Published: December 16th 2011 - at 12:50 pmWhy the economy is about to get worse in 2012
After a busy week for UK economic data, today brought the FT headline ’IMF chief warns of 1930s style threats’, the perfect accompaniment to a fairly grey and drizzly morning.
I can see why Christine Lagarde is concerned – the economic data has been grim for the past few months, there are rising international economic tensions (such as the ludicrous spat between the UK and France over who’s AAA rating is least deserved) and the Eurozone’s most recent summit was very disappointing.
But closer to home – what did the data this week tell us?
Over the past 18 months inflation has risen faster than wages causing a squeeze on real incomes which has hit consumer spending and hence depressed domestic demand.
So any fall in inflation should be welcome as it should boost real incomes and hence provide a prop to consumer spending and domestic demand.
But there are some worrying signs that this might not be the case.
To start with real wages are not rising as much as falling inflation might suggest. Since peaking in September at 5.2% CPI inflation has fallen by 0.4 percentage points to 4.8% in November whilst RPI has also fallen 0.4 percentage points (from 5.6% to 5.2%) in the same period.
Sadly though we have seen a fall of a similar magnitude in average weekly earnings (total pay measure). In September they were growing at an annual rate (3 month average) of 2.3%, in October that feel to 2.0% – a fall of 0.3 percentage points – very similar to the 0.4% fall in inflation.
Indeed back in January real wages were falling at an annual rate of 2.7%, on the latest data they are falling at an annual rate of 3.2%. Inflation might be coming down, but so is wage growth.
The fall in inflation then is not, at the moment, leading to an improvement in real wage growth or providing much support to spending.
In fact the opposite seems to be true.
This week’s retail sales figures showed a monthly fall of 0.4% in volume terms. As Bloomberg noted the fall in inflation has been driven by “food and transport prices as the prospect of another recession weighed on the economy”.
Rather than a reduction in inflation supporting consumption, a fall in consumption is driving inflation lower. And real wages aren’t improving as the labour market remains very weak.
Add in the debt overhang faced by households, the weak growth of the money supply and bank lending and the prospects of a second credit crunch hitting UK banks in 2012 and you get something very close to Irving Fisher’s ‘Debt Deflation’ (his 1933 article is available here and makes for grim weekend reading).
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A longer version is at Touchstone blog
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Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
· Other posts by Duncan Weldon
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Reader comments
price inflation without wage inflation is bad for real wages, but it is also consistent with VAT and terms of trade explanations of the inflation data, and is also why the MPC has been able to sustain expansionary MP – if wages started taking off to match inflation, indicating an inflationary spiral on the cards, MPC would tighten and we’d not be better off. Some people still think inflation data reflects one-off factors and has peaked:
http://ftalphaville.ft.com/blog/2011/12/13/795881/the-uks-inflation-myth/
@1 – I’m unsure of whether this is correct, but it seems to me likely that inflation will not increase next year on the grounds that if you were a company planning to raise prices you’d probably choose to do so now when everyone else is doing it so you take less of a PR hit (eg: Orange).
The bullish case from a monetarist perspective.
http://www.moneymovesmarkets.com/journal/2011/12/15/uk-data-wrap-weak-not-recessionary.html
There is plenty of bearish sentiment and it is easy to find reinforcing trends in the data. Therefore, one has to look for evidence why the consensus may be wrong. Too many people are forming opinions based on the High St. Around 12% of all purchases are now through the internet and that as much as depressed consumer demand is killing the High St. There clearly is a global manufacturing slowdown and that can be seen in the decline of commodities. However, how do you explain last months good trade figures? The previous month was poor so they may have been rebounding from a low base. Still, exports grew by 9% and reached record levels. Moreover, if consumer demand is so poor why have imports not declined even more?
There are certainly arguments to support you about 2012, just not as overwhelming as you think. The Standard Chartered economist certainly agrees with you about 2012. He has been the most accurate forecaster over the last two years. His forecast is not for weak growth like most people, but a decline of 1.7% for 2012. If that happens the UK triple A will be gone within the next 18 months.
@ 2:
“it seems to me likely that inflation will not increase next year on the grounds that if you were a company planning to raise prices you’d probably choose to do so now when everyone else is doing it …”
Inflation is (a) domestic and (b) imported. Causes of (a) include trade union and producer greed. Causes of (b) include rising commodity prices and a devaluing currency.
One more post – another Orange Books appears to have been written, originally in 2001 and updated in 2004, a book written by the Treasury about Risk Management in Government – presumably concepts such as asset bubbles and housing booms, running a deficit when in a boom, and having lax regulation of the banks, were not things covered in it?!?!? http://www.hm-treasury.gov.uk/orange_book.htm
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