George Osborne in his recent Autumn Statement, once again stressed that ‘the government is committed to strong, sustainable and balanced growth’. But while he plans to reduce government debt as a percentage of GDP, consumer debt is rising, both absolutely and as a percentage of household disposable income. The rise in household borrowing, and the resulting rise in consumer expenditure, has been the main factor driving economic growth. It has not been exports nor, until recently, investment, as the Chancellor had hoped. Indeed, investment in new housing is falling.
The Office for Budget Responsibility in its latest Economic and Fiscal Outlook forecasts that gross household debt will reach 163 per cent of household disposable income by 2021, up from 146% at the end of 2015.
Consumer gross debt includes both secured debt and unsecured debt. Secured debt is essentially debt secured on property (i.e. mortgages), while unsecured debt is largely in the form of credit card debt, overdrafts and personal loans.
The chart shows that from 2008 to 2013, gross debt fell as a percentage of personal disposable income. Following the financial crisis, banks were more cautious about lending as they sought to increase their capital and liquidity ratios. And consumers were more cautious about borrowing as the uncertainty made many people keen to reduce their debts. This decline in credit reversed the massive growth in household debt from 2000 to 2008: one of the contributing factors to the financial crisis. (Click here for a PowerPoint of the chart.)
But since late 2013, household debt – both secured and unsecured – has been rising. In absolute (nominal) terms, individuals’ debt is now £1.43 trillion, slightly above the previous high in 2008. And as the chart shows, the OBR forecasts that it will continue rising. This makes consumers more vulnerable to adverse economic shocks, such as a downturn in emerging markets, another crisis in the eurozone or financial crises in other parts of the world.
And as consumer debt has been rising, the personal saving ratio (the ratio of saving to personal disposable incomes) has been falling and is now lower than before the financial crisis.
The rise in consumer borrowing has been of some concern to the Bank of England. Andy Haldane, the Bank’s Chief Economist, appearing before the Treasury Select Committee, warned that consumer credit, and in particular personal loans, had been ‘picking up at a rate of knots. That ultimately might be an issue that the Financial Policy Committee might want to look at fairly carefully.’
The UK economy may be growing, but in a highly unbalanced way The Guardian, Phillip Inman (27/11/15)
UK growth hit by biggest drag from net trade on record The Telegraph, Szu Ping Chan (27/11/15)
Surge in consumer lending could prompt Bank of England intervention The Guardian, Patrick Collinson and Jill Treanor (30/11/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Between Debt and the Devil by Adair Turner review – should the government start printing money? The Guardian, Tom Clark (25/11/15)
Lending rises as Bank of England ponders new curbs Financial Times, Ferdinando Giugliano (30/11/15)
Carney indicates BoE’s willingness to rein in credit Financial TImes, Chris Giles (5/11/15)
FCA sounds alarm at rising credit card debt Financial Times, Emma Dunkley (3/11/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
Seven years after the crisis, Britain is still addicted to the drug of debt Independent, James Moore (1/12/15)
Vince Cable: Former Business Secretary warns that ‘severe economic storms’ are on the way Independent, Ben Chu (14/11/15)
The risks stalking the UK economy BBC News, Kamal Ahmed (1/12/15)
Economic and fiscal outlook Office for Budget Responsibility (25/11/15)
Economic and fiscal outlook charts and tables (Excel file) Office for Budget Responsibility (25/11/15)
- Does it matter if economic growth is driven by a rise in consumer demand, in turn driven by a risen in consumer credit?
- Is there an inflation risk from growth being driven by a rise in consumer credit?
- What is the precise relationship between the household saving ratio and the household debt ratio? (Which of these ratios is a stock and which is a flow?)
- What might cause a fall in consumer borrowing? Would this be a good thing?
- Why did consumer borrowing fall following the financial crisis of 2007–8?
- What could the Bank of England’s Financial Policy Committee do to curb consumer borrowing?
- If banks were forced to hold more reserves, how could aggregate demand be maintained? Would ‘helicopter money’ be a good idea?
- What are ‘countercyclical buffers for banks’? What are the arguments for raising them at the current time?
