The most important graph for the UK economy?

16 Apr 2013, by Duncan Weldon Guest in Economics

I’ve argued before that if I was forced to choose just one graph to understand the UK economy over the last two and half decades, the one I’d go for is the household savings ratio.

I’ve marked the three stages of the UK economy since 1992. The ‘great moderation’ of unbroken growth from 1992 to 2008 – characterised by a falling savings ratio, the sharp recession of 2008/09 – with a rapidly rising savings ratio and the virtual stagnation of 2010-2012 -complete with flat-ish savings ratio.

In the absence of either strong growth in household incomes (which looks unlikely at the moment) or extremely rapid rebalancing towards investment and net trade (also looking unlikely at the moment) then this chart will almost certainly continue to be one of the most important indicators for the UK economy.

If the household savings ratio remains broadly flat then so will the economy, if if suddenly rises again then renewed recession is likely and if it starts to drift downwards then household spending will rise quicker than household incomes providing a boost to growth.

I don’t think I’m the only one who has noticed this. It is hard to read current Treasury policy on the housing market as anything other than an attempt to drive down down the household savings ratio by encouraging more mortgage borrowing. Rebalancing, as I noted after the budget, has been all but abandoned.

Last week’s forecasts from the Item Club confirmed this. The International Business Times noted that rebalancing is ‘on hold’ whilst the “government’s influence on the housing market could spike consumer spending and engender a faster recovery than many UK businesses are currently anticipating”.

The question then becomes – are policies that drive down the household savings ratio desirable? And here I think the answer is far from clear. Of course faster consumer spending would provide a boost to GDP in the short to medium term but in the longer term is rising household debt not one of the key factors behind the mess we are now in?

In the long run a recovery will only be sustainable if it is build on the solid foundations of rising household incomes. Sadly that doesn’t look to be happening anytime soon.