Interest rates in the UK have been at 0.5% since mid-2009, when they were reduced with the objective of stimulating the economy, through encouraging consumption and investment. Over the past 12 months, economic recovery has begun and with the housing market rising by 8.4% over the past year, what can we expect from interest rates?
Interest rates are a powerful tool of monetary policy and affect many of the components of aggregate demand. As such, they are also a key tool in achieving low and stable inflation rates and keeping unemployment low. Unemployment has been falling, as the economic recovery has taken hold, but is still above the 7% level that the Bank of England has said is needed before rates are increased. However, with the improvements in the housing market,
some are now expecting interest rates to go up sooner than previously thought. (Click here for a PowerPoint of the chart.)
28 economists were questioned about the future of interest rates in the UK and 93% of those asked were of the opinion that interest rates will still be at 0.5% by the end of 2014. Furthermore, more than 50% think that interest rates will not begin to go up until the second half of 2015 and 15% suggest that they will not increase until 2016.
What happens to interest rates will depend on many things, including changes in productivity, unemployment trends, wage growth and inflation. It is also likely to depend on economic changes in countries around the world. The following articles consider the future of interest rates.
UK interest rates to stay at 0.5% in 2014 – economists BBC News (3/1/14)
It is high time we raised interest rates and returned to normality The Telegraph, Jeremy Warner (2/1/14)
BoE will ‘move goalposts’ on interest rates Financial Times, Chris Giles and Claire Jones (1/1/14)
Interest rate rise with no wage increase ‘will push heavily-indebted to edge’ The Guardian, Heather Stewart (2/12/14)
BoE may lower jobless rate guidance, but not this month – Reuters poll Reuters, Suzanne Plunkett (3/1/14)
Questions
- Explain how each component of aggregate demand will be affected by changes in interest rates.
- How do interest rates affect unemployment?
- Interest rates are used to keep inflation on target. Explain how this is done.
- What might be the effect on the macroeconomic objectives if interest rates are increased?
- What are the arguments (a) for increasing Bank rate and (b) for maintaining it at the current 0.5% level?
A constant feature of the UK economy (and of many other Western economies) has been record low interest rates. Since March 2009, Bank Rate has stood at 0.5%. Interest rates have traditionally been used to keep inflation on target, but more recently their objective has been to stimulate growth. However, have these low interest rates had a negative effect on the business environment?
Interest rates are a powerful tool of monetary policy and by affecting many of the components of aggregate demand, economic growth can be stimulated. This low-interest rate environment is an effective tool to stimulate consumer spending, as it keeps borrowing costs low and in particular can keep mortgage repayments down. However, this policy has been criticised for the harm it has been doing to savers – after all, money in the bank will not earn an individual any money with interest rates at 0.5%! Furthermore, there is now a concern that such low interest rates have led to ‘zombie companies’ and they are restricting the growth potential and recovery of the economy.
A report by the Adam Smith Institute suggests that these ‘zombie companies’ have emerged in part by the low-interest environment and are continuing to absorb resources, which could otherwise be re-allocated to companies with more potential, productivity and a greater contribution to the economic recovery. During a recession, there will undoubtedly be many business closures, as aggregate demand falls, sales and profits decline until eventually the business becomes unviable and loans cannot be repaid. Given the depth and duration of the recent recessionary period, the number of business closures should have been very large. However, the total number appears to be relatively low – around 2% or 100,000 and the report suggests that the low interest rates have helped to ‘protect’ them.
Low interest rates have enabled businesses to meet their debt repayments more easily and with some banks being unwilling to admit to ‘bad loans’, businesses have benefited from loans being extended or ‘rolled over’. This has enabled them to survive for longer and as the report suggests, may be preventing a full recovery. The report’s author, Tom Papworth said:
Low interest rates and bank forbearance represent a vast and badly targeted attempt to avoid dealing with the recession. Rather than solving our current crisis, they risk dooming the UK to a decade of stagnation … We tend to see zombies as slow-moving and faintly laughable works of fiction. Economically, zombies are quite real and hugely damaging, and governments and entrepreneurs cannot simply walk away.
