Getting and spending – the key to recovery

The debate is raging in Westminster and throughout the country about whether the coalition government’s austerity programme of spending cuts and tax increases is damaging the economy and making it harder for UK PLC to recover from the longest downturn since the war.

Deputy Prime Minister Nick Clegg has indicated that cuts in capital spending after the 2010 election, to help reduce the deficit, may have been counter-productive.

Many of us have an opinion about what Chancellor George Osborne could do to foster growth, but surely consumers have their part to play?

Our failure to grow is often attributed to a lack of demand in the economy, that we are not spending enough to get the wheels moving faster.

This is due to a host of factors: less money in our pockets as pay fails to keep pace with inflation; anxiety about our future prospects; indebtedness; and difficulties obtaining credit.

The Bank of England has cut base rate to a record low; it has remained at 0.5 per cent for almost three years and there are no signs it will be rising any time soon.

All of this is to some extent is ignoring the elephant in the room – questions about government policy. Simon Kirby, NIESR

As well as keeping the cost of mortgages low – assuming we are able to get one at a time credit is not always easy to obtain – the bank is trying to convince us that we are better off spending than saving at a derisory interest rate.

Spend, spend, spend

As Charlie Bean, the bank’s deputy governor, told Channel 4 News in 2010: “What we’re trying to do by our policy is encourage more spending.

“Ideally, we’d like to see that in the form of more business spending, but part of the mechanism that might encourage that is having more household spending.

“So in the short term, we want to see households not saving more, but spending more.”

Despite this encouragement, consumer spending is sluggish. But the economy needs our hard-earned money, so what should we do with it?

Move home, hand the government thousands of pounds in stamp duty, and commission a new bathroom?

The stamp duty would help the government reduce the deficit, which would ease austerity, while a new bathroom would create demand for builders and plumbers, as well as sinks, taps and showers.

This is the biggest contribution we could make to the economy, but it depends on being able to obtain finance from a bank or building society. Then there is the fact that we do not move home that often.

Another option, if we want to take advantage of interest rates that will never be lower, is to pay off our mortgages faster than we have to – saving tens of thousands of pounds during the loan period.

But while benefiting personally from this arrangement, we would be depriving the economy of money we could be spending on creating demand for consumer goods and services.

‘Absence of demand’

Speaking to Channel 4 News, Simon Kirby, principal research fellow at the National Institute of Economic and Social Research, said the problem was that people were making “rational” decisions that “add up to an absence of demand”.

Mr Kirby said: “We need more spending in the UK economy. The bank is trying to get people spending by cutting interest rates by record amounts. It’s designed to stimulate consumption now rather than in the future.

“But people are hesitant about the future. I am wary of running round forcing people to do things. All of this is to some extent is ignoring the elephant in the room – questions about government policy. Cutting the deficit is having an effect on people’s jobs.

“If you’re focusing on the consumer, you are ignoring the fact there will be constraints on the consumer from fiscal policy.”

But even with those constraints, how should we spend our money?

Mr Kirby said buying British goods and services had the most beneficial effect on the economy.

“Reducing import penetration would stimulate domestic demand. Buying a car made in the UK is better than buying something made abroad. And you could holiday in the UK, too.”

Before splashing out, people need money and there is not always much to go around. Benefit recipients, including those in work who receive tax credits, are having future rises capped below inflation.

“The important point about rising less than inflation is that it means your purchasing power falls, and people on benefits are unlikely to get credit from banks,” said Mr Kirby.

Work

Surely the economy would improve if people out of work moved into jobs? Yes, but people on the lowest salaries do not pay income tax and are entitled to tax credits, so UK PLC only gains so much.

If we, as nervous consumers, are limited in what we can do, what about the banks?

Mr Kirby said: “The banks are sitting on record amounts of cash. They are not using it to invest, in part because they are in a relatively weak state, are trying to improve their balance sheets and are more risk averse.

“Small businesses complain about their inability to raise finance from the banks. People may be saving, but this isn’t going to the mortgage market or small businesses.”

Mr Osborne is desperate to avoid another three months of negative growth. He does not want to enter the history books as “the triple-dip chancellor”. But unless confidence returns to the consumer, he might well do so.