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Right now, credit is crucial

David Cameron today exhorts us to pay off our debts. Were any economists involved in drafting the speech?

Here are the latest Bank of England figures for August:

  • Consumer credit (defined as borrowing by UK individuals to finance current expenditure on goods and services) outstanding totalled £209bn
  • Of which £57bn was credit cards and £152bn other loans and advances

Latest national accounts data (in nominal terms):

  • Q2 2011: consumer spending £230bn, GDP £374bn
  • Last four quarters: consumer spending £916bn, GDP £1,483bn

So if we paid off only the credit card debt:

  • In one quarter, this would reduce consumer spending by 25 per cent and GDP by 15 per cent (and these are first round effects only – this would lead to job losses, further cuts in spending and output etc)
  • Over one year, it would reduce consumer spending by 6 per cent per quarter and GDP by 4 per cent per quarter (ditto)
  • Over the remainder of this parliament (3.5 years) it would reduce consumer spending by 1.25 per cent per quarter and GDP by 1 per cent per quarter (ditto)

Estimates of trend growth in the UK are around 2.25 per cent a year (ie no more than 0.6 per cent per quarter), so even paying off just credit card debt over the life of this parliament would guarantee that the economy shrank quite significantly between now and 2015 (and that’s before taking into account the government’s cuts in its spending and the knock-on effects on investment, employment etc).

In the long run, the UK consumer does need to help reduce their nation’s debts. The economy needs rebalancing towards investment and exports. In the short to medium term, if the consumer took the prime minister seriously, we’d be in real trouble.

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2 Responses to Right now, credit is crucial

  1. Alastair says:

    “it would reduce consumer spending by 1.25 per cent per quarter and GDP by 1 per cent per quarter”

    If lower household consumption demand was not offset by higher demand in another sector, lower overall aggregate demand would be disinflationary. In this counter-factual, lower inflation, or a lower inflation forecast, must therefore be offset by looser monetary policy to boost demand and bring inflation (or the forecast) back up to target.

    (For example, looser monetary policy could devalue sterling and lead to greater demand for exports.)

    Your argument reduces to a tautology: “if demand is lower, demand is lower”. Well, yes.

    It is mostly nonsense to presume lower consumer borrowing is not offset anywhere else within the economy, in any case. If I borrow from my neighbour and spend the proceeds, what would my neighbour have done had I not borrowed? Maybe he would have spent instead – or invested differently.

    • TOwen says:

      I’m no economist or monetary expert but do you not make an assumption that those who may “lend” would still spend, and if they do spend they would not spend in this country of for this country’s goods.
      the IPPR comments are simply that, a comment on the possible impact upon indiduals paying off credit card debt.