The problem they create is that resources are invested into these companies – labour, capital, innovation. This creates an opportunity cost – the resources may be more productive if invested into new companies, with greater productive potential. The criticism is that the competitiveness of the economy is being undermined by the continued presence of such companies and that this in turn is holding the UK economy back. Perhaps the interest rate rise that may happen this time next year may be what is needed to encourage the re-allocation of capital. However, a 0.5 percentage point rise in interest rates would hardly be the end of the world for some of these companies. Perhaps a more focused approach looking at restructuring is the key to their survival and the allocation of resources to their most productive use. The following articles and the report itself consider the case of the trading dead.
Report
The Trading Dead The Adam Smith Institute, Tom Papworth November 2013
Articles
Zombie firms threaten UK’s economic recovery, says thinktank The Guardian, Gyyn Topam (18/11/13)
Zombie companies ‘probably have no long term future’ BBC News (18/11/13)
Rate rise set to put stake through heart of zombie companies Financial Times, Brian Groom (14/11/13)
Why we can still save the zombie firms hindering the UK economic rival City A.M., Henry Jackson (18/11/13)
Breathing new life into zombies The Telegraph, Rachel Bridge (9/11/13)
Questions
- Which components of aggregate demand are affected (and how) by low interest rates?
- Why do low interest rates offer ‘protection’ to vulnerable businesses?
- How is the reallocation of resources relevant in the case of zombie companies?
- If interest rates were to increase, how would this affect the debts of vulnerable businesses? Would a small rate irse be sufficient and effective?
- What suggestions does the report give for zombie companies to survive and become more productive?
- Is there evidence of zombie companies in other parts of the world?
The latest preliminary GDP estimates for 2013 Q3 suggest that the economy’s output (real GDP) expanded by 0.8 per cent following on the back of a 0.7 per cent increase in Q2. Growth was observed across the main industrial sectors with the important service sector growing by 0.7 per cent. While the output of the service sector is now 0.5 per cent higher than its 2008 Q1 peak, the total output of the economy remains 2.6 per cent below its 2008 Q1 peak.
The volatility of growth underpins the idea of business cycles and on occasions results in recessions. Today’s release needs to be set in the context of this volatility and in the context of 2008/9 recession which saw output fall by 7.2 per cent. UK output peaked in 2008 Q1 (£392.786 billion at 2010 prices). There then followed 6 quarters during which output declined.
Output declined again in 2010 Q4 (–0.2% growth) and again in 2011 Q4 (–0.1% growth). The estimates of real GDP for 2011 Q4 and 2012 Q1 are identical at £376.462 billion (at 2010 prices). Previous revisions have seen the 2012 Q1 growth number revised up so that a further recession resulting in a double-dip recession no longer appears in the figures.
While output is now portrayed as (very) flat in 2012 Q1, it did fall again in 2012 Q2 (–0.5 per cent growth) and in 2012 Q4 (–0.3 per cent growth). Moving forward in time, the latest ONS numbers show an economy that grew by 0.4 per cent in 2013 Q1 (to £377.301 billion at 2010 prices), by 0.7 per cent in 2013 Q2 (to £379.780 billion at 2010 prices) and by 0.8 per cent in 2013 Q3 billion (to £382.818 billion at 2010 prices). Compared with 2012 Q3, the output of the UK economy in 2013 Q2 is 1.5 per cent higher.
Chart 1 helps to put the recent growth numbers into an historical context. It shows the quarterly change in real GDP since the 1980s. From it, we can see the 5-quarter recession that commenced in 1980 Q1 when output shrunk by 4.6 per cent, the 5-quarter recession that commenced in 1990 Q3 when output shrank by 2.4 per cent and the 6-quarter recession that commenced in 2008 Q2 when output shrank by 7.2 per cent. (Click here to download a PowerPoint of the chart.)
Chart 2 scratches a little below the surface by looking at output by the four principal industrial types. The interesting finding is that the output of the service sector has now risen above its 2008 Q1 peak. In 2013 Q3 output is 0.5 per cent larger. By contrast, the other three sectors remain smaller than in 2008 Q1. Agriculture, forestry and fisheries is 5.9 per cent smaller, construction 14.3 per cent smaller and production (including manufacturing) is 14.6 per cent smaller. (Click here to download a PowerPoint of the chart.)