The UK and US governments face a conundrum. To achieve economic recovery, aggregate demand needs to expand. This means that one or more of consumption, government expenditure, exports and investment must rise. But the government is trying to reduce government expenditure in order to reduce the size of the public-sector deficit and debt; exports are being held back by the slow recovery, or even return to recession, in the eurozone and the USA; and investment is being dampened by business pessimism. This leaves consumer expenditure. For recovery, High Street spending needs to rise.
But herein lies the dilemma. For consumer spending to rise, people need to save less and/or borrow more. But UK and US saving rates are already much lower than in many other countries. You can see this by examining Table 23 in OECD Economic Outlook. Also, household debt is much higher in the UK and USA. This has been largely the result of the ready availability of credit through credit cards and other means. The government is keen to encourage people to save more and to reduce their reliance on debt – in other words, to start paying off their credit-card and other debt. That way, the government hopes, the economy will become ‘rebalanced’. But this rebalancing, in the short run at least, will dampen aggregate demand. And that will hardly help recovery!
In the following podcast, Sheldon Garon discusses his new book Beyond Our Means. He describes the decline of saving in the USA and UK and examines why other countries have had much higher saving rates.
‘He also seeks to explain why high interest rates didn’t encourage saving in the boom years and why current levels of relatively high inflation haven’t stopped savings rates shooting up again in Britain.’
Living beyond our means Guardian: the Business Podcast, Sheldon Garon talks to Tom Clark (2/11/11)
- Why have saving rates in the UK and USA been much lower than those in many other countries? How significant has been the availability of credit in determining savings rates?
- Why have saving rates increased in the UK and USA since 2008/9 despite negative real interest rates in many months?
- Explain what is meant by the “paradox of thrift”. What are the implications of this paradox for government policy at the present time?
- Why may it be difficult to have a consumer-led recovery in the UK and US economies?
- What is the life-cycle theory of consumption and saving? How well does it explain saving rates?
- Can people be given a “nudge” to spend more or to save more? If so, what nudges might be appropriate in the current situation?
- Why do countries with a more equal distribution of income have higher saving rates?
- What is the relationship between the saving rate and (a) the rate of inflation and (b) the real rate of interest? Why is this the case?
One of the structural problems facing the UK economy is that people have been borrowing too much and saving too little. As a result, vast numbers of people have been living on credit and accumulating large debts, and many people have little in the way of savings when they retire.
So should the government or Bank of England be encouraging people to save? Not according to Charles Bean, Deputy Governor of the Bank of England – at least not in the short term. While acknowledging that people should be saving more over the long term, he argues that the main purpose of the historically low Bank Rate since the beginning of 2009 has been to encourage people to spend, thereby boosting the economy. In other words, if the purpose of a loose monetary policy is to increase aggregate demand and stimulate the economy, then what is needed is increased consumption and reduced saving, not increased saving.
In the following webcast, Charles Bean gives his views about interest rates and counters the criticism that savers are being pid too little interest. He argues that for many the solution is to start drawing on some of their capital – not a solution that most savers find very appealing!
Bank of England: savers should eat into cash Channel 4 News, Faisal Islam (27/9/10)
Savers told to stop moaning and start spending Telegraph, Robert Winnett and Myra Butterworth (28/9/10)
Bean Says Bank of England Trying to Get Reasonable Economic Activity Level Bloomberg, Scott Hamilton and Gonzalo Vina (27/9/10)
Spend, spend, spend, demands Bank of England deputy governor Investment & Business News , Tom Harris (28/9/10)
International saving data (see Table 23) Economic Outlook, OECD
AMECO on line (see tables in section 15.3) AMECO, Economic and Financial Affairs (European Commission)
Economic and Labour Market Review (see Table 1.07) National Statistics
- What is meant by the ‘paradox of thrift’?
- Reconcile the argument that it is in the long-term interests of the UK economy for people to save more with the Bank of England’s current intention that people should save less?
- Is there a parallel argument about fiscal policy and government spending (see the news item The ‘paradox of cuts’?)
- What are the determinants of saving?
- Look at the data links above and compare the UK’s saving rate with that of other countries.
- What has happened to the UK saving rate over the past four years? Attempt an explanation of this.