The Consumption and Saving Trend of the UK Households’

September 14, 2011

I wrote this article for Positive Money. It was first published on the Positive Money Website on September 14, 2011. You can also read it on I am publishing this on my blog so that people who access to my blog read this as well.

Households saving is the proportion of disposable income that is not spent on consumption, or alternatively the difference between current income and current consumption. Households’ decisions to save or spend plays a key role in the determination of aggregate demand and their willingness to spend on final goods and services. It has a key effect on economic outlook of the UK because 60 percent of contribution in the consumption of the UK is by consumer sector. The saving ratio of the UK fell steadily from 1995 – 2007 but increased by the end of 2008 and 2009. The output of the UK also fell over 5 ½ percent in 2007.

Berry and Williams in their paper “Household Saving” explained that either saving or debt can be used to accumulate assets by households. They used the following equation to explain this:

S+D = A+H


S= Saving


A=Financial Assets (deposits and shares)

H= Housing Assets

This means that households can acquire financial assets or housing assets by saving or by obtaining debt. In practice some of the households will be obtaining debt to increase the amount of funds for consumption and some of the households will be saving. But during the last decade saving ratio of the UK households has decreased and household debts have increased markedly.

Saving ratio in the UK has declined since 1992 as the household sector increased its consumption expenditure. The increase in rate of consumption was greater than the increase in disposable income which means that households acquired huge debt to finance their consumption expenditure. Following figure shows the decline in consumption of households in 2007.

The households saving ratio declined from around 10 percent in the mid – 1990 to around 2 percent in mid 2007 and then -0.7 percent in 2008. It then increased to 4 percent in 2009. The following figure shows the actual saving ratio and inflation adjusted saving ratio.

 The households saving ratio declined over last decade due to low interest rates, low inflation, excessive lending by banks to households sector, loose credit conditions, high asset prices and an economic boom (naturally fuelled by debt).

According to the modern consumption theory, which is based on Friedman’s “life-cycle permanent income” model, households decide on their current spending on their expected future income. If they expect the income to be higher today than in future than they will save today and if they expect the income to be lower now than expected future income than households will ‘dis-save’ (by borrowing or using ‘saving’ assets for consumption). [Of course, this theory is very much open to dispute – ed.]

The ‘risk-free real interest rate’ is also one of the key determinants of the households consumption and saving. In economic conditions with low interest rates, the saving ratio is also low because the households are able to borrow  easily to fund their consumption (because increase in house prices provide more collateral against which they can borrow more). A higher real interest rate encourages consumers to spend less at the moment to maintain their real value of money by saving higher interest receipts.

Over a last decade long term interest rate of the UK was at historically low levels making possible for households to obtain credit easily. The spread between bank rate and mortgage rates narrowed to around 50 basis point from 100 basis points at the end of 2006. This encouraged the households to increase their consumption and reduce savings.

The increase in consumption and decrease in saving of households was not a result of their expectation of high future income but due to easy availability of credit. Banks played a crucial role in influencing consumption and saving pattern of the households. The excessive lending by banks  in the form of secured (mortgage) and unsecured (credit cards, overdrafts etc) encouraged the borrowers to increase their consumption and decrease saving over last ten years period. The consumption and saving trend reversed during economic slowdown.

Households decisions to save or spend are dependent on their expectation of future economic growth and easy availability of credit. Households increased their saving during the financial turmoil because they were uncertain about future positive growth prospects, non-availability of credit in the economy, increased job uncertainty, decrease in net financial wealth, and lower expected future income.

Increase in unemployment and low future expected income was major causes that encouraged households to increase their savings and cut consumption. Unemployment in the UK increased sharply during the financial crisis. Unemployment rate rose over 2 ½ percentage points over the past two years. Households expected increase in unemployment and prolonged period of economic slowdown so they cut their spending. Following figure shows the households expectation of unemployment.


GDP growth of 0.2 percent in the second quarter caused households to revise their expected future income. Following figure shows that households are expecting to have low future income.

Due to financial turmoil and uncertain future economic conditions consumers responded by cutting back their consumption / spending. Households are now trying to save for debt repayment and to maintain their real value of money. This adjustment in saving will have important consequences on the economic outlook keeping in mind the role of households spending in the aggregate demand.

Reduction in consumption by households will push down economic outlook and eventually households income because businesses will cut their capital spending that leads to low job creation in the economy. The drag on households income will make it harder for them to increase their saving which mean that we don’t see increase in consumption by households in near future.

If banks continue to invest in mortgages and speculative investments we will soon be witnessing another economic boom and bust. Banks should invest in productive sector of the economy particularly to Small and Medium Businesses that contribute to the economic development, create employment opportunities, increase saving of households, lead to stable consumption and spending in the economy and reduce vulnerability of output in the economy and for businesses.