With today’s release, quarterly growth now averages –0.11 per cent since 2008 Q2. If we take the series back to the mid 1950s when it began, the average quarterly rate of growth is 0.64 per cent which is equivalent to an annual rate of increase of 2.57 per cent. While today’s news is encouraging it remains important to keep it in perspective and to ensure that growth is sustainable and built on firm foundations.
Data
Preliminary Estimate of GDP – Time Series Dataset Q3 2013 Office for National StatisticsGross Domestic Product Preliminary Estimate, Q3 2013 Office for National Statistics
New Articles
UK economy grows by 0.8% – the fastest pace in three years Guardian, Larry Elliott (25/10/13)
UK economy grew by 0.8% in third quarter Independent, Nick Renaud-Komiya (25/10/13)
UK GDP: fastest growth for three years BBC News (25/10/13)
UK economy grows by 0.8pc in third quarter Telegraph, Szu Ping Chu (25/10/13)
UK Economy: GDP Growth Accelerates To 0.8% Sky News (25/10/13)
Previous Articles
GDP grows 0.7% as UK economy shows steady recovery Guardian, Phillip Inman (26/9/13)
Hopes of economic recovery take double blow as GDP remains at 0.7% Independent, Russell Lynch (26/9/13)
UK economic growth confirmed at 0.7% BBC News (26/9/13)
IMF cuts global growth outlook but raises UK forecast BBC News (9/10/13)
Good news as IMF upgrades UK’s growth forecast Independent, Ben Chu (8/10/13)
Economy: IMF Makes UK Growth Forecast U-Turn Sky News (8/10/13)
Questions
- What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
- Looking at Chart 1 above, summarise the key patterns in real GDP since the 1980s.
- What is a recession? What is a double-dip recession?
- What are some of the problems with the traditional definition of a recession?
- Explain the arguments for and against the proposition that the UK has recently experienced a double-dip recession.
- Can a recession occur if nominal GDP is actually rising? Explain your answer.
- What factors might result in economic growth being so variable?
- What factors might explain the very different patterns seen since the late 2000s in the volume of output of the 4 main industrial sectors?
- Produce a short briefing paper exploring the prospects for economic growth in the UK over the next 12 to 18 months.
One very important characteristic of economic growth is its short-term volatility. The volatility of growth underpins the idea of business cycles and on occasions results in recessions. The traditional definition is where real GDP (output) declines for 2 or more consecutive quarters. Interestingly, the latest GDP numbers contained in the Quarterly National Accounts mean that the recession previously evidenced from 2011 Q4 to 2012 Q2 has effectively disappeared. Nonetheless, output today is still 3.3 per cent lower than before the 2008 economic downturn.
The ONS’s latest output numbers raise some interesting questions around our understanding of what constitutes a recession. Should, for instance, we define it solely in terms of real GDP and, even if we do, is a strict statistical definition based around two consecutive quarterly falls appropriate? The recent estimates from the ONS show that the 2008/9 recession saw output fall by 7.2 per cent. They show that UK output peaked in 2008Q1 (£392.786 billion at 2010 prices). There then followed 6 quarters during which output declined.
Output declined again in 2010 Q4 (-0.2% growth) and again in 2011 Q4 (-0.1% growth). The new estimates of real GDP for 2011 Q4 and 2012 Q1 are now identical at £376,462 billion (at 2010 prices). Previous revisions have also seen the 2012 Q1 growth number revised up and, hence, a further recession resulting in a double-dip recession has effectively now been statistically removed. The 2013 Q1 Quarterly National Accounts revised growth up so that 2012 Q1 only saw a percentage fall when measured to the third decimal place (–0.007% growth).
While output is now portrayed as (very) flat in 2012 Q1, it did fall again in 2012 Q2 (-0.5 per cent growth) and in 2012 Q4 (-0.3 per cent growth). Moving forward in time, the latest ONS numbers show that the economy grew by 0.4 per cent in 2013 Q1 (to £377,301 billion at 2010 prices) and by 0.7 per cent in 2013 Q2 (to £379,780 billion at 2010 prices). Despite this, output remains 3.3 per cent below its 2008 Q1 peak. A more positive spin on the numbers would be to point out that output is up 4.2 per cent from its 2009 Q3 trough (£364,557 billion at 2010 prices).
