economic Essay example

Words: 1155
Pages: 5

Consumer expenditure Mini Case

John Hawksworth “Opinion: Economic Trends - Saved by the consumer?”, Accountancy, London, Mar 2002 (with minor editing)

How long can the UK economy buck the global trend just because our consumers keep spending money? Have we avoided the recession that has gripped the US, Japan and Germany over the past six to 12 months or are we just postponing the day of reckoning? And are we storing up worse problems for the future as a result of rising household debt levels and a widening trade deficit?

Driving force
A good starting point is to consider what drives consumer spending. In the long run, economic research indicates a stable relationship between household spending, disposable income and wealth (all
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Having said that, consumers may have been taking on too much debt because they failed to distinguish between real and nominal interest rates. Headline mortgage and consumer credit rates have fallen significantly with lower inflation, allowing debt-to-income ratios to rise to record highs in 2001 while keeping debt service burdens at affordable levels.

According to economic theory, however, real interest rates should drive decisions on borrowing and investment, not nominal rates. If inflation stays low, the real burden of servicing a given level of mortgage debt will not decline over time as fast as in a high-inflation environment. There is therefore a real danger that consumers will be unpleasantly surprised by the ongoing burden of servicing the debts they have taken on in recent years, resulting in a moderation of consumer spending growth. This is likely to be a long-run phenomenon (ie, with impacts over 10 years or more) rather than a factor that, in itself, would precipitate a UK recession over the next year or two in the absence of sharp interest-rate rises.

Fly in the ointment

However, the fly in the ointment may be the rising gap between our imports, boosted by high levels of consumer spending, and our exports, which have been hit by the global downturn and