Should We Expect A Decrease in Unemployment and Poverty?

August 24, 2011

I wrote this article for Positive Money. It was first published on the Positive Money Website on August 24, 2011You can also read it on I am publishing this on my blog so that people who access to my blog read this as well.

Poverty is one of the most prominent problems of the entire world. Numerous measures have been taken world wide to reduce poverty but it is still a burning issue. It is particularly much discussed in the post financial crisis period because an economic slowdown affects businesses, who cut back on production and costs, which in turn leads to an increase in unemployment. Unemployment is the main cause of poverty with other factors such as higher indirect taxes, high inflation that take higher percentage of low income group leading to low disposable income.

The unemployment rate of UK over the last seventeen (17) years was highest in early 1990s.  The unemployment rate in early 1990s was around 12 percent in Inner London, 10 percent in London, 9 percent in Outer London and 7 percent in the rest of England.

Unemployment rate started to decrease due to expansion of financial sector as banks had excess liquidity and these banks lent to health sector, construction, education, real estate, public administration and defense (but predominantly real estate and property). These sectors contribute more than 58 percent of GDP. Over the last decade these sectors also expanded due to excessive credit extension (i.e. too much lending) leading to decrease in unemployment.

During the financial crisis when the entire economy collapsed the unemployment rate rose significantly in the entire UK. The following graph shows the unemployment rate during the financial crisis.

Unemployment, Inner, Outer, London and rest of England

Labour Force Survey stated that in 2007 due to economic breakdown the unemployment rate in Inner London was 6 percent, and 5 percent in Outer London. In 2009 unemployment rate for Inner London and Outer London both were around 7 percent. It is important point to note  that the unemployment rate gap was wider between London and the rest of England from early 1990s till 2007 but it was nearly equal in 2009 which means that due to financial crisis increase in unemployment was witnessed in entire UK.

The number of part time workers also grew by 8 percent from 760,000 in 2007 to 825,000 in 2009. The increase in part time workers was due to the fact that they were not able to find full time jobs.

The increase in unemployment also leads to increase in Job Seekers’ Allowance, which is a drag on public finance (although a very small proportion of government revenue goes towards job seekers’ allowance). The following figure shows the increase in job seekers allowance payment. The highest increase was in the West Midlands and North East.

The high inflation rate is also pushing low income households in poverty by decreasing their purchasing power. Inflation rate in the UK is 4.4 percent against a target inflation rate of 2 percent.

The UK economy recorded a growth of only 0.2 percent in the second quarter and with lending cut by banks means that there will be negligible growth of the economy as eight largest sectors, which contribute around 58 percent of economic output, are dependent on private borrowing. This means that we should expect further increases in unemployment and higher levels of poverty going forwards.

The Consequences of UK Household Debt

August 20, 2011

I wrote this article for Positive Money. It was first published on the Positive Money Website on August 20, 2011 (at 7.00 a.m.). You can also read it on I am publishing this on my blog so that people who access to my blog read this as well.

The financial sector is an effective tool that can contribute to the economic development of the country. It can help in the expansion of business, assist in the expansion of the productive sector of the economy that contribute more to GDP growth and reduce poverty in the economy. Banks are important part of the financial sector that can have a significant influence on the economic growth. Over the last two decades banking sector grew phenomenally and accounted for an increased share of GDP, of corporate profits, and of stock market capitalization.

In theory, banks are the channel through which savings are channeled into the productive activities that are crucial for growth and general welfare. Households and firms provide their savings to the banks and banks act as intermediaries to supply funds from lenders to the ultimate borrowers which are mainly firms, governments and households. If the banks are making productive investments it will lead to sustainable growth of the economy. But since last decade banks have been making speculative and non-productive investments that led us to the financial crisis.

Average private borrowing by banks from 2003 till 2010 increased at 11.2 percent of GDP but it decreased to £16 billion in 2008-09 from £114 billion in 2007-08 due to the financial crisis. This had a significant impact on the economic growth since the eight largest economic sectors of the UK are dependent upon borrowing.

Household debt was one of the major concerns during the financial crisis. During the last decade banks lending to households in the form of secured (mortgage) and unsecured (credit cards, overdrafts etc) increased more than 50 percent. The households’ debt stood at over £1.4 trillion at the end of 2010. Out of total debt of £1.4 trillion in 2010, £1.24 trillion (85 percent) accounted for secured debt (mortgages) and £216 billion (15 percent) accounted for unsecured debt.

The average house price grew from £40,000 in 1987 to over £170,000 in 2006. The increase in housing prices increased the consumption of households’ as they borrowed against the increase in home equity due to the easy availability of credit. During 2007 the consumption fell sharply due to credit crunch. Total household resources and household final consumption expenditure was negative in Q3 of 2008 and Q1 of 2009.

