Has The Boe Got Its Sums Wrong?

[FreeTrader]

Mervyn King has come under criticism from a number of economists recently for what is seen as an overly rosy view of the UK economy. The BoE seems to be expecting growth to revert to trend by the end of the year. In particular, Merv has stated that he expects consumer spending growth to recover from last year's dip.

You can get an idea of the logic behind this from the BoE Inflation Report:

In principle, a downward revision to permanent income should lead to reduced consumption growth for a period, as households move to a lower spending path. But once that adjustment is complete, spending growth is likely to revert to a growth rate more in line with its historical trend. So it is possible that the temporary dip in consumption growth can at least in part be explained by households adjusting to a lower level of permanent income.

What they appear to be saying is that if, for example, your disposable income was 100 and it fell to 98, there would be temporary stall in spending, but a year later you would spend (say) 101.92 instead of 104, and thus the *percentage* increase would be the same, 4%. So the *rate* of spending growth would revert to normal.

But let's look at this from a different viewpoint - household disposable income at a time of an exponential rise in debt. First look at this web page, which shows the response from the National Statistician to two House of Commons questions from Vince Cable on personal debt:

Response to Parliamentary Questions

These figures differ slightly from the ones we're familiar with because they include 'non-profit institutions serving households (NPISH) sectors' (also the 'Average Household Personal Income' heading is misleading, as the figs have been converted to individuals). But for the purpose of this argument there's not really much difference.

Note that in the second table, between 2000 and 2001, household disposable income increased by a very healthy £42b, or 6.5%. Between 2003 and 2004 however, the increase was only £26b (3.5%). The BoE ascribe this to higher taxation, and remarked that there's no sign of any recovery yet:

But there has been little sign yet of a pickup in quarterly post-tax income growth in 2005, though data for Q4 are not yet available.

So let's say that in 2005 the growth rate in disposable income stayed at 3.5%. This gives an increase of £27b in disposable income.

Now think about the total debt figure, which the NS says was 155% of disposable income at end 2004. This gives total debt of £1194b (770.23 * 1.55). That debt would have increased by some 10% in 2005, meaning that these households took on some £120b in extra debt. The interest on that extra debt would be roughly the same 8.3% as in 2004 (might actually be slightly higher in 2005 despite the recent cut - see the BoE tables), meaning that an extra £10b of interest would have to be paid.

Remember also though (as Professor Wynne Godley keeps having to point out) that capital repayments have to be made on all that new debt, which further eats into disposable income. Let's say those repayments are £3b. Altogether then we have a whopping £13b in debt servicing costs coming straight off our extra £27b disposable income, leaving just £14b to play with. That's a nominal increase of 1.75%, which is below the rate of inflation - in other words a *fall* in real spending power.

It's very hard to see how we're going to get the sort of spending recovery that Merv is predicting unless:

A ) Taxes fall

B ) Wage growth accelerates

C ) Interest rates fall

If we get A then my views on pigs being able to fly will change.

If we get B then interest rates may have to rise in response.

If we get C (which I think is likely) then we're just putting off the evil day, because the reponse from households will be to just pile on more debt. It's not a solution.

This just goes to demonstrate why the idea that HPI is good for the economy is a complete myth. Debt servicing costs are creating an ever greater drag on the economy which could well lead to years of low growth. It's a yoke which the UK will have round its neck for a decade or more.

Am I missing something?

[Elizabeth]

I actually don't believe that option C will lead to greater credit spending. The tide has turned in terms of media and therefore people attitudes. Of course that could turn around on a pin head, but at the moment, there are too many bankrupcies out there, and I think that has reached critical momentum from the past 7 years and can't be averted at this point so will continue to be news. It also puts the most prolific spenders out of the picture for the next 7.

[FreeTrader]

I actually don't believe that option C will lead to greater credit spending. The tide has turned in terms of media and therefore people attitudes.

