The economic recovery is under threat. British consumers are saving and not spending.
Here are Paul Ormerod's thoughts in his latest blog.
The Office for Budget Responsibility (OBR) estimates that during lockdown, households accumulated a massive £180 billion of so-called “excess savings”.
Earlier in the year, most economic forecasts assumed that these would be run down. Lockdown had constrained people’s normal behaviour. And with the removal of restrictions, spending would soar.
This has not happened at all. Indeed, individuals are continuing to save more than they did in the years just before the pandemic.
In the 2017-19 period, the total amount of personal savings increased by around £5 billion a month on average. Even after lockdown was lifted in the summer, they have kept squirrelling away double that amount.
Just less than a year ago I wrote in this column that there was a distinct possibility of exactly this happening.
In contrast to the private sector build up of savings, the public sector has been running massive deficits. In the financial year 2020/21, the government spent £304 billion more than it raised in taxes. The OBR projection for 2021/22 is that the deficit will come out at a massive £183 billion.
The deficits can be paid for by raising taxes, exactly as Rishi Sunak is doing. There is fierce political resistance, but further substantial increases in the near future cannot be ruled out.
In these circumstances it makes sense to save a bit more. You could very well get hit with a large overall tax bill than expected.
The other way of financing the deficits is to issue government bonds, which is exactly what the government is doing. Surely there is no need to save extra if this is happening?
Exactly the same question was asked by the great English economist David Ricardo two hundred years ago. He was pondering the implication of the then massive deficits which the government had run up in fighting the Napoleonic wars.
Ricardo argued that whichever combination of tax increases or bond financing were used, the impact on the economy would be the same.
When the government runs a deficit, spending power is injected into the economy. But an increase in taxes cancels this out.
If the government issued bonds to pay for its spending, Ricardo believed the private sector would act rationally. People would anticipate that for many years into the future, taxes would have to go up anyway to pay both the stream on interest on the debt, and eventually to pay it off. As a result, they would save more and spend less now to be able to pay these taxes.
This idea, known as “Ricardian equivalence”, was revived in very influential 1974 paper by the Harvard economist Robert Barro.
There is now a huge literature on the topic, and it is fair to say that the majority of economists are not convinced by it.
But the current behaviour of consumers in the UK is entirely consistent with the concept of Ricardian equivalence.
If Ricardo was right, consumer spending will only boom again once the Chancellor gets a grip on the massive deficits of the public sector.
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