Perhaps the debate around the appearance and disappearance of recessions in official data strengthen the argument for a more holistic and considered view of what constitutes a recession. In the USA the wonderfully-named Business Cycle Dating Committee takes a less fixed view of economic activity and, hence, of recessions. Its website argues:
It (the Committee) examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve’s index of industrial production (IP).
Of course, the advantage of focusing on real GDP alone in measuring activity and in determining recessions is that it is usually very straightforward to interpret. Regardless of whether the UK did or did not experience a recession at the end of 2011 and into 2012, the chart helps to put the recent growth numbers into an historical context. It shows the quarterly change in real GDP since the 1980s.
From the chart, we can see the 5-quarter recession that commenced in 1980 Q1 when output shrunk by 4.6 per cent, the 5-quarter recession that commenced in 1990 Q3 when output shrank by 2.4 per cent and the 6-quarter recession that commenced in 2008 Q2 when output shrank by 7.2 per cent. (Click here to download a PowerPoint version of the chart.)
The chart allows to see the other characteristic of growth too: over the long run growth is positive. Since 1980, the average rate of growth per quarter has been 0.57 per cent. This is equivalent to an average rate of growth of 2.3 per cent per year.
Since 2008 Q2, quarterly growth has averaged -0.16 per cent which is equivalent to an annual rate of growth of -0.63 per cent! In any language these are extraordinary numbers and certainly help to put the recent rebound in growth into context.
Data
Quarterly National Accounts Time Series Dataset Q2 2013 Office for National StatisticsStatistical Bulletin: Quarterly National Accounts Q2 2013 Office for National Statistics
New Articles
GDP grows 0.7% as UK economy shows steady recovery Guardian, Phillip Inman (26/9/13)
Hopes of economic recovery take double blow as GDP remains at 0.7% Independent, Russell Lynch (26/9/13)
UK economic growth confirmed at 0.7% BBC News (26/9/13)
IMF cuts global growth outlook but raises UK forecast BBC News (9/10/13)
Good news as IMF upgrades UK’s growth forecast Independent, Ben Chu (8/10/13)
Economy: IMF Makes UK Growth Forecast U-Turn Sky News (8/10/13)
Previous Articles
UK avoided double-dip recession in 2011, revised official data shows Guardian, Phillip Inman (27/6/13)
Britain’s double dip recession revised away, but picture still grim Reuters, David Milliken and William Schomberg (27/6/13)
UK double-dip recession revised away BBC News (27/6/13)
IMF raises UK economic growth forecast BBC News (9/7/13)
IMF raises UK economic growth forecast to 0.9% but cuts prediction for global growth Independent, Holly Williams (9/7/13)
IMF Upgrades UK Growth Forecast For 2013 Sky News (9/7/13)
Questions
- What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
- Looking at the chart above, summarise the key patterns in real GDP since the 1980s.
- What is a recession? What is a double-dip recession?
- What are some of the problems with the traditional definition of a recession?
- Explain the arguments for and against the proposition that the UK has recently experienced a double-dip recession.
- Can a recession occur if nominal GDP is actually rising? Explain your answer.
- What factors might result in economic growth being so variable?
- Produce a short briefing paper exploring the prospects for economic growth in the UK over the next 12 to 18 months.
One very important characteristic of economic growth is its short-term volatility. Economic activity is notoriously volatile. It is such a fundamental idea that economists refer to it as one of their threshold concepts. The volatility of growth sees occasional recessions. The traditional definition is where real GDP (output) declines for 2 or more consecutive quarters. The latest figures from the Quarterly National Accounts call into question whether the UK technically experienced a recession at the start of 2012 with output broadly flat in 2012 Q1 following a contraction of 0.1 per cent in 2011 Q4.
The ONS’s latest output numbers raise some interesting questions around our understanding of what constitutes a recession. These figures show that the 2008/9 recession was deeper than first thought with output declining by 7.2 per cent. They show that UK output peaked in 2008Q1 (£392.786 billion at 2010 prices). There then followed 6 quarters where output declined.
