in real disposable income of 0.6 per cent in the quarter. However, the bigger picture shows a marked downward trend in the saving ratio over the period from 2012.
When seen in a more historic context the latest numbers taken on even greater significance. Chart 3 shows the annual saving ratio since 1963. From it we can see that the 2015 value of 4.2 was the first year when the ratio fell below 5 per cent. With 2014 being the previous historic low, there must be some concern that UK consumption growth is not being underpinned by income growth. (Click here to download a PowerPoint.)
Of course, consumption theory places great emphasis on expected future income in determining current spending. To some extent it may be argued that households were liquidity-constrained following the financial crisis. They were unable to borrow to support spending and, as time moved on, to borrow against the expectation of stronger income growth in the future. This would have depressed consumption growth. But, there may also have been a self-imposed liquidity constraint as the financial crisis unfolded. Heightened uncertainty may have led households to be more prudent and divert resources to saving. Such precautionary saving would tend to boost the saving ratio and so may be a factor in the sharp rise we observed in the ratio.
The easing of credit constraints as we headed through the early 2010s allied with stronger economic growth may help to explain the strength of the recovery in consumption growth. However, it is the extent and, in particular, the duration of this strong consumption growth that is fuelling a debate over its sustainability. The current uncertainty around future income growth and the need for households to be mindful of the indebtedness built up prior to the financial crisis point to households needing to retain a degree of caution. Consequently, the debates around the financial well-being of households and the need to rebalance the UK economy away from consumer spending are likely to be further intensified by the latest consumption and saving data.
All data related to Quarterly National Accounts: Quarter 4 (Oct to Dec) 2015 Office for National Statistics
Office for National Statistics Office for National Statistics
Britons raid savings to fund spending as economists warn recovery ‘built on sand’ Telegraph, Szu Ping Chan (31/3/16)
UK Growth Higher But Deficit Hits New Record Sky News, (31/3/16)
Britain is a nation that has forgotten how to save Telegraph, Jeremy Warner (31/3/16)
A vulnerable economy: the true cost of Britain’s current account deficit Guardian, Larry Elliott (31/3/16)
U.K. Manufacturing ‘In the Doldrums’ Leaves Growth Lopsided Bloomberg, Emma Charlton (1/4/16)
Pound drops as UK manufacturing languishes in the doldrums Telegraph, Szu Ping Chan (1/4/16)
- Why is the distinction between nominal and real growth an important one when looking at many macroeconomic variables.
- Examine the argument that the historic low saving ratio in the UK is a cause for concern.
- What factors might we expect to impact on the saving ratio?
- To what extent do you think the current growth in consumer spending is sustainable?
- How important are expectations in determining consumer behaviour?
- Explain what you understand by consumption smoothing.
- Why would we would typically expect consumption growth to be less variable than that in disposable income?
- Why might consumption sometimes be observed to be less sensitive or more sensitive to income changes?
- What factors might cause households to be liquidity constrained?
- What is precautionary saving? What might affect its perceived importance among households?
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.
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)
- 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?
There’s some good news and some bad news about the UK economy. The good news is that there are signs that the recovery is gathering momentum; the ‘green shoots’ are growing bigger. The bad news is that it’s the ‘wrong type of growth’!
One of the main underlying problems of the 2008 financial crisis was that household debt had been increasing to unsustainable levels, egged on by banks only too willing to lend, whether as personal loans, on credit cards or through mortgages. When the recession hit, many people sought to reduce their debts by cutting back on spending. This further fuelled the recession.
What the government and most economists hoped was that there would be some rebalancing of the economy, with less reliance on consumer spending to drive economic growth. Instead it was hoped that growth would be driven by a rise in investment and exports. Indeed, the 25% depreciation of sterling exchange between 2007 and 2009 was seen as a major advantage as this would boost the demand for exports and encourage firms to invest in the export sector.
But things haven’t turned out the way people hoped. The recession (or lack of growth) has been much deeper and more prolonged than previous downturns in the economy. Today, real GDP per head is more than 7% below the level in 2007 and many people have seen much bigger declines in their living standards.
But also, despite the austerity policies, the economy has not been ‘rebalanced’ towards exports and investment. Exports are 3% lower than in 2006 (although they did grow between 2009 Q2 and 2011 Q1, but have since stagnated). And investment is 27% lower than in 2006. Household consumption, however, has grown by about 2% and general government consumption by around 9% since 2006. The chart shows the figures, based on 2006 Q1 = 100.
(Click here for a PowerPoint of the chart.)
