Double Dip Recession 2012

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Preliminary figures for Q1 2012 show the UK has re-entered recession, with a second successive quarter of negative economic growth.

latest-economic-growth

The negative economic growth occurred despite a small growth in the service sector and spurt in retail sales of petrol. The biggest factor contributing to the negative economic growth came from the construction sector, which saw a drop of 3.0%.

Brief Summary on Causes of Double Dip Recession

  • Spending Cuts – creating lower wages, unemployment and decline in confidence
  • Cost-push inflation and decline in real wages. Workers are seeing a squeeze in incomes leading to lower spending
  • Uncertainty in housing market causing a drop in construction
  • Uncertainty in Eurozone holding back investment and spending.
  • Slower exports to the Eurozone facing its own economic downturn.
  • More on causes of double dip recession

Implications of Double Dip Recession

After the serious 2008/09 recession – where GDP fell a record 6%, the economy has struggled to recover.
inflation

  • Despite the spare capacity, inflation has remained above target, giving little room for manoeuvre. At least one member of the MPC have started talking about the prospect of interest rate rises sooner than later. But, this news of economic recession, will give more weight to the inflation doves who are more concerned about lack of growth and unemployment.

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Should the Pace of UK’s Deficit Reduction be Slower?

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Since coming to power, the Conservatives have made reducing the UK’s record peace time deficit a high priority. It has been argued that drastic action was necessary to avoid the UK’s debt becoming unmanageable. David Cameron argues without rapid spending cuts, the UK could be facing rising interest rates and the prospect of debt default, …

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World Without Oil Scenario

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Is this the future of a world without oil? Readers Question: What would a world without oil look like? Oil is currently the most important commodity. It is vital to transport (air, sea, road and rail) and also the production of goods like tar and plastic. Without oil, society and the economy would look quite …

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Latest UK Inflation April 2012

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inflation-latest

Inflation in the UK remains relatively high given the state of the economy. It continues to be above the Bank of England’s target of 1-3%. However, the MPC will not be overly concerned about inflation. They are more worried about the weak prospects for economic growth and will be ‘hoping’ / predicting inflation will continue to slowly fall throughout 2012.

  • The difference between CPI – RPI
  • CPI consumer price index
  • RPI – includes mortgage interest payments and other housing costs not in CPI.
  • CPI-CT – excludes the effect of taxes (e.g. VAT)

The gap between CPI, CPI-CT and RPI has recently narrowed. This is due to expiration of tax increases and interest rates have been stable.

Why is Inflation still above target given spare capacity in the economy?

Commodity Prices. There is still some impact of past increases in oil prices and other commodities. Though the March CPI figures were helped by a fall in petrol prices. Yet, the price of petrol remains quite volatile, reaching another recent peak during April. This renewed price of petrol means CPI inflation may fall by less than Bank of England predicts throughout 2012.  Yet, with the global slowdown, oil prices are again forecast to fall over coming weeks.

The ONS state that the biggest upward factors in UK inflation are currently in food, clothing, recreation and culture.

Wage inflation

Due to weak economic growth and continued high unemployment, wage growth continues to remain weak. This means many  consumers are seeing a continued fall in real incomes. The Bank of England think this is a significant factor in depressing future inflation.

realwages

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Question: Why is the current recession (2012) in Europe so bad?

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Readers Question: Why is the current recession in Europe so bad?

The recession in the Eurozone is one of the deepest recessions on record. For example, Greece are expecting 2013 to be the sixth consecutive year in recession (with on and off quarters of recovery)- this is  one of the longest recession on record. Output in Greece is 16% lower than at the start. Other countries such as Spain, Ireland and Italy also face large falls in GDP, which have been much more prolonged than previous recessions.

There are a number of reasons why the European recession for Eurozone countries is so severe.

1. Spending Cuts

Faced with budgetary constraints, countries have been forced into ‘austerity measures’ For example, Madrid has been set a target by the European Commission of reducing the country’s budget deficit from 8.5 per cent to 5.8 per cent by the end of 2012, and to 3 per cent in 2013. This level of deficit reduction is difficult in normal circumstances. But, if you cut spending when economy is already in recession, then there will be a large fall in domestic demand and rise in unemployment. Spain already has an unemployment rate of 20%, spending cuts will inevitably worsen the unemployment problem.

2. Legacy of Asset Price Bubble and Household Debt.

In the boom years, countries such as Ireland and Spain both had a rapid increase in house prices. After the credit crunch,  house prices have fallen by upto 40%, leaving many banks, business and homeowners facing higher levels of personal debt. This personal debt creates a big drag on spending. Households face the prospect of trying to pay off debt rather than spend. UK’s personal debt stands at £1.4 tn (close to 100% of GDP – up from 69% of GDP in 1997 link) This is known as a balance sheet recession.

A graph (EV) showing the rapid fall in real per capita housing equity in the US. – A major drag on US consumer spending.

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Does low inflation always mean low interest rates?

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Readers Question: Does low inflation always mean low-interest rates? Generally low inflation will lead to low-interest rates. Although in practice there may be some divergence. The UK has an inflation target of CPI = 2%. Therefore, interest rates are used to achieve this target. If inflation falls to below 2% the MPC will cut rates …

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Austerity in Europe 2012

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Most European countries have embarked on a range of austerity measures designed to reduce their budget deficits.

  1. Why have austerity measures been pursued with great vigour in Europe?
  2. What is impact of austerity measures on economic activity?

Why Austerity?

  1. Pressure from Bond Markets. Investors have become nervous about holding debt in several Euro-zone countries. This has pushed up interest rates and increased risk of liquidity shortages. This pressure from the bond market is greater because there is no lender of last resort in Euro-zone.

bondyield (EU bond yields)

  1. Cyclical Debt Issues. The recession of 2008led to a sharp rise in budget deficits across Europe. Combined with the credit crunch and fears over liquidity, these deficits have become harder to finance.
  2. Long-Term Debt issues. Some countries have a  long standing structural deficit that has concerned markets. For example, even before the crisis, Greece had substantial debt and a poor record of attracting sufficient funds. A country like Italy has a primary budget surplus, but long-term demographics create concerns over future spending commitments and ability to raise tax revenue (ageing population cause increased pension spending, but lower tax)
  3. Commercial Bank Losses. In the case of Ireland, the Irish government took on significant losses from its own commercial banks. However, by taking on private bank debt, the government became overly-indebted itself. Therefore, it was necessary for Irish government to cut spending. One reason the Irish government took on Irish bank debt, is that other European banks could have faced very high losses had the Irish banks failed.
  4. Demands of ‘Fiscal Union’. Concerned over debt crisis, the EU have responded by threatening to redraw the Lisbon treaty and imposing harsher penalties on countries who exceed budget limits.
  5. Political Will. There is an old expression ‘if it’s not hurting, it’s not working.’ mentality. Perhaps this influenced the UK Conservative party – who were keen to make bold spending cuts in their first year of office. Certainly in US, calls for austerity agree with certain political ideologies which advocate lower government spending.

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Prospects for Recovery in the UK economy 2012?

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Given very low expectations, there are some encouraging signs for a weak economic recovery in the UK. The OBR increased growth forecasts to 0.8% in the UK for 2012. Helped by the recovery in the service sector, it looks like the UK will avoid a double dip recession. This still leaves GDP below the 2008 …

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