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Sunday, 22 December 2013

Some notes on the UK recovery

The latest national accounts data we have is for 2013 Q3. Between 2012Q4 and 2013Q3 real GDP increased by 2.1% (actual, not annual rate). Not a great number, but it represented three continuous quarters of solid growth, which we had not seen since 2007. So where did this growth come from? The good news is that investment over that same period rose by 4%. (This and all subsequent figures are the actual 2013Q3/2012Q4 percentage growth rate.) Business investment increased (2.7%), public investment did not (0.5%), but dwellings investment rose by 8%. The bad news is that exports rose by only 0.1%. Government consumption increased by 1.0%.

Over half of the increase in GDP was down to a 1.8% rise in consumption. Not huge, but significant because it represented a large fall in the savings ratio, as this chart shows.

The large increase in saving since 2009 is a major factor behind the recession. The recovery this year is in large part because the savings ratio has begun to fall. We should be cautious here, because data on the savings ratio is notoriously subject to revision. However if we look at the main component of income, compensation of employees, this rose by 3.4%, while nominal consumption rose by 4.4%, again indicating a reduction in savings.  

So the recovery so far is essentially down to less saving/more borrowing, with a minor contribution from investment in dwellings (house building). As Duncan Weldon suggests, the Funding for Lending scheme may be an important factor here. However it may also just be the coming to an end of a balance sheet adjustment, with consumers getting their debts and savings nearer a place they want them to be following the financial crash.

I cannot help but repeat an observation that I have made before at this point. Macro gets blamed for not foreseeing the financial crisis, although I suspect if most macroeconomists had seen this data before the crash they would have become pretty worried. But what macro can certainly be blamed for is not having much clue about the proportion of consumers who are subject to credit constraints, and for those who are not, what determines their precautionary savings: see this post for more. This is why no one really knew when the savings ratio would start coming down, and no one really knows when this will stop.

Some people have argued that we should be suspicious about this recovery, because it involves consumers saving less and borrowing more. Some of the fears behind this are real. One fear is that, encouraged by Help to Buy, the housing market will see a new bubble, and many people will get burned as a result. Another is that some households will erroneously believe that ultra low interest rates are here forever, and will not be able to cope when they rise. But although these are legitimate concerns, which macroprudential policy should try and tackle, the truth is that one of the key ways that monetary policy expands the economy is by getting people to spend more and save less. So if we want a recovery, and the government does not allow itself fiscal stimulus, and Europe remains depressed because of austerity, this was always going to be how it happens. [1]

However there is a legitimate point about a recovery that comes from a falling savings ratio which is that the savings ratio cannot go on falling forever. The moment it stops falling, consumption growth will match income growth. The hope must be that it will continue for long enough to get business investment rising more rapidly, and for the Eurozone to start growing again so that exports can start increasing. But the big unknown remains productivity. So far, the upturn in growth does not seem to have been accompanied by an upturn in productivity. In the short term that is good because it reduces unemployment, but if it continues it will mean real wages will not increase by much, which in turn will mean at some point consumption growth will slow.

There is a great set of graphs in this post at Flip Chart Fairy Tales which illustrate the scale of the productivity problem. (Rick - apologies for not discovering your blog earlier.) For example the OBR, in November 2010, were expecting real wages in 2015 to be 10% higher than in their recent Autumn Statement forecast. We will not recover the ground lost as a result of the recession until productivity growth starts exceeding pre-recession averages. As Martin Wolf and I suggest, the Chancellor should be focusing on the reasons for the UK’s productivity slowdown rather than obsessing about the government’s budget deficit.

[1] In theory it could have happened through a large increase in investment. However the experience of the recession itself, and more general evidence, suggests that investment is strongly influenced by output growth. That is why investment has not forged ahead as a result of low interest rates, and why firms continue to say that a shortage of finance is not holding them back. Having said that, I would have prefered the government to try fiscal incentives to bring forward investment rather than implement measures aimed at raising house prices. 


  1. Prof Wren-Lewis,

    As you rightly say, if saving ceases to fall, aggregate demand will decline (or cease rising). You then say “The hope must be that it will continue for long enough to get business investment rising more rapidly, and for the Eurozone to start growing….”