And recent evidence is that consumption is beginning to grow faster – not because of rising household incomes, but because of falling saving rates. In 2008, the household saving ratio had fallen to nearly 0% (i.e. households were on average saving about the same as they were borrowing). Then the saving ratio rose dramatically as people reined in their spending. Between 2009 and 2012, the ratio hovered around 7%. But in the first quarter of 2013, it had fallen to 4.2%
So the good news is that aggregate demand is rising, boosting economic growth. But the bad news is that, at least for the time being, this growth is being driven by a rise in household borrowing and a fall in household saving. The videos and articles consider whether this is, however, still good news on balance.
Britain’s imbalanced economy The Economist, Zanny Minton Beddoes and Richard Davies (4/7/13)
Britain’s Export Drought: an enduring disappointment The Economist, Andrew Palmer and Richard Davies (9/2/13)
‘Green shoots’ of economic recovery in Rugby BBC News, Paul Mason (12/6/13)
Is the UK economy seeing the ‘wrong kind’ of green shoots? BBC News, Stephanie Flanders (3/7/13)
The export drought: Better out than in The Economist (9/2/13)
Exports and the economy: Made in Britain The Economist (21/1/12)
The economy: On a wing and a credit card The Economist (6/7/13)
Unbalanced and unsustainable – this is the wrong kind of growth The Telegraph, Jeremy Warner (8/7/13)
The UK economy’s looking up – but no one’s told manufacturers The Guardian, Heather Stewart (10/7/13)
Quarterly National Accounts, Q1 2013 (27/6/13)
Forecasts for the UK economy: a comparison of independent forecasts HM Treasury (June 2013)
ISM Manufacturing Report on Business® PMI History Institute for Supply Management
- What are forecasters expecting to happen to economic growth in the coming months? Why?
- What factors determine investment? Why has it fallen so substantially in the UK?
- Explain what is meant by the ‘accelerator’. Is the rise in consumption likely to lead to an accelerator effect and, if so, what will determine the size of this effect?
- Why have exports not grown more rapidly despite the depreciation of sterling after 2007?
- What will determine the rate of potential economic growth in the UK economy? How will a rise in real GDP driven by a rise in consumption impact on potential GDP and potential economic growth?
- What supply-side policies would you recommend, and why, in order to increase potential economic growth?
Interest rates have, for some years, been the main tool of monetary policy and of steering the macroeconomy. Across the world interest rates were lowered, in many cases to record lows, as a means of stimulating economic growth. Interest rates in the UK have been at 0.5% since March 2009 and on 2nd May 2013, the ECB matched this low rate, having cut its main interest rate from 0.75%. (Click here for a PowerPoint of the chart.)
Low interest rates reduce the cost of borrowing for both firms and consumers and this in turn encourages investment and can boost consumer expenditure. After all, when you borrow money, you do it to spend! Lower interest rates will also reduce the return on savings, again encouraging spending and for those on variable rate mortgages, mortgage payments will fall, increasing disposable income. However, these above effects are dependent on the banks passing the ECB’s main interest rate on its customers and this is by no means guaranteed.
Following the cut in interest rates, the euro exchange rate fell almost 2 cents against the dollar.
Interest rates in the eurozone have been at 0.75%, but a 0.25 point cut was widely expected, with the ongoing debt crisis in the Eurozone continuing to adversely affect growth and confidence. A lack of trust between banks has also contributed to a lack of lending, especially to small and medium sized enterprises. The ECB has injected money into financial institutions with the aim of stimulating lending, but in many cases, banks have simply placed this extra money back with the ECB, rather than lending it to other banks or customers. The fear is that those they lend to will be unable to repay the money. In response to this, there have been suggestions of interest rates becoming negative – that is, if banks want to hold their money with the ECB they will be charged to do it. Again, the idea is to encourage banks to lend their money instead.
Small and medium sized businesses have been described as the engine of growth, but it is these businesses who have been the least able to obtain finance. Without it, they have been unable to grow and this has held back the economic recovery. Indeed, GDP in the Eurozone has now fallen for five consecutive quarters, thus prompting the latest interest rate cut. A key question, however, will be how effective this quarter of a percent cut will be. If banks were unwilling to lend and firms unwilling to invest at 0.75%, will they be more inclined at 0.5%? The change is small and many suggest that it is not enough to make much of a difference. David Brown of New View Economics said:
The ECB rate cut is no surprise as it was well flagged by Draghi at last month’s meeting. Is it enough? No. The marginal effect of the cut is very limited, but at least it should have some symbolic rallying effect on economic confidence.
This was supported by Howard Archer at HIS Global Insight, who added:
Admittedly, it is unlikely that the trimming of interest rates from 0.75% to 0.5% will have a major growth impact, especially given fragmented credit markets, but any potential help to the eurozone economy in its current state is worthwhile.
