Throughout the credit crunch and since then, one of the major problems in the global economy has been a lack of lending by banks. A key cause of the credit crunch and many of the debt problems countries and people face today is because of people living off borrowed money. In the past, credit was so easy to obtain – people could receive a mortgage for more than 100% of the value of their property. However, when more and more people began to struggle to make their monthly mortgage repayments, the banking crisis began and since then mortgage lenders have become increasingly wary about who they lend to and how much.
The Bank of England has said that in the coming months it will become even harder to obtain mortgages, as banks become increasingly wary about who becomes their customer and potential home buyers put off even applying for a mortgage. Although mortgage approvals are at a 2-year high, they still remain significantly below their pre-crisis level. Indeed, the Bank of England said:
“Lenders expected the proportion of total loan applications being approved to fall over the coming quarter with some lenders commenting that they had revised down expectations for households’ disposable incomes and hence the affordability of taking out new secured loans.”
As part of this new rationing of mortgages, lenders are requiring applicants to put down larger and larger deposits and so for first time buyers, getting on to the property ladder is becoming more and more of a dream. The property market has been suffering from this mortgage rationing as house sales are down below their pre-crisis level. The housing market is crucial to any economy, as so many other sectors and hence jobs depend on it. If mortgages remain scarce and the required deposit so high, the UK housing market is likely to remain stagnant and this will certainly prove damaging for the prospects of the UK economy in 2012.
Articles
Mortgage approvals hit new two-year high The Telegraph, Angela Monaghan (4/1/12)
Mortgage approvals up but overall lending weak Reuters (4/11/12)
Mortgage rationing becomes worse, Bank of England says BBC News (5/1/12)
Mortgage demand fell in Q4 2011, say lenders Mortgage Strategy, Tessa Norman (5/11/12)
Mortgage lending still stagnant, Bank figures show BBC News (4/11/12)
BoE: Lending to be tighter in Q1 2012 Mortgage Introducer, Yuan Phoon (5/11/12)
Data
Lending to Individuals Bank of England
Questions
- Why are mortgages being rationed?
- Why is the housing market so important for the UK economy?
- Which other sectors of the economy employ people whose jobs are dependent on a buoyant housing market?
- Why has the Bank of England said that in the coming months it will become harder to get a mortgage?
- Why would increased mortgage lending be a much needed stimulus for the UK economy?
- Using an aggregate demand and aggregate supply diagram, show how rationing of mortgages and other loans will affect the UK economy.
With Christmas approaching, many high street stores will be hoping for a big increase in sales, but that seems unlikely to be enough for Arcadia, whose brands include Top Shop, BHS and Dorothy Perkins. Arcadia’s profits have decreased to £133m, which is a fall of 38% and, based on this data, it is planning on closing many stores across the country over the next few years. With leases expiring on many of their stores within about 3 years, the current plan, according to Sir Phillip Green, is to close about 250 stores. Speaking to the BBC, he commented:
‘Now, there may be other opportunities that turn up that we might want to open. But certainly, in terms of our existing portfolio, currently that’s our thinking.’
The economic climate has obviously played a key role, but so has the weather. With the hottest October and November for decades, people have been delaying their shopping and purchases of winter clothing and this has put increased strain on many high street traders (see the news item Dreaming of a white Christmas).
What is perhaps of more concern than one company’s profits being significantly lower is the impact this may have on unemployment. With over 2500 stores, Arcadia is one of the largest private employers in the UK and if 250 stores are closed, there may be severe consequences for the labour market and this may have further adverse effects on aggregate demand. A key factor that may partly determine the future of firms such as Arcadia is how much consumers spend this Christmas. Perhaps for these stores, they really may be hoping for a white Christmas – at least that may encourage people to stock up on winter clothes – if they can get to the shops!
Arcadia to close stores after reporting loss Financial Times, Andrea Felsted (24/11/11)
Arcadia and Dixons post profit loss BBC News (19/4/10)
Retail slowdown hits Arcadia stores Guardian, Zoe Wood (9/5/11)
Arcadia set to close up to 260 stores as profits fall BBC News (24/11/11)
Has Sir Phillip Green lost his Midas touch? Independent, James Thompson (25/11/11)
Arcadia suffers 40% slide in profits The Press Association (24/11/11)
Questions
- Explain why the current economic situation has caused a slowdown in retail sales.
- Illustrate the way in which a firm will maximise profits. If profits are declining, is it because sales revenue has fallen or that costs have risen? Adapt your diagram to show a fall in profits based on your answer.
- According to the article by the Press Association, margins were ‘squeezed by 1.8% as it took a £53 million hit to absorb price increases’. What does this mean?
