Tag: Financial system and consumer spending

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How sustainable is UK consumer spending? (update)

In our blog How sustainable is UK consumer spending? we considered concerns of some commentators that consumer spending was growing unduly quickly given the absence of any sustained growth in disposable income. The Second Estimate of GDP, Q2 2013 reports that the economy grew by 0.7 per cent in the second quarter of the year, with household expenditure growing by 0.4 per cent.

Because household spending makes up about two-thirds of aggregate demand in the UK it is important to keep an eye on it. The latest figures show that the real value of consumer spending by British households has risen in each quarter since 2011 Q4. In other words, the volume of household purchases has risen for seven consecutive quarters. Over the period, the growth in real consumer spending has averaged 0.4 per cent per quarter.

The chart helps to demonstrate the stark turnaround in the growth in consumer spending. Over the period from 2008 Q1 to 2011 Q3, real consumer spending typically fell by 0.4 per cent each quarter. As we noted in our previous blog, this was a period when the global financial system was in distress, with the availability of credit severely dampened, but also a period when households were concerned about their own financial balances and the future prospects for growth. Over the same period, real GDP typically fell by a little under 0.3 per cent each quarter. (Click here to download a PowerPoint of the chart.)

The real value of consumer spending has yet to return to its 2007 Q4 peak (£242 billion at 2010 prices). In 2013 Q2 the real value of consumer spending is estimated still to be 3 per cent below this level (£235 billion at 2010 prices). These figures are mirrored by the economy at large. Real GDP peaked in 2008 Q1 (£393 billion at 2010 prices). Despite the back-to-back quarterly increases in real GDP of 0.3 per cent in Q1 and 0.7 per cent in Q2, output in 2013 Q2 (£380 billion at 2010 prices) remains 3.2 per cent below the 2008 Q1 peak.

While real consumption values are below their 2007 Q4 peak, the concern is whether current rates of growth in consumer spending are sustainable. In particular, should this growth cause the household sector financial distress there would be real pain for the economy further down the line. Some commentators argue that the latest GDP figures are consistent with a more balanced recovery. In Q2 economic growth was supported too by other parts of the economy. For instance, we saw a 3.6 per cent rise in export volumes and a 1.7 per cent rise in gross fixed capital formation (i.e. investment expenditure).

Nonetheless, it is the protracted period over which consumer spending has been growing robustly that concerns some economists. Hence, we will need to continue to monitor the growth in all components of aggregate demand and, in particular, changes in household consumption, income, saving and borrowing.

Data

Second Estimate of GDP, Q2 2013 Dataset Office for National Statistics

Articles

New articles
UK economic growth revised up to 0.7% BBC News, (23/8/13)
UK GDP revised up to 0.7pc in second quarter: reaction Telegraph, (23/8/13)
UK rallying faster than thought as exports leap boosts GDP Independent, Russell Lynch and Ben Chu (24/8/13)
UK economy expanding faster than first thought, GDP revision shows Guardian, Heather Stewart (23/8/13)
Growth upgrade points to ‘sustainable’ recovery Telegraph, Philip Aldrick (23/8/13)

Previous articles
UK wages decline among worst in Europe BBC News, (11/8/13)
Squeezing the hourglass The Economist, (10/8/13)
UK first-quarter growth unchanged BBC News, (28/5/13)
Summer heatwave triggers shopping spree in ‘Wongaland’ economy Telegraph, Steve Hawkes and Steven Swinford (15/8/13)
Retail sales data better than expected as UK economy enjoys summer bounce Guardian, Heather Stewart (15/8/13)
Mark Carney is banking on you to keep spending Telegraph, Philip Aldrick (10/8/13)
NIESR upgrades UK economy but warns on consumer spending Telegraph, Philip Aldrick (2/8/13)
Consumers ‘expect better economy’ Belfast Telegraph, (4/8/13)

Questions

  1. Explain what you understand by a ‘sustainable’ economic recovery.
  2. What are the expenditure components that make up Aggregate Demand?
  3. Explain what you understand by consumption smoothing.
  4. Why would we would typically expect consumption growth to be less variable than that in disposable income?
  5. Would we expect consumption growth to always be less variable than that in disposable income? Explain your answer.
  6. What impact do you think the financial crisis has had on consumer behaviour?
  7. To what extent do you think the current growth in consumer spending is sustainable?
  8. How important are expectations in determining consumer behaviour?
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How sustainable is UK consumer spending?