Inflation in the eurozone is only at 1.2%, which is significantly below the ceiling of 2%, so this did give the ECB scope for the rate to be cut. (Click here for a PowerPoint of the chart.) After all, when interest rates fall, the idea is to boost aggregate demand, but with this, inflation can emerge. Mr Draghi said ‘we will monitor very closely all incoming information, and assess any impact on the outlook for price stability’. The primary objective of the ECB is the control of inflation and so had inflation been somewhat higher, we may have seen a different decision by the ECB. However, even then, 5 consecutive quarters of negative growth is hard to ignore.
So, if these lower interest rates have little effect on stimulating an economic recovery, what about a movement away from austerity? Many have been calling for stimulus in the economy, arguing that the continuing austerity measures are stifling growth. The European Council President urged governments to promote growth and job creation. Referring to this, he said:
Taking these measures is more urgent than anything … After three years of firefights, patience with austerity is wearing understandably thin.
However, Mr. Draghi urged for policymakers to stick with austerity and continue to focus on bringing debt levels down, while finding other ways to stimulate growth, including structural reform. The impact of this latest rate cut will certainly take time to filter through the economy and will very much depend on whether the 0.5% interest rate is passed on to customers, especially small businesses. Confidence and trust within the financial sector is therefore key and it might be that until this emerges, the eurozone itself is unlikely to emerge from its recession.
ECB ready to enter unchartered waters as bank cuts interest rate to fresh low of 0.5pc The Telegraph, Szu Ping Chan (2/5/13)
Draghi urges Eurozone governments to stay the course on austerity Financial Times, Michael Steen (2/5/13)
Eurozone interest rates cut to a record low of 0.5% The Guardian, Heather Stewart (2/5/13)
ECB’s Draghi ‘ready to act if needed’ BBC News (2/5/13)
Eurozone interest rates cut again as ECB matches Bank of England Independent, Russell Lynch (3/5/13)
Margio Draghi urges no let-up in austerity reforms after Eurozone rate cut – as it happened The Guardian, Graeme Wearden (2/5/13)
ECB cuts interest rate to record-low 0.5% in desperate measure to drag Eurozone out of recession Mail Online, Simon Tomlinson and Hugo Duncan (2/5/13)
ECB cuts interest rates, open to further action Reuters, Michael Shields (2/5/13)
Eurozone loosens up austerity, slowly Wall Street Journal (2/5/13)
ECB cuts interest rate, not enough to pull the region out of recession The Economic Times of India (2/5/13)
Euro steady ahead of ECB interest rate announcement Wall Street Journal, Clare Connaghan (2/5/13)
European Central Bank (ECB) cuts interest rates BBC News (2/5/13)
All eyes on ECB as markets expect rate cut Financial Times, Michael Steen (2/5/13)
- How is a recession defined?
- Using an aggregate demand/aggregate supply diagram, illustrate and explain the impact that this cut in interest rates should have.
- On which factors will the effectiveness of the cut in interest rates depend?
- Using the interest rate and exchange rate transmission mechanisms to help you, show the impact of interest rates on the various components of aggregate demand and thus on national output.
- What would be the potential impact of a negative interest rate?
- Why did the low inflation rate give the ECB scope to cut interest rates?
- What are the arguments for and against austerity measures in the Eurozone, given the 5 consecutive quarters of negative growth?
The latest growth data for the UK is somewhat difficult to interpret. It’s positive, but not that positive. The Conservatives say it shows that the economy is moving in the right direction. Labour suggests it is evidence that the Coalition’s policies are not working. With a return to positive growth, the UK has avoided the triple dip recession and here we take a closer look at the economic performance of other key nations.
In the final quarter of 2012, the US economy grew at 0.4%, but in the 3 months to March 2013, economic growth in America picked up to 2.5%. Consumer spending significantly increased, growing at an annualized rate of 3.2%, according to the Commerce Department. This figure helped boost the growth rate of the US economy, as consumer spending accounts for around two thirds of economic activity.
However, the growth figure was lower than expected, in part due to lower government spending. Furthermore, there are suggestions that the positive consumer spending figures are merely a positive blip and spending will fall as the US economy moves through 2013.
If this does prove to be the case in the USA, it will do little to further boost UK economic growth, which was recorded at 0.3% for the first 3 months of 2013. The Chancellor has said that the growth figures are encouraging and are evidence that the government’s policies are working.
Today’s figures are an encouraging sign the economy is healing … Despite a tough economic backdrop, we are making progress. We all know there are no easy answers to problems built up over many years, and I can’t promise the road ahead will always be smooth, but by continuing to confront our problems head on, Britain is recovering and we are building an economy fit for the future.
