Consumption, Debt and the Household Balance Sheet 2016-7 Lecture Series: Where are we after the Storm? The UK Economy in the Aftermath of Financial Crisis: Consumption, Debt and the Household Balance Sheet Professor Jagjit S. Chadha Mercers’ School Memorial Professor of Commerce  © Jagjit S. Chadha 2016-7

Polonius Costly thy habit as thy purse can buy, But not express'd in fancy; rich, not gaudy; For the apparel oft proclaims the man, And they in France of the best rank and station Are of a most select and generous, chief in that. Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry. Hamlet, Act i Scene iii, William Shakespeare.

Issues Consumption is some stable fraction of income Life-Cycle Permanent Income Hypothesis Consumption and savings go hand in hand Consumption is tilted by the returns on savings or the prices of assets But does consumption make you happy?

Consumption and Income: UK in the 21st century Income standard deviation : 0.0621 Consumption standard deviation : 0.0567 => Consumption less volatile than income Q: Is this real total consumption i.e. durable and non-durable? Here it is total consumption in constant prices, and Income is equal to real Total Resources, while in the other graphs I use the disposable income not total resources

Issues: post-referendum consumption resilience? Permanent income has risen following the referendum vote; Was it the result of confidence in the future by those who voted to leave; Were households bringing forward consumption before prices rose; Did the response of monetary policy induce more expenditure or, relatedly, did increased lending encourage greater consumer expenditure?

Life cycle income Income, consumption Households smooth there consumption over their life time income Income Consumption path Time

Life cycle income Income, consumption R Cutting rates might tilt consumption and bring it forward Income Consumption path Time

Life cycle income with a positive income shock When household expectations about their future income change they optimise they consumption accordingly Income, consumption Income 2 Higher expected future income 1 Consumption path after anticipating a higher future income 2 1 Time

Life cycle income with liquidity constraint consumption Households facing a liquidity constraint are not able to perfectly smooth their consumption over their life time, it implies a higher variation of consumption over time Income 2 1 1 1 Consumption path with liquidity constraint 2 2 Time

Life cycle income and consumption: US and UK

Life cycle non-durable consumption per adult: US and UK

Life-Cycle Permanent Income Consumption equals income over the lifetime Consumption is smooth over the life time Saving occurs in mid-life Increases in future income expectations will tend to increase indebtedness Reductions in interest rates (increase in supply of funds) will tend to tile or bring forward consumption

Household real consumption per head Q: this cannot be consumption per head i.e. £5bn per head? Is it nominal consumption but not per head? Please check and change. I changed it, it in pound per quarter Source: United Kingdom Economic Accounts time series dataset

Real household consumption and disposable income Q: can you give the fraction of total consumption that is non-durable. Chart 15 tells us that consumption>income in 2007/8 but not in this chart. Please explain or change. In chart 15 for the 3centuries dataset, the BoE uses Final consumption expenditure by households (Domestic + tourists) plus the consumption expenditure by NPIHs, while here I am using consumption by households only (domestic, so not the tourrists included) and the disposable income from households. I don’t know why they use Household + NPIH consumption and disposable income, because if I am correct disposable income is only for the household sector. Therefore I believe it is better to use total domestic consumption by households Source: ONS, Consumer trends

Ratio of household consumption to disposable income

Fraction of total consumption that is non-durable Source: ONS, Consumer trends

Ratio of household national consumption to disposable income Source: Bank of England, Three Centuries dataset

Household national savings rate Households + NPISH (Non Profit Institutions Serving Households) : (Disposable Income - consumption) / Disposable income Household national savings rate Source: Bank of England, Three Centuries dataset

Growth of real household consumption and disposable income Q: what is the final quarter in this dataset? 2016 Q3 Source: ONS, Consumer trends

Real growth of household consumption and disposable income Q: is this consistent with Figure 4? Pretty much, but they use total ressources divided by the consumption expenditure deflator, here it is disposable income in constant prices. It is difficult to verify which series of consumption they use.. Source: United Kingdom Economic Accounts time series dataset

Consumption and disposable income 2000 - 2016 Q: Can we re-do this in terms of the correlation in q/q growth rates not levels? Please annualise the growth rates. Slope estimate ≈ 0.5

Balance Sheet of the Household sector Assets Liabilities Tangible Assets Real Estate Durable goods Financial liabilities Loans Insurance & pensions Debt securities Other Financial Assets Equities Cash & deposits Net Wealth (= Assets – Liabilities) On a given year household income can come from transfers from the government, wages from employment or interests from tangible and financial assets. This income can be used to pay taxes and to purchase consumption goods, tangible assets and financial assets. If in a given year expenditure exceeds income then there is borrowing in the household sector.

Balance Sheet of the Household sector - 1995 Assets 3,401,418 Liabilities Tangible Assets 1,257,570 37% Real Estate 1,132,286 90% Durable goods 125,284 10% Financial liabilities 556,439 16% Loans 493,365 89% Insurance & pensions 12,389 2% Debt securities 1,737 0% Other 48,948 9% Financial Assets 2,143,848 63% Insurance & pensions 1,157,510 54% Equities 402,955 19% Cash & deposits 468,451 22% Debt securities 42,538 2% Other 72,394 3% Net Wealth (= Assets – Liabilities) 2,844,979 84% Source: ONS, National balance sheet: households & non-profit institutions serving households (NPISH), £ million, 1995 Q: How do we get to 11.9 Tn on assets. 5.6+.33 does not get me 11? HELP?

Balance Sheet of the Household sector - 2015 Assets 11,947,663 Liabilities Tangible Assets 5,636,735 47% Real Estate 5,306637 94% Durable goods 330,098 6% Financial liabilities 1,750946 15% Loans 1,622,233 92% Insurance & pensions 63,777 4% Debt securities 3,017 0% Other 61,919 4% Financial Assets 6,310,928 53% Insurance & pensions 3,730,675 59% Equities 791,130 13% Cash & deposits 1,473,887 23% Debt securities 94,318 1% Other 220,918 4% Net Wealth (= Assets – Liabilities) 10,196,717 85% Source: ONS, National balance sheet: households & non-profit institutions serving households (NPISH), £ million, 2015 Q: How do we get to 11.9 Tn on assets. 5.6+.33 does not get me 11? HELP?

Ratio of household net wealth to consumption Source: ONS, National balance sheet: households & non-profit institutions serving households (NPISH)

Household Sector Net Wealth Source: ONS, National balance sheet: households & non-profit institutions serving households (NPISH)

Household debt to GDP ratio Source: BIS long series on total credit

Household debt in the UK compared to the advanced economies Source: BIS long series on total credit

Concluding Remarks Consumption is closely related to welfare Aggregate consumption follows current income and sentiment and may not be fully rational Cohort and household level analysis required to understand aggregate patterns e.g. in booms Debt accumulation matched by net wealth, which is concentrated on housing assets Adjustment of household debt far from complete