- How might the unseasonably warm weather be an explanation for a weaker trading environment?
- If 260 stores are closed, what impact might this have on unemployment?
- If more workers lose their jobs, how might this have a subsequent adverse effect on sales? Think about the multiplier effect here.
As European leaders gather for an emergency summit in Brussels to tackle the eurozone debt crisis, we consider the issues and possible solutions. In Part B we’ll consider the actual agreement.
There are three key short-term issues that the leaders are addressing.
1. The problem of Greek debt
With fears that the Greek debt crisis could spread to other eurozone countries, such as Italy and Spain, it is vital to have a solution to the unsustainability of Greek debt. Either banks must be willing to write off a proportion of Greek debt owed to them or governments must give a fiscal transfer to Greece to allow it to continue servicing the debt. Simply lending Greece even more provides no long-term solution as this will simply make the debt even harder to service. Writing off a given percentage of debt is known as a ‘haircut’. The haircut on offer before the summit was 21%. Leaders are reportedly considering increasing this to around 60%.
2. The size of the eurozone bailout fund
The bailout fund, the European Financial Stability Facility (EFSF), stood at €440 billion. This is considered totally inadequate to provide loans to Italy and Spain, should they need a bailout. France and other countries want the ECB to provide extra loans to the EFSF, to increase its funds to somewhere between €2 trillion and €3 trillion. Germany before the meeting was strongly against this, seeing it as undermining the rectitude of the ECB. A compromise would be for the EFSF to provide partial guarantees to investors and banks which are willing to lend more to countries in debt crisis.
3. Recapitalising various European banks
Several European banks are heavily exposed to sovereign debt in countries such as Greece, Italy and Spain. It is estimated that they would need to raise an extra €100 billion to shield them against possible losses from haircuts and defaults.
But there is the key longer-term issue as well.
Achieving long-term economic growth
Without economic growth, debt servicing becomes much more difficult. The austerity measures imposed on highly indebted countries amount to strongly contractionary fiscal policies, as government expenditure is cut and taxes are increased. But as the economies contract, so automatic fiscal stabilisers come into play. As incomes and expenditure decline, so people pay less income tax and less VAT and other expenditure taxes; as incomes decline and unemployment rises, so government welfare payments and payments of unemployment benefits increase. These compound public-sector deficits and bring the possibility of even stronger austerity measures. A downward spiral of decline and rising debt can occur.
The answer is more rapid growth. But how is that to be achieved when governments are trying to reduce debt? That is the hardest and ultimately the most important question.
Articles
Brussels summit: the main issues to be resolved The Telegraph (25/10/11)
EU crisis talks in limbo after crucial summit is cancelled The Telegraph, Louise Armitstead (25/10/11)
Euro zone summit likely to give few numbers on crisis response Reuters, Jan Strupczewski (25/10/11)
Factbox: What EU leaders must decide at crisis summit Reuters (24/10/11)
Hopes low ahead of EU summit Euronews on YouTube (25/10/11)
Euro crisis: EU leaders hope to reach debt plan BBC News (26/10/11)
The deadline Europe cannot afford to miss BBC News, Nigel Cassidy (26/10/11)
Why EU summit is crunch day for the eurozone BBC News, Paul Mason (26/10/11)
Southern European banks need most capital BBC News blogs, Robert Peston (23/10/11)
Will Germany insure Italy against default? BBC News blogs, Robert Peston (26/10/11)
Plan B for the eurozone? BBC News blogs, Stephanie Flanders (26/10/11)
‘No such thing as Europe’ BBC Today Programme, Stephanie Flanders and Martin Wolf (26/10/11)
Markets to eurozone: It’s the growth, stupid BBC News blogs, Stephanie Flanders (24/10/11)
Fears euro summit could miss final deal Financial Times, Peter Spiegel, Gerrit Wiesmann and Matt Steinglass (26/10/11)
Time to unleash financial firepower or face euro breakup Guardian, Larry Elliott (25/10/11)
The Business podcast: eurozone crisis Guardian, Larry Elliott, David Gow and Jill Treanor (25/10/11)
Why is Germany refusing to budge on the eurozone debt crisis? Guardian blogs, Phillip Inman (26/10/11)
Questions
- In terms of the three short-term problems identified above, compare alternative measures for dealing with each one.
- To what extent would the ECB creating enough money to recapitalise European banks be inflationary? On what factors does this depend?
- Does bailing out countries create a moral hazard? Explain.
- What possible ways are there of achieving economic growth while reducing countries sovereign debt?
