Bad news - households are paying off their credit card bills
Back in October, the text of the Prime Minister’s speech to the Conservative party conference called upon households to pay off their credit card debts . By the time he came to deliver the speech just hours later, strong criticism of the call had caused him to back away.
Yet the latest dire economic forecasts from the Office for Budget Responsibility shows that as a description of what households were doing anyway, Mr. Cameron was broadly right – and the OBR wildly wrong. No one, though, can take any comfort from this.
The strong criticism he received is easily explained: at a time when monetary demand is already weak, households saving more to pay off their debts simply weakens demand even further. Since it is monetary demand that drives growth, at least in the short run, Cameron was in effect calling for a reduction in the rate of growth at a time when it was no more than anaemic at best.
Moreover, as several economic commentators pointed out , Cameron’s call was directly at odds with the OBR’s latest forecast, which from the second quarter of 2011 onwards, foresaw the household sector running a financial deficit, thereby adding to, rather than reducing, their debts. This, combined with steady growth in exports net of imports would help sustain economic growth even as the public sector’s financial deficit shrank. That is because the public sector deficit can only fall if the financial balances of the other three sectors (rest of the world, corporations and households) adjust to allow it to do so.
The new OBR forecast shows that what Cameron was calling for was already happening – and that household spending and saving was far removed from what the OBR had been expecting just eight months earlier.
Now, instead of households moving into deficit from the second quarter of 2011 as the OBR expected in March, it now foresees them remaining in surplus until the start of 2015: see chart. Instead of delivering a demand stimulus of 1¼% of GDP per year up to 2015, the OBR now foresees households spending behaviour depressing demand by ½% of GDP per year over that period. The total effect here – a net reduction in demand from the household sector of 1¾% a year over five years is huge.
Given that the early numbers in the graph represent revisions to the historical data published by the Office for National Statistics, part of the reason for the shift from deficit to surplus seems to represent the lingering effect of that shift in the baseline. Even allowing for this shift, however, the subsequent fall in the surplus between early 2010 and the end of 2011 is also much less than the OBR was expecting back in March.
The OBR itself explains the lower than expected economic growth by reference to “higher-than-expected inflation (which) has squeezed household incomes and consumer spending”. Even if this guess is true, it is not the whole story. If someone who is thinking of going out for a walk discovers that it is raining and stays indoors instead, it is not enough to blame the rain alone: after all, why didn’t they just put a coat on or take an umbrella? So it is with the OBR: why did households react to the inflation shock by sticking to their spending plans (but buying less because prices were higher) rather than buying what they wanted and spending more? The answer, surely, is that households are even more uncertain, anxious and fearful – our coats are increasingly threadbare and our umbrellas lost.
The words that Cameron wrote but didn’t speak in October obviously have had no time to impact on any of the OBR’s statistics, although it is possible that they might in future. But the sense of impending economic doom that this government’s words and actions have instilled in the nation since its election in May 2010 most certainly have. The Chancellor’s 2011 Autumn Statement made this much worse, conveying a sense that we now face hardship and austerity without end. The economic danger in this is that households will react by cutting spending even further so as to leave more in reserve. If that happens, both demand and growth will fall even further, presumably provoking demands from the OBR for yet more austerity still. This is a death-spiral.