Elizabeth,

I agree that there's more awareness about these issues now, but I'll believe the tide has turned when I see those monthly rates of debt growth in the BoE stats start to decrease. There's been the beginnings of a slowdown in the rate of growth of unsecured debt, but secured has actually accelerated.

The party's still rocking.

[Guest Charlie The Tramp]

This just goes to demonstrate why the idea that HPI is good for the economy is a complete myth. Debt servicing costs are creating an ever greater drag on the economy which could well lead to years of low growth. It's a yoke which the UK will have round its neck for a decade or more.

Mervyn King said a while back the next ten years will not be the same as the last ten years and I agree with that statement one hundred percent.

Am I missing something?

In one word <NO>.

BTW great post.

[Elizabeth]

Elizabeth,

I agree that there's more awareness about these issues now, but I'll believe the tide has turned when I see those monthly rates of debt growth in the BoE stats start to decrease. There's been the beginnings of a slowdown in the rate of growth of unsecured debt, but secured has actually accelerated.

The party's still rocking.

Fair enough comment. I guess what we don't understand we often forget to see

[DavidGold]

I recall the debt is now (2005) £1158bn - The Telegraph had an article on this in the past few days as debt now exceeds GDP by approx £30bn.

Capital on debt may have to be repaid: the big question is when? Credit cards are the traditional "never, never" and more mortgages are interest only than was previously thought (buried somewhere in here:

http://www.cml.org.uk/cml/filegrab/Newmort...L_.pdf?ref=4635

It is interesting to note the Nationwide has started asking for proof/confirmation (I cannot off-hand remember which) that borrowers actually have set up a scheme to repay the capital.

Of course, the rising IVAs and bankruptcies means some debt is not repaid.

All the above notwithstanding, your general point that this debt will act as a big drag on economic GROWTH is correct. If you think it is bad now just wait until you have to make compulsory pensions contributions. That too can be put off - the Turner Report took 3 years - but the longer it is left, the worse the problem will get. We Brits are so smug thinking Japanese style prolonged deflation can't happen to us: I'm not so sure.

PS - Yes interest rate cuts will lead to more debt: when were they last cut? August. When did the sucker's rally start? August. Just because some / many are cutting back, does not mean that significant numbers - enough to pose a risk to the economy - will not continue their optimistic / ignorant ways.

[pyewackitt]

V. Good Post!

Especially the BoE inflation report link:

"It is unclear whether long-term real interest rates will remain at their current levels. Furthermore, if investors use the current low level of long rates to value the flow of returns that they expect to recieve from other assets, then an unwinding of recent falls in the long rates could trigger a broadly based decline in asset prices. But if long rates remain at their current low levels that could support asset prices, and ultimately demand." BoE inflation report p.6

The MPC may get the rates wrong but they can see exactly where this is all heading.

Only they fail to consider that if rates remain at current low levels then borrowing will keep growing and the risk of an even larger fall becomes greater.

- Pye

Edited February 16, 2006 by pyewackitt

[FreeTrader]

pyewackitt,

I thought the best quote from the Inflation Report was at the end of page 12. It's an absolute classic:

Households’ current income alone can also materially affect consumer spending. That is because some households have few financial assets and find it difficult to access credit. Those households may be constrained to consume out of their current resources irrespective of the likely path of future

income.

God forbid that some poor souls can only spend what they earn. How degrading...

[bazzzzzzz]

Capital on debt may have to be repaid: the big question is when? Credit cards are the traditional "never, never" and more mortgages are interest only than was previously thought (buried somewhere in here:

http://www.cml.org.uk/cml/filegrab/Newmort...L_.pdf?ref=4635

Here it is.

Methods of Repayment

The RMS shows 69% of loans taken out with capital plus interest repayment type, 7% lower than

the SML (Chart 8). Again this is partly due to lenders reporting different figures in the RMS

than they did for the SML, and partly because there are a number of lenders now reporting in the

RMS who have different lending profiles to those in the SML. RMS also shows a greater

proportion of interest-only mortgages where the repayment vehicle is unspecified. In many cases

there will be a repayment vehicle attached to these loans. But because borrowers are not required

to specify the vehicle, lenders cannot provide this information to us.