- Would you agree that the problem facing eurozone countries at the moment is more of a political one than an economic one? Explain.
- What are the arguments for and against greater fiscal integration in the eurozone?
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.
Retail sales in UK unexpectedly increase at fastest pace in five months Bloomberg, Scott Hamilton (20/10/11)
UK retail sales see stronger-than-expected rise BBC News (20/10/11)
Nothing expected from today’s UK retail sales figure FX-MM, Richard Driver (20/10/11)
Retail sales: what the economists say Guardian (20/10/11)
£1 in every £10 now spent online, says ONS Telegraph, Harry Wallop (20/10/11)
Retail sales rise more than expected Financial Times, Sarah O’Connor (20/10/11)
Retail sales up but good weather has a price Sky News (20/10/11)
Questions
- Which factors have contributed to the higher than expected sales figures for September?
- Why do economists not believe that the higher growth in sales means signs of recovery for the UK economy?
- How has higher inflation impacted UK households?
- To what extent do you think the warm weather held back retail sales?
- What could explain why there has been a significant growth in online sales?
No, bonfire night hasn’t been moved, but the 30th November could certainly be a day to remember. This day has been ‘selected’ by Unions for a nationwide day of action in response to government plans to increase workers’ pension contribution. The action would undoubtedly lead to massive disruption to public services across the UK and if an agreement is not reached with Ministers, we are likely to see further days of industrial action. In the words of the TUC boss, Brendan Barber, if no agreement is forthcoming, there will be ‘the biggest trade union mobilisation for a generation’.
The so-called pensions crisis has been an ongoing saga with seemingly no end in sight. As the UK population gets older, the strain on the state pension will continue to grow. The dependency ratio has increased – there are more and more pensioners being supported by fewer and fewer adults of working age. If the level of benefits is to be maintained, workers must either work for longer or make larger contributions to make up the deficit.
Plans are already in motion to increase the retirement age, but this in itself will not be sufficient. If pension contributions do increase, workers will undoubtedly find themselves worse off – a larger proportion of their gross income will be taken and hence net incomes will be lower. With less disposable income, consumer expenditure will fall, and given that consumption is the largest component of aggregate demand, the economy will take a hit. This is even more of a concern given the pay freezes we have already seen, together with rising inflation. People’s purses will get squeezed more and more, So, while raising pension contributions may help plug the pensions deficit, it could spell trouble for the economic prospects of the UK economy.
In addition to the potential longer term effects, there will also be a significant short term effect, namely, the loss of output on the day of the strike action. If workers are absent, the company will produce less than their potential and in some cases, the lost output can never be regained. If the postal workers go on strike, businesses may find packages go undelivered, customers experience delays, bills are not paid and so on. In all, strike action on the scale that is planned will have an impact on everyone, so it is in the interests of the economy for some sort of agreement to be reached. As Mr. Barber said:
‘If there’s no progress, then potentially we will see very widespread industrial action across the public services’
The following articles look at this conflict.
Unions plan ‘day of action’ over pensions Financial Times, Brian Groom (14/9/11)
TUC: ‘Strikes will be the biggest for a generation’ says Brendan Barber Telegraph (14/9/11)
Unions call for ‘national day of action’ over pensions BBC News (14/9/11)
Unions call collective day of strike action in November Guardian, Helene Mulholland and Dan Milmo (14/9/11)
Ed Miliband to warn trade unions that they must modernise Independent, Andrew Grice (13/9/11)
Trade unions plan day of action over pensions on Nov 30 Associated Press (14/9/11)
Are the trade unions about to save Britain? Telegraph, Mary Riddell (12/9/11)
Pension row unions in day of action The Press Association (14/9/11)
Unions set date for pensions strike as ‘unprecedented ballot begins’ Telegraph, Christopher Hope (14/9/11)
TUC to attack ministers over public sector pensions BBC News(14/9.11)
Secret plan for union strikes to cripple the country Telegraph, Christopher Hope(14/9/11)
Questions
- What are the main costs of strike action to (a) the individual going on strike (b) the firms which lose their workers (c) small businesses (d) the economy?
- What is meant by the dependency ratio? What action could be taken to reduce it? For each type of action, think about the costs and benefits.
- If pension contributions do increase, explain how workers will be affected. How will this affect each of the components of aggregate demand?
- Based on your answer to the above questions, what is likely to be the impact on the government’s macroeconomic objectives?
- What other action, besides striking, could unions take? Is it likely to be as effective? Do you think strikes are a good thing?
- Illustrate on a diagram the effect of a trade union entering an industry. How does it normally affect equilibrium wages and employment?