    I think that’s a bit fatalistic. I’d rather see you repeat the message that the deficit is the counterpart to private sector saving (as MMTers keep pointing out). At least that’s the case for a closed economy (just to keep things simple). And the deficit is wholly within the control of a country that issues its own currency. So there’s no need to sit around hoping that “business investment” or the Eurozone make up for any drop in demand caused to the private sector saving too much.

    I know Osborne doesn’t like deficits, but how much economics does he understand?

  2. For what it is worth, there may be some evidence that UK households are becoming less constrained by worries about credit if my reading of the latest survey of household finances reported in the Bank of England's latest Quarterly Bulletin (2013 Q4) is correct. Details here
    Thanks for your always useful and informative blog.Ian Bright

  3. A very disturbing picture about the working poor by Flip. The reasons must be structural - technological change, historically very high rates of low wage immigration (no wonder UKIP is doing well). You can't blame the conservatives for this. We have tried unconventional monetary policy, it is now time to consider unconventional labour market pollicy. Just leaving this to the market and hoping that ending macro policy contraction will fix it is not enough.

  4. Do you think not enough emphasis is put on international aspects?

    'A balance of payments deficit means a country cannot pay its own way in the world. Of course the country can 'plug the hole' by borrowing for a while, but eventually, it will have to lower the value of its currency, thereby reducing its ability to import, and thus its living standard.'

    from ''23 things They don't tell you about Capitalism'' by Prof Ha-Joon Chang

  5. I will give a political scientist rather than an economist answer.

    It is true for small countries on the gold standard.

    It is less true for hegemonic powers whose currencies underwrite the international monetary system. Such currencies are safe havens and are threatened only if their hegemony is threatened. They are not immediately threatened by BOP deficits.

  6. Have a look at inventories as well.
    In the US more than half of the growth can be attributed to increasing inventories. Which (much more and much faster than savingrates) cannot go on for ever. Effectively the large corps already have stopped further increases.

    You cannot predict in anyway how savingrates will go when there is a climate of huge uncertainty (like now). The short term trend might point into one direction but when you get 2-3 months with bad or good news it can turn.
    However unless it is for catch up demand it is a clear sign of consumer confidence rising.
    But the same as savingrates goes for consumer confidence.
    You need a clear long term trend (in things as consumer confidence) to get proper indications and there simply isnot. Now we see a lot of talking things up but that is already falling apart (why would the ECB do the things it does and talk about further measures if the economy is catching up simply doesnot combine). Anyway hard to see this talking up will work so there will be a reversion as always. Stockmarkets at all time highs in a lousy unstable economic (sort of ) recovery simply indicate a bubble. And look at the trend extrapolate it and it will get to complete unrealistic highs and not too far from now (now people are riding the wave, believing that there are always greater fools). Anyway within a year or so or likely shorter things will collapse. No QE can help that. It only can keep things up when there is no market panic. Same as with bonds CBs can catch new supply but when the existing holders are starting to sell massively there is no money in the world that can stop it.

    Anyway hard to see how the UK could sustain this while its by far largest tradingpartner is at around zero growth (although the UK especially does more business with its North that looks better than their average). US not getting back to a structural growth (combined with no deficits) and structural EM growth getting down.
    It does a good job in moving from the bad markets and it is not linked that tight to it by things as the same currency. And compared to the EZ Cameron and Co are at least trying to increase dynamism in society/the economy. While all transfer backs to the man in the street in Europe are basically simply caused by running out of money by governments.
    Anyway hard to see how 2-2.5% structural growth can be achieved in a worldeconomy that sucks and likely will be doing that for the next couple of years.

    Also now it becomes clear that part of the growth came from immigration (simply incresing the numbers) while you have to look at per capita.
    My guess we will see a structural growth in countries like the UK of say 1% or just above that. Of which a lot should be used to pay for the cost of aging (hardly less than 1%, allthough parts (roughly half) will show as increased GDP in the books, doubtful if the man in the street will see it that way.
    Add the trend that lower incomes are under downward pressure and higher under upward worldwide looks like a not very stable political (and economical) situation.
    Will be fun to watch.


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