Household spending makes up about two-thirds of aggregate demand in the UK. Understanding its determinants is therefore important to understanding short-term economic growth. The real value of consumer spending by British households has risen in each quarter since 2011 Q4. Over the same period real disposable income has flat-lined. This suggests that the British household sector has stepped up attempts to smooth their longer-term spending profile despite the current absence of growth in their real incomes.

When viewed over many years, disposable income and consumer spending grow at very similar rates. After stripping out inflation we find that over the past 50 years both have grown at about 2½ per cent per annum. However, if we measure growth from one quarter of the year to the next we tend to find that consumption growth is less variable than disposable income. This is known as consumption smoothing.

Chart 1 shows the quarterly percentage change in consumption and disposable income since 1998. (Click here to download a PowerPoint of the chart).The variability in the disposable income series is generally greater than that in consumption so helping to illustrate consumption smoothing.

Consumption smoothing is facilitated by the financial system enabling us to either borrow to supplement our spending or to save to enjoy more spending in the future. The financial system can help households to avoid large variations in their spending over short periods.

Consumption smoothing does not prohibit falls in consumption nor periods when it is more variable than income. Over the period from 2008 Q1 to 2011 Q3, real consumption typically fell by 0.4 per cent each quarter while disposable income was flat. This was a period when the global financial system was in distress. Sharp contractions in credit meant that the financial system was no longer able to support economic activity as it had previously. Furthermore, households too looked to repair their balance sheets with economic uncertainty acting as an incentive to do so.

What is interesting is the extent to which British households are spending again. Since 2011 Q4 the real value of spending has typically expanded by 0.4 per cent each quarter while income growth remains largely absent. One might argue that this just demonstrates a willingness for households to engage in consumption smoothing. With credit conditions still tight, the growth in spending has been aided by a decline in the saving ratio. This can be seen from Chart 2.

In 2009 Q2 the proportion of income saved hit 8.6 per cent having been as low as 0.2 per cent in 2008 Q1. In 2013 Q1 the saving ratio had fallen back to 4.2 per cent. (Click here to download a PowerPoint of the chart.)

It is of course all too easy to over-interpret data. Nonetheless, there be will concern if households look to maintain consumption growth at rates substantially greater than those in disposable income for too long a period of time. Consumption smoothing could become a real problem for future economic activity if it was to result in a financially distressed household sector. Hence, an important question is the extent to which current rates of consumption growth are sustainable. Future consumption and income trends will therefore be analysed with enormous interest.

Data

Quarterly National Accounts, Q1 2013 Dataset Office for National Statistics

Articles

UK wages decline among worst in Europe BBC News, (11/8/13)
Squeezing the hourglass The Economist, (10/8/13)
UK first-quarter growth unchanged BBC News, (28/5/13)
Summer heatwave triggers shopping spree in ‘Wongaland’ economy Telegraph, Steve Hawkes and Steven Swinford (15/8/13)
Retail sales data better than expected as UK economy enjoys summer bounce Guardian, Heather Stewart (15/8/13)
Mark Carney is banking on you to keep spending Telegraph, Philip Aldrick (10/8/13)
NIESR upgrades UK economy but warns on consumer spending Telegraph, Philip Aldrick (2/8/13)
Consumers ‘expect better economy’ Belfast Telegraph, (4/8/13)

Questions

  1. Explain what you understand by consumption smoothing.
  2. Why would we would typically expect consumption growth to be less variable than that in disposable income?
  3. Would we expect consumption growth to always be less variable than that in disposable income? Explain your answer.
  4. What impact do you think the financial crisis has had on consumer behaviour?
  5. To what extent do you think the current growth in consumer spending is sustainable?
  6. How important are expectations in determining consumer behaviour?