[FreeTrader]

Dave & Baz,

Thanks for your comments. My £3b figure was just picked out of the air, and may well be less if a good proportion of secured borrowing is interest only.

Also I should stress that a proportion of this year's fix of new borrowing will boost the £14b extra disposable income I discuss in my post. Maybe that's what Merv is relying on. As long as everyone keeps piling on the debt, the train can keep moving.

[GCS15]

2006 my pay drops by $5k

2007 my pay rises by $7k you bet I'll still be smarting from the previous years kick in the pants. In addition I'll be saving just in case 2008 brings a nasty surprise.

My point is that people won't be forgiving of a downturn

[Guest Charlie The Tramp]

As long as everyone keeps piling on the debt, the train can keep moving.

Then on the return journey many more will be joining the other train.

The Return Journey

[Ignorant Steve]

Mervyn King has come under criticism from a number of economists recently for what is seen as an overly rosy view of the UK economy. The BoE seems to be expecting growth to revert to trend by the end of the year. In particular, Merv has stated that he expects consumer spending growth to recover from last year's dip.

You can get an idea of the logic behind this from the BoE Inflation Report:

What they appear to be saying is that if, for example, your disposable income was 100 and it fell to 98, there would be temporary stall in spending, but a year later you would spend (say) 101.92 instead of 104, and thus the *percentage* increase would be the same, 4%. So the *rate* of spending growth would revert to normal.

But let's look at this from a different viewpoint - household disposable income at a time of an exponential rise in debt. First look at this web page, which shows the response from the National Statistician to two House of Commons questions from Vince Cable on personal debt:

Response to Parliamentary Questions

These figures differ slightly from the ones we're familiar with because they include 'non-profit institutions serving households (NPISH) sectors' (also the 'Average Household Personal Income' heading is misleading, as the figs have been converted to individuals). But for the purpose of this argument there's not really much difference.

Note that in the second table, between 2000 and 2001, household disposable income increased by a very healthy £42b, or 6.5%. Between 2003 and 2004 however, the increase was only £26b (3.5%). The BoE ascribe this to higher taxation, and remarked that there's no sign of any recovery yet:

So let's say that in 2005 the growth rate in disposable income stayed at 3.5%. This gives an increase of £27b in disposable income.

Now think about the total debt figure, which the NS says was 155% of disposable income at end 2004. This gives total debt of £1194b (770.23 * 1.55). That debt would have increased by some 10% in 2005, meaning that these households took on some £120b in extra debt. The interest on that extra debt would be roughly the same 8.3% as in 2004 (might actually be slightly higher in 2005 despite the recent cut - see the BoE tables), meaning that an extra £10b of interest would have to be paid.

Remember also though (as Professor Wynne Godley keeps having to point out) that capital repayments have to be made on all that new debt, which further eats into disposable income. Let's say those repayments are £3b. Altogether then we have a whopping £13b in debt servicing costs coming straight off our extra £27b disposable income, leaving just £14b to play with. That's a nominal increase of 1.75%, which is below the rate of inflation - in other words a *fall* in real spending power.

It's very hard to see how we're going to get the sort of spending recovery that Merv is predicting unless:

A ) Taxes fall

B ) Wage growth accelerates

C ) Interest rates fall

If we get A then my views on pigs being able to fly will change.

If we get B then interest rates may have to rise in response.

If we get C (which I think is likely) then we're just putting off the evil day, because the reponse from households will be to just pile on more debt. It's not a solution.

This just goes to demonstrate why the idea that HPI is good for the economy is a complete myth. Debt servicing costs are creating an ever greater drag on the economy which could well lead to years of low growth. It's a yoke which the UK will have round its neck for a decade or more.

Am I missing something?

Good post and one I broadly agree with.

Taxes will be cut, both personal and corporation. Public spending will be slashed, public sector employment will be reduced.

