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?
The spectre of debt has awoken many of us in the night. Indebtedness is a key economic issue in the 2010s. Economists are devoting ever increasing amounts of research time trying to understand its impact on economic behaviour. This will not surprise you when you learn that the debt owed by the UK non-bank private sector to banks stood at £2.17 trillion at the end of September. This is the equivalent to 150% of annual GDP.
Chart 1 shows the stock of outstanding lending by Monetary Financial Institutions (banks and building societies) to the non-bank private sector bank since 1979. Back then the non-bank private sector had bank debt to the tune of around £70 billion or 10 per cent of GDP. Today’s figure is nearly 3000 per cent higher! Of this debt, around about 55 per cent is currently held by the household sector, 27 per cent by Other Financial Corporations (such as insurance companies and pension funds) and 18 per cent by private non-financial corporations. (Click here for a PowerPoint of the chart.)
Chart 2 shows the stocks of debt as percentages of annual GDP. We can infer from it that there are waves of growth in bank debt. Two notable periods are during the 1980s and again from the late 1990s up to the financial crisis of the late 2000s. During the early and mid 1990s the relative size of debt stocks tended to stabilise while in the early 2010s the actual stocks of debt, as well as relative to GDP, declined. A credit binge seems to be followed by a period of consolidation. (Click here for a PowerPoint of the chart.)
It is important that we understand the drivers of the growth of debt. The impact of debt on the balance sheets of the non-bank private sector and on banks themselves has implications for economic behaviour. In the early 2010s this has been to markedly slow the pace of growth through its impact on aggregate demand. Economic agents have, in general, looked to consolidate. There is no doubt that this partly reflects a precautionary motive. An important means by which debt and the balance sheets on which it is recorded affect behaviour is through a precautionary mechanism. This is difficult to accurately quantify because it represents a psychological influence on spending. Furthermore, it is affected by the prevailing circumstances of the time.
In looking to understand the factors that affect the growth of debt we may, as a result, learn more about the framework within which we may want banks and their customers to operate. Consequently, we may be in a better position to ensure sustainable longer-term growth and development. If there are cycles in credit it is important that we understand why they arise and whether, as some have suggested, they are an inherent part of the financialised economy in which we live. If they are, can we mitigate their potentially destabilising effects?
Retail shares facing nightmare before Christmas The Telegraph, John Ficenec (9/11/14)
Growing wealth inequality in the UK is a ticking timebomb The Guardian, Danny Dorling (15/10/14)
Richest 10% of Britons now control more than half the country’s wealth: Nation is only member of G7 where inequality between rich and poor has increased this century Mail Online, Mark Duell and Corey Charlton, (15/11/14)
Household debt is growing as families struggle Yorkshire Evening Post (31/10/14)
Consumer spending forecast to be the highest for four years The Telegraph, Ashley Armstrong (10/11/14)
Statistical Interactive Database Bank of England
Quarterly National Accounts, Q2 2014 Dataset Office for National Statistics
- What is the non-bank private sector?
- What factors might affect the rate at which non-bank private sector debt stocks grow?
- How might we go about assessing whether the aggregate level of lending by financial institutions to the non-bank private sector is sustainable?
- How might we go about assessing whether the level of lending by individual financial institutions to the non-bank private sector is sustainable?
- What information is conveyed in the balance sheets of economic agents, such as households and private non-financial corporations
- What is meant by precautionary saving?
- Can precautionary saving occur when the economy is growing strongly?
- What are the mechanisms by which non-bank private sector debt could impact on economic behaviour?
In a statement to the House of Commons on 9 February 2011, the Chancellor announced that banks would extend their new lending to SMEs (Small and Medium-Sized Enterprises) from £179 billion in 2010 to £190 billion in 2011. An important question is the extent to which this initiative, which forms part of a series of initiatives in conjunction with the banking sector known as Project Merlin, will impact on economic activity.
Let’s begin by thinking about the role that credit plays in an economy. Firstly, it serves a short-term role by enabling individuals and firms to ‘bridge the gap’ between their income and their spending. Secondly, it can, depending on the size and terms of the credit, help to fund longer-term investments. In the case of firms, for instance, it can help to fund capital projects such as an expansion of premises or the installation of new equipment or production processes.
The extension of credit is the main source of growth in the money supply. If the credit which is extended by financial institutions is spent it increases economic activity. The size of the increase in economic activity will depend on how many times the credit is passed on from one firm or individual to the next. In other words, it depends on the velocity of circulation of money – often referred to simply as V. If the initial credit funds a series of purchases and the recipients of these monies, i.e. those from whom the purchases are made, then use their increased deposits to fund purchases themselves, the expansion could be sizeable.
There is every indication that the additional credit for SMEs will be welcome and it seems reasonable to assume that this will positively impact on spending. But, by how much is not entirely clear. This is what fascinates me about macroeconomics, but, perhaps understandably, may well frustrate others! Once the payments for the purchases made using the newly available credit become new deposits, how will these recipients respond? Will other credit-constrained firms use this liquidity to engage in purchases themselves? But, what if these recipients use the monies to increase or rebuild their own financial wealth? In this last scenario – a pessimistic scenario – the velocity of circulation will increase relatively little and economic activity little too.
The corporate sector, of course, does not exist in isolation of other sectors of the economy and, in particular, of the household sector. As some of the income from the expanded credit flows to them in the form of factor payments (i.e. wages and profits) – though by how much is itself debtable – how will they respond? Again will credit-constrained households look to spend? Alternatively, will they hold on to these liquid balances perhaps using them as buffer-stock savings? This is not an unrealistic possibility given the leverage of households and the need to rebuild wealth, especially so in times of incredible economic uncertainty? But, who knows!
So while Merlin may have waved his wand, the full extent of its impact, though probably positive, is far from clear. Time will tell. Isn’t macroeconomics wonderful!
HM Treasury Press Release
Government welcomes banks’ statement on lending by 15% more to SMEs, and on pay and support for regional growth, HM Treasury, 9 February 2011
Statement to the House of Commons by the Chancellor
Statement on banking by the Chancellor of the Exchequer 9 February 2011
Banks sign lending and bonus deal BBC News (9/2/11)
Banks agree Project Merlin lending and bonus deal BBC News (9/2/11)
Osborne’s plans arrive too late for the economy Independent, Sean O’Grady (11/2/11)
Project Merlin ‘could weaken UK banks’ Telegraph, Harry Wilson (11/2/11)
Nothing wizard about Project Merlin Guardian UK, Nils Pratley (7/2/11)
Softball: Britain’s banks make peace with the government – for now The Economist (10/2/11)
Smaller firms insist banks must change their attitude The Herald (11/2/11)
- Detail the various roles that financial institutions play in a modern-day economy.
- Do the activities of banks carry with them any risks? How might such risks be reduced?
- What is meant by the velocity of circulation or the velocity of money?
- What factors do you think could affect the velocity of money?
- How does credit creation affect the growth of the money supply?
- What do you understand by individuals or firms being credit-constrained?
- What factors are likely to affect how credit-constrained an individual household is?
- What do you think might be meant by buffer-stock saving? What might affect the size of the buffer-stock held by a household?
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.
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)
Housing equity withdrawal (HEW) statistical releases Bank of England
- 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?