While the USA and UK have recorded positive growth, expectations of growth throughout Europe remain uncertain. Spain has revised its forecasts downwards for 2013, expecting the economy to shrink by over 1%. Even after 2013, growth is expected to remain very weak, forecast to be 0.5% in 2014 and 0.9% in 2015. To make matters worse, Spain’s unemployment continues to move in the wrong direction, with data for the first 3 months of 2013, recording an unemployment rate of 27.2% – the highest on record.
However, it’s not just Spanish unemployment that is on the rise. Figures for March show that in France, 3.2 million people were out of work, a 1.2 % rise compared to February. In the UK, 2.56 million people were recorded as unemployed, representing just under 8% of the working population. The German economy continues to outperform its European partners, but eurozone growth continues to look weak for the rest of 2013.
Despite much bad news in Europe, growth in other parts of the world remains buoyant. South Korea has recorded economic growth that is at its highest level in 2 years. Economic growth was just under 1%, but construction and investment both increased, perhaps a sign of an economy starting its recovery.
The Chinese economy has seemed relatively unaffected by the economic downturn, yet its economic growth has slowed. Averaging over 10% per annum for the last decade, the growth for January – March 2013 was only 7.7%. This is a decline on the previous 3 months and is lower than expected. If the Chinese economy does begin to slow (relatively speaking), this could present the global economic recovery with an unwelcome obstacle.
Many Western economies are reliant on exports to boost their growth figures and with such high demand in China, this is a key export market for many countries. If the Chinese economy continues to slow, consumer spending may even fall and this could mean a reduction in Chinese imports: that is, a reduction in other countries’ exports to China. However, for China’s competitors, the news is better, as with China’s move from a low to middle-income country, other countries will now see an opportunity to grasp a competitive advantage in the production of cheaper products. David Rees from Capital Economics said:
Trade data show that Chinese imports of commodities, and industrial metals in particular, have been falling in recent months … That is bad news for those emerging markets in Latin America, the Middle East, and Africa that predominately export commodities to China. It is not all bad news … To the extent that China’s structural slowdown reflects its transition from low to middle-income status, opportunities will present themselves for other EMs as China moves up the value chain. We are particularly upbeat on the manufacturing-based economies of South East Asia, along with Mexico, Poland, and Turkey.
News is better in Japan, where growth forecasts have been raised to 2.9% over the same period and the economy is expected to grow by 1.5% throughout both 2013 and 2014. Furthermore, suggestions that inflation may also reach 0.7% have boosted confidence. This might be the end of Japan’s troubles with deflation.
So, we have something of a mixed picture across the world, although the IMF predicts a global rate of growth of 3.5% for 2013, which would be an improvement on 2012 figures. The following articles consider the global situation.
Spain slashes economic growth forecast Sky News (26/4/13)
UK avoids triple-dip recession with better than expected 0.3% GDP growth The Guardian, Heather Stewart (26/4/13)
US economy grows 2.5% on buoyant consumer spending BBC News (26/4/13)
Poor French and Spanish jobs data but UK economy returns to growth – as it happened The Guardian, Graeme Wearden and Nick Fletcher (25/4/13)
UK economy avoids tiple-dip recession with 0.3pc GDP growth The Telegraph, Szu Ping Chan (25/4/13)
South Korea economic growth hits two year high BBC News (25/4/13)
S. Korea economy grows at the fastest pace in two years Bloomberg, Eunkyung Seo (25/4/13)
Spain revises down its economic forecast BBC News (26/4/13)
US economy sees broad growth Financial Times, Robin Harding (25/4/13)
Germany’s private sector shrinks as Eurozone decline continues – as it happened The Guardian, Graeme Wearden and Nick Fletcher (23/4/13)
China economic growth lower than forecast BBC News (15/4/13)
China’s slowing economy: what you need to know Bloomberg Business Week, Dexter Roberts (25/4/13)
Modest Growth Pickup in 2013, Projects IMF International Monetary Fund (23/1/13)
- How is economic growth measured?
- What is meant by a triple-dip recession?
- What has caused the small increase in growth in the UK? Do you think this signifies the start of the economic recovery?
- In the USA, what has caused the growth rate to reach 2.5% and why is it lower than expected?
- Why are growth rates in countries across the world relevant for UK forecasts of economic growth?
- Which factors have allowed the Chinese economy to achieve average growth rates above 10% for the past decade?
- Using an AD/AS diagram, illustrate the desired impact of the Coalition’s policies to boost economic growth.
- With unemployment rising in countries like Spain and France, how might Eurozone growth be affected in the coming months?
- Japanese growth is looking positive and inflation is expected to reach about 0.7%. Why is it that Japan has suffered from deflation for so many years and why is this a problem?