When? Don't know. I think Gordon Brown was thinking a few years ago that he might reduce taxes last year. He may well panic in the run up to the next election and cut taxes anyway.

I think only the Conservatives would have the bottle to fight an election on the promise of tax cuts know ing full well that that means a massive rise in unemployment.

It's going to be a painful 10 year period.

[Guest Charlie The Tramp]

Taxes will be cut, both personal and corporation. Public spending will be slashed, public sector employment will be reduced.

I agree Public spending will have to be slashed, but tax cuts very unlikely. Gordon Brown is a

psychopathic pickpocket. To be fair he only picks the pockets of the prudent and the hardworking.

[The Masked Tulip]

How do you slash public spending? That means jobs going surely and that means anyone in a job for more than 2 years getting some kind of pay-off. Plus, you then have them on benefits and not contributing to the economy - i.e. retail spending - so you often end up worse off. This is exactly what Labuor argued in the 1980s when the Tories had about 6 million officially unemployed.

[Marina]

How do you slash public spending? That means jobs going surely and that means anyone in a job for more than 2 years getting some kind of pay-off. Plus, you then have them on benefits and not contributing to the economy - i.e. retail spending - so you often end up worse off. This is exactly what Labuor argued in the 1980s when the Tories had about 6 million officially unemployed.

There is only one way to slash public spending. You stop employing more public servants and let natural wastage start to reduce their numbers.

Have to say I don't recall ever having 6 million officially unemployed in the 1980s. Where did you get that figure from?

I saw a figure somewhere yesterday that said 9.75 million adults of working age in this country do not work.

It does not matter what the circumstances are - employing people by the state is a sure way to ruin an economy. Look at the countries over the years that have tried to have everyone employed by the state - did any of them have a successful economy - no, they had corruption, inefficiency and poverty. This is where we are heading. The mess this government have got us into will take a generation to sort out. They may have terminally ruined what was a pretty successful economy when they came to power in 1997.

[George Mainwaring]

At the time, the early 80's unemployment figure was quoted as being 3 million. This was a significant number since that was the unemployment figure during the 1930's depression (at least that was said in the early 1980's - I havn't checked these numbers).

I had a horrible though this morning whilst walking the dog, what if Mr Clown gets to be PM soonish and calls a snap general election before the shit really hits the fan. We could be stuck with him for years as he frantically tries to avoid the inevitable recession. I suspect if you cut him in half (form an orderly que please) it would say "Harold Wilson".

[Guest Charlie The Tramp]

I suspect if you cut him in half (form an orderly queue please) it would say "Harold Wilson".

Surely not.

Harold Wilson, who won four General Elections as Labour leader, is often regarded as one of the more intellectual politicians of the twentieth century.

[CrashIsUnderWay]

Good post and one I completely agree with.

Taxes can't be cut, either personal and corporation, and public spending can't be slashed, because if public sector employment is reduced they just end up on the dole.

When? Don't know. I think Gordon Brown was thinking a few years ago that he might be able to reduce taxes last year as a lead in to No 10. He may well panic in the run up to the next election and try to cut taxes anyway, which is what all inciumbent governments normally do.

I think only the Conservatives would have the bottle to fight an election on the promise of tax cuts know ing full well that that means a massive rise in unemployment.

It's going to be a painful 10 year period, especially for overleveraged landlords.

[Ignorant Steve]

Good post and one I completely agree with.

Taxes can't be cut, either personal and corporation, and public spending can't be slashed, because if public sector employment is reduced they just end up on the dole.

When? Don't know. I think Gordon Brown was thinking a few years ago that he might be able to reduce taxes last year as a lead in to No 10. He may well panic in the run up to the next election and try to cut taxes anyway, which is what all inciumbent governments normally do.

I think only the Conservatives would have the bottle to fight an election on the promise of tax cuts know ing full well that that means a massive rise in unemployment.

It's going to be a painful 10 year period, especially for overleveraged landlords.

What a buffoon you are CIUW.

Take a holiday and relax.