This decrease in household consumption affected the GDP growth of UK as private consumption is an important contributing factor in the GDP growth of the economy. In the UK 60 percent of consumption is by the household sector. The household sector alone has a direct impact on the economic growth of UK. As long as households were able to obtain debt finance their consumption could grow but as soon as banks stopped lending, their consumption decreased and so did economic growth.

High household debt accumulation decreased the purchasing power of the households. Bank of England estimates that 13 percent of households spend more than 35 percent of their income on debt repayments and 18 percent of households with unsecured debt spend more than one-fifth of their income servicing unsecured debt payments.  One fifth of the households with mortgages spend 20 percent of their gross income on mortgage repayments, 13 percent are spend more than 35 percent on debt repayment cost and 6 percent of households have debt repayment ratio greater than 50 percent.

Monthly average budget (income receipts minus expenditures) position of the low income group households declined from £51 in 2005 to -£450 in 2010.Many households are breakeven and even a slight increase in their expenditure will tip them into indebtedness unless they have any other source of saving. This means that households will have to borrow more in order to maintain their consumption levels which will further decrease their purchasing power as they will allocate large proportion of their disposable income for repayment of debt, leading to further decrease in their monthly budget position.

Saving ratio (proportion of disposable income not contributed for final consumption) also declined during the last decade due to increase in final consumption. The saving ratio declined to -0.7 percent in 2008. It increased to 8.4 percent in 2009 due to households response to uncertain economic conditions and holding of liquid assets. The large difference between property income receipts and property income payments also contributed to increase in saving ratio as many homeowners exploited the financing  by banks by obtaining ‘buy to let’ mortgages.

Office for Budget Responsibility (OBR) projected that debt will rise to 175 percent of household income by 2015 compared with 160 percent in 2010. OBR estimated that households debt will rise over £1,700 billion by 2012 and £2,100 billion by 2015.  This will have a drag on households personal finances and their ability to save for future that will lead to financial vulnerability.

Currently 29 percent of households with no savings have debt to income ratio of more than 60 percent. If this level of debt is made available in the economy by the banks, this means further increase in credit in the economy, asset prices boom and another financial crisis.

If UK banks continue to lend to make speculative and non- productive investments, particularly mortgages, we will be facing another crisis in near future because UK economy needs more debt to sustain growth and prevent a depression. More debt means more interest and more interest payments means less purchasing power. This means that we need more debt to service and this cycle continues until we enter into another recession when this cycle breaks down.

Bank Capital Requirements

August 19, 2011

Bank capital requirements will play an important part in the global economic recovery since banks do not have sufficient liquidity to lend to the private sector that is hampering the economic growth. The total credit to GDP ratio is an important indicator over or under supply of the lending in the economy. This ratio has decreased markedly after 2007.

The figure shows that credit to GDP ratio as per Bank of England calculation has decreased in  2010.  The credit growth in the economy has been low in 2010 particularly to small and medium business that do not have access to capital markets unlike their large counterparts.

 The capital requirements of banks might hamper the economic growth more as the current international and domestic conditions suggest that contraction in the lending will continue in near future. Considering the current economic conditions, should the regulators relax the capital requirements in the short term enabling the economic to recover?

Are We Facing Series of Crises?

August 18, 2011

I was on the way to home from office when I heard two guys talking about the slowdown in the economic conditions and that they were lucky enough to secure their jobs despite the cut in their monthly pay. It was when that I came across the ‘feature’ in the newspaper about rental trends  . The feature starts like this: “Heard the one about the Russian, the Spaniard and the American? They were all trying to rent the same house in Brompton Square. The Russian thought it was his when he bid £5,000 a week for a five years term. But he was gazumped by the Spaniard who then gazumped by the American, who offered £8,000 a week”.

The American who rented the house will be paying over £2 million over a five years term, amount enough for a low-income family to buy a house in nice suburb. This depicts that, we are, and will be heading towards a series of crisis. With inflation over 4.5 percent against a target of 2 percent, this is another drag on the households’ disposable income who are at the moment hardly meeting their consumption needs.

Rents have increased over 14.5 percent over the past year eventually pushing average selling price of house over £450,000 last month. The rents are expected to increase due to the increase in population of the city in terms of migrants and expected increase in number of students who can afford to pay high rents to live in smarter areas. The increase in population of the City due to Olympic next year will also fuel up the rents of the City.

The households who rented properties due to financial crisis rather than buying (taking out mortgages) no longer can think to become homeowners due to drag on their income that will probably be long-lasting.

The surge in rents will take the major proportion of their disposable income forcing the households to cut down their consumption even further, thereby further depressing the economic conditions. If appropriate measures are not taken soon we will be witnessing ‘no economic growth’ which has expanded ‘negligible’ 0.2 percent in the second quarter of 2011 over first quarter.