Yesterday provided us with more information on a subject which has troubled me for some time about the UK economy. The issue has been the falling levels of wages in real or inflation-adjusted terms. This has been caused by a combination of low nominal wage growth (currently 1.5%) and higher inflation (the official inflation measure the Consumer Price Index is currently 2.4%). This has persisted for a while and the current annual rate of fall at -0.9% is better than it has been as falling inflation has reduced the gap in 2012.
Why do falling real wage levels matter? It is simply because of the likely effect from this on domestic demand in the economy which will have been depressed by it. And this has been backed up by a weak performance by the UK economy which according to the official data has not grown for two years now.
An Unintended Consequence of Quantitative Easing?
When we look at the Bank of England’s website we see that QE was supposed to do this.
The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand. …… Without that extra spending in the economy, the MPC thought that inflation would be more likely in the medium term to undershoot the target.
So we see that QE was always expected to raise inflation indeed the MPC hoped it would. But the problem is that it contributed to inflation overshooting its target and a sustained episode of this. If we break this down we see that the boost to nominal demand struggled to be a boost to real demand because of the inflation it contributed too.
Then we saw a perverse second order effect where the higher inflation reduced the level of real wages and hence demand in the economy. You might say that as fast as the QE tap tried to boost demand the plughole of falling real wages let it out of the bath. So the £334 billion of Gilt purchases so far if we include this afternoon’s has put money somewhere but virtually entirely not where it was intended. When we were trying the reverse policy of selling Gilts to suck money up called over-funding we called this problem disintermediation
What did we learn yesterday?
The Office for National Statistics updated us on the level of real household income.
In the first quarter of 2012, real household actual income per head, taking account of inflation, fell by 0.6 per cent quarter on quarter. Real household actual income per head stood at its lowest level since the second quarter of 2005.
The opening sentence confirms what we already believed but the second gives an interesting perspective on where we stand. We have gone back seven years on this measure to 2005 leaving us just three years short of our own version of a lost decade. The next bit will make uncomfortable reading for our inflation guardians the Bank of England.
This was primarily due to prices going up at an increasing rate over most of the period…….. The increase in prices eroded the growth of (real) household incomes.
Of course it gets even worse for the Bank of England when we see above that the increase in prices was a deliberate policy. Rather than control inflation they have deliberately exacerbated it.
We also see that income growth has fallen over the period.
Furthermore, the growth of actual household incomes on a current price basis weakened over the period
And an interesting insight into the net immigration which has taken place. Although they do use a euphemism rather than actually saying it clearly.
Finally, sustained population growth led to incomes being spread across a greater number of people, and therefore further reduced the growth of actual income per head over the period.
We are seeing here the impact of cheap (mostly) Eastern European tradesmen and women. And this illustrates my view of immigration which is that there are benefits -cheaper tradesmen for example- but also consequences which we see here in lower nominal wage growth. One might also add in the likelihood of them sending some of their incomes home.
The state steps in
The ONS gets itself in something of a mess explaining this but in essence the state has stepped in and ameliorated some of the fall in household income. This of course goes against the mantra so often repeated these days of cuts,cuts,cuts. But also it means this if we look at disposable income.
for households’ disposable income per head the level was the lowest since the third quarter of 2003
So on this measure we are somewhat nearer to a lost decade. And we now get an estimate of our decline since the peak of 2007.
Between the fourth quarter of 2007 (when both series were at record levels) and the latest period, households’ expenditures per head fell by 6.4 per cent including in kind services and 8.6 per cent excluding them.
By “in kind services” they mean help from the state.
So this numbers confirm what we feared which is that as wages have fallen so have incomes and so has expenditure. No wonder we are in trouble!
So we have addressed income and expenditure today albeit from the first quarter of 2012 so let us look at output and in particular manufacturing output. We have numbers here which are as up to date as we get and we find that we seem to be in the same morass.
The July PMI survey suggests that the domestic market shows no real signs of renewed life
Indeed the headline numbers indicate weakness.
The downturn in the UK manufacturing sector gathered pace at the start of Q3 2012. At 45.4 in July, down from a revised reading of 48.4 in June, the seasonally adjusted Markit/CIPS Purchasing Manager’s Index® (PMI®) fell to its lowest level since May 2009.
So we see weak output levels and indeed ones which mimic the problems we had in 2009 which is a grim message. We have seen quite a few economists promise a bounce back in the UK economy in the third quarter of 2012 and whilst some caution is required as this is only a third of the period it already looks like manufacturing is struggling.
House Prices Too
After looking in depth at some house price numbers on Monday we see that the Nationwide backs them up the theme’s expressed today.
UK house prices declined for the fourth time in five months in July, with prices falling by 0.7%. This pushed the annual pace of price growth down to -2.6%, from -1.5% in June – the weakest outturn since August 2009.
And the numbers will be flattered by the central London property bubble. However you spin it these numbers look likely to get worse. Oh and talking of spinning.
The UK economy is likely to see an Olympics-related boost in Q3.
Wouldn’t the real boost have come from the infrastructure improvements and the stadia building? Because if so we have already had it! So far they have all looked finished to me.
And before I move on let me introduce this topic.
Northern Ireland continues to see largest price falls
There has been something of a bloodbath in house prices here which mirrors in many ways what happened south of the border. Which leads to an obvious implication for the state of banks balance sheets in Northern Ireland.
So we see that income and expenditure for UK households has been weak over the credit crunch era. Looking at such trends it is no surprise that our economy has struggled to recover and in fact appears to be losing ground. Today’s purchasing managers numbers for manufacturing give further backing to the thought that we are in something of a gathering storm. And that staple topic of dinner parties,house prices, does not inspire any confidence either.
So we see that the Monetary Policy Committee will be having a heated debate right now about what to do. I see some in the media arguing for more QE, apparently forgetting that we are currently getting more and that we will see another £1 billion today alone. Oh and they are also forgetting that there is no evidence that it has worked and some that it has made things worse. Even the thinning band of QE supporters must struggle to think of a what good would be done by announcing more of it tomorrow.
As the MPC has shown itself to be prone to panic that only really leaves an interest-rate cut available to them. They have not been keen on this option.
In March 2009, the Monetary Policy Committee (MPC) announced that it would reduce Bank Rate to 0.5%. The Committee also judged that Bank Rate could not practically be reduced below that level
So there is the panic option for them and frankly it would symbolise panic….
And as a final thought if we consider the implications of our “Step Back in Time” to 2005 and maybe 2003, were we so badly off then?