How do you slash public spending? That means jobs going surely and that means anyone in a job for more than 2 years getting some kind of pay-off. Plus, you then have them on benefits and not contributing to the economy - i.e. retail spending - so you often end up worse off. This is exactly what Labuor argued in the 1980s when the Tories had about 6 million officially unemployed.

You're thinking too short term. Yes for a few years the economy is in recession. And for the 3 - 4 million unemployed it's going to be horrible. Just like the eighties. Benefits will be gradually reduced, invalidity benefits will be managed much more rigorously.

However for all those in employment reduced taxes mean a slightly enhanced consumption opportunity although sentiment will initially prevent profligate spending. Eventually the "green shoots of recovery will be seen" and off we go again.

Lets all hope CIUW is one of the economic casualties eh?

[Without_a_Paddle]

Mervyn King has come under criticism from a number of economists recently for what is seen as an overly rosy view of the UK economy. The BoE seems to be expecting growth to revert to trend by the end of the year. In particular, Merv has stated that he expects consumer spending growth to recover from last year's dip.

You can get an idea of the logic behind this from the BoE Inflation Report:

What they appear to be saying is that if, for example, your disposable income was 100 and it fell to 98, there would be temporary stall in spending, but a year later you would spend (say) 101.92 instead of 104, and thus the *percentage* increase would be the same, 4%. So the *rate* of spending growth would revert to normal.

But let's look at this from a different viewpoint - household disposable income at a time of an exponential rise in debt. First look at this web page, which shows the response from the National Statistician to two House of Commons questions from Vince Cable on personal debt:

Response to Parliamentary Questions

These figures differ slightly from the ones we're familiar with because they include 'non-profit institutions serving households (NPISH) sectors' (also the 'Average Household Personal Income' heading is misleading, as the figs have been converted to individuals). But for the purpose of this argument there's not really much difference.

Note that in the second table, between 2000 and 2001, household disposable income increased by a very healthy £42b, or 6.5%. Between 2003 and 2004 however, the increase was only £26b (3.5%). The BoE ascribe this to higher taxation, and remarked that there's no sign of any recovery yet:

So let's say that in 2005 the growth rate in disposable income stayed at 3.5%. This gives an increase of £27b in disposable income.

Now think about the total debt figure, which the NS says was 155% of disposable income at end 2004. This gives total debt of £1194b (770.23 * 1.55). That debt would have increased by some 10% in 2005, meaning that these households took on some £120b in extra debt. The interest on that extra debt would be roughly the same 8.3% as in 2004 (might actually be slightly higher in 2005 despite the recent cut - see the BoE tables), meaning that an extra £10b of interest would have to be paid.

Remember also though (as Professor Wynne Godley keeps having to point out) that capital repayments have to be made on all that new debt, which further eats into disposable income. Let's say those repayments are £3b. Altogether then we have a whopping £13b in debt servicing costs coming straight off our extra £27b disposable income, leaving just £14b to play with. That's a nominal increase of 1.75%, which is below the rate of inflation - in other words a *fall* in real spending power.

It's very hard to see how we're going to get the sort of spending recovery that Merv is predicting unless:

A ) Taxes fall

B ) Wage growth accelerates

C ) Interest rates fall

If we get A then my views on pigs being able to fly will change.

If we get B then interest rates may have to rise in response.

If we get C (which I think is likely) then we're just putting off the evil day, because the reponse from households will be to just pile on more debt. It's not a solution.

This just goes to demonstrate why the idea that HPI is good for the economy is a complete myth. Debt servicing costs are creating an ever greater drag on the economy which could well lead to years of low growth. It's a yoke which the UK will have round its neck for a decade or more.

Am I missing something?

You forgot

D) Borrow more billions and increase public spending yet more...

(What was that about a "Golden Rule"?....)

I would expect to see a bit of C) and D) followed by a general election and then lots of the opposite of A)

(i.e. MORE TAX to foot the bill) and increased inflation.

Edited February 17, 2006 by Without_a_Paddle