Output declined again in 2010 Q4 (–0.2% growth) and again in 2011 Q4 (–0.1% growth). But then interpretations of the data become more controversial. Not least, we get in the debates concerning the accuracy with which we can expect to measure the size of the economy and so to how many decimal places one should realistically measure a rise or fall. In terms of the raw real GDP numbers output fell in 2012 Q1. In 2011 Q4 GDP is estimated at £376,462 billion (at 2010 prices) ‘falling’ to £376,436 billion (at 2010 prices) in 2012 Q1. But, this is a percentage fall only when measured to the third decimal place (–0.007% growth).
In its publication Impact of changes in the National Accounts and economic commentary for Q1 2013 the ONS argue that:
While some commentators may attempt to read some significance into this revision, particularly in the context of whether the UK experienced a “double-dip” recession, it is clearly absurd to imagine that it is possible to measure the size of the economy to this degree of accuracy. The best interpretation of the Blue Book figures is that the economy was flat in the first quarter of 2012, and 0.6% larger than in the same quarter of 2011.
It is however understandable that those with vested interests – including economists, policy-makers and politicians – will take a slightly different view and will read more into the figures than perhaps an objective, sober view might demand. What appears more certain is that output did again fall in 2012 Q2 (–0.5 per cent growth) and in 2012 Q4 (–0.2 per cent growth). Despite estimated growth of 0.3 per cent in 2013 Q1, output remains 3.9 per cent lower than at its 2008 Q1 peak.
Perhaps the ‘absurdity’ or not around the debate of a double-dip recessions strengthens the argument for a more holistic and considered view of what constitutes a recession. In the USA the wonderfully-named Business Cycle Dating Committee takes a less fixed view of economic activity and, hence, of recessions. Its website argues:
It (the Committee) examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve’s index of industrial production (IP).
Of course, the advantage of focusing on real GDP alone in measuring activity and in determining recessions is that it is usually very straightforward to interpret. Regardless of whether the UK has experienced or not two recessions in close proximity, our chart helps to put the recent growth numbers into an historical context
. It shows both the quarter-to-quarter changes in real GDP (left-hand axis) and the level of output as measured by GDP at constant 2010 prices (right-hand axis). Click here to download the chart to PowerPoint.
The chart captures nicely the twin characteristics of growth. Since 1960, the average rate of growth per quarter has been 0.63 per cent. This is equivalent to an average rate of growth of 2.55 per cent per year. Since 2008 Q2, quarterly growth has averaged –0.19 per cent which is equivalent to an annual rate of growth of –0.78 per cent! In any language these are extraordinary numbers. Indeed, one could argue that focusing any policy debate around whether or not the UK experienced a double-dip recession rather misses the more general point concerning the absense of any sustained economic growth since 2008.
Data
Quarterly National Accounts Time Series Dataset Q1 2013 Office for National StatisticsStatistical Bulletin: Quarterly National Accounts Q1 2013 Office for National Statistics
Articles
UK avoided double-dip recession in 2011, revised official data shows Guardian, Phillip Inman (27/6/13)
Britain’s double dip recession revised away, but picture still grim Reuters, David Milliken and William Schomberg (27/6/13)
UK double-dip recession revised away BBC News (27/6/13)
IMF raises UK economic growth forecast BBC News (9/7/13)
IMF raises UK economic growth forecast to 0.9% but cuts prediction for global growth Independent, Holly Williams (9/7/13)
IMF Upgrades UK Growth Forecast For 2013 Sky News (9/7/13)
Questions
- What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
- Looking at the chart above, summarise the key patterns in real GDP since the 1960s.
- What is a recession? What is a double-dip recession?
- What are some of the problems with the traditional definition of a recession?
- Explain the arguments for and against the proposition that the UK has recently experienced a double-dip recession.
- Can a recession occur if nominal GDP is actually rising? Explain your answer.
- What factors might result in economic growth being so variable?
- Produce a short briefing paper exploring the prospects for economic growth in the UK over the next 12 to 18 months.
Interest rates in the UK have been at 0.5% since mid-2009, when they were reduced with the objective of stimulating the economy, through encouraging consumption and investment. Over the past 12 months, economic recovery has begun and with the housing market rising by 8.4% over the past year, what can we expect from interest rates?