Guide to Economic Indicators
Page 8
Budget balance, deficit, surplus
Measures: Net total of government spending less revenues in one month/year.
Significance: Indicator of government’s fiscal stance.
Presented as: Monthly and annual totals in current prices.
Focus on: Totals; trends.
Yardstick: The average OECD deficit was 3.2% of GDP during the 1990s and 3.5% in 2008.
Released: Monthly, at least one month in arrears.
Overview
Balanced budgets (revenues equal spending) sound prudent but may not always be in the best interests of economic management. Perfect balance is hard to achieve anyway, because of the automatic stabilisers in spending and revenue.
Budget deficits (spending exceeds revenues) boost total demand and output through a net injection into the circular flow of incomes. As with personal finances, a deficit on current spending may signal imprudence. However, a deficit to finance capital investment expenditure helps to lay the basis for future output and can be sustained so long as there are private or foreign savings willing to finance it in a non-inflationary way.
Deficits are more common than surpluses. In the 1970s and early 1980s many OECD governments went on a borrowing binge, often with adverse consequences. High levels of government borrowing tend to push up interest rates and so may crowd out private-sector investment. The average budget deficit of OECD countries rose in the early 1990s. However, after peaking at 5.0% of GDP in 1993 it became a 0.2% surplus in 2000 (see Table 6.2 on page 86). In that year, 16 of the 30 countries in the OECD ran a surplus. In the new century, deficits became more common but were not excessive until the financial crisis. Governments stepped in to support the financial system, sending the average budget deficit to an estimated 8.2% in 2009. Norway was the only OECD member expected to show a surplus. At the other end of the scale, Iceland, Greece, Ireland and Britain were estimated to be running deficits of over 11% of GDP.
Table 6.2 General government budget balances
Budget surpluses (revenues exceed expenditure) may be prudent if a government is building up a large surplus on its social security fund in order to meet an expected increase in its future pensions bill as the population ages. However, a surplus may be undesirable if it takes too much money out of the circular flow.
The world’s largest relative budget surpluses (20–40% of GDP) have been run up by Kuwait after the 1970 oil price hikes and Botswana, as a result of income from the sale of oil and diamonds respectively. The receipts come from foreigners rather than the domestic circular flow, so the surpluses manage to stimulate even though they appear deflationary. Other countries’ surpluses tend to be smaller, typically up to 5% of GDP.
Tighter or looser
Fiscal policy is said to have tightened if a deficit is reduced or converted into a surplus or if a surplus is increased, after taking into account the effects of the economic cycle. A move in the opposite direction is called a loosening of fiscal policy.
The cycle and the automatic stabiliser
There is an automatic stabiliser built into the budget balance. Surpluses reduce or tip into the red and deficits grow during a recession when tax revenues fall and welfare spending increases. This helps to maintain aggregate demand. The opposite happens during an economic boom.
The cyclically adjusted budget balance is the normal balance with cyclical fluctuations removed. This helps to identify the underlying fiscal stance, but such figures should always be regarded with suspicion because it is difficult to get the adjustments right.
Definitions
There are three main ways of looking at the budget balance. One is the published headline balance which depends on national definitions and accounting practices. The other two are the borrowing requirement and net savings, both of which are usually tricky to identify precisely from published figures.
The borrowing requirement
The net total of government spending less revenues is the gap which has to be financed by borrowing or which allows debt to be repaid. The announced budget balance in Britain used to be exactly this figure: the public-sector borrowing requirement (PSBR), or for surpluses the public-sector debt repayment (PSDR). However, the PSBR (renamed the public-sector net cash requirement) has now been downgraded in favour of the “current balance” (see below).
In most countries the precise definition varies depending on what is included in the “budget". There are two important areas to consider.
6.2 Budget balances
Source: OECD
Level of government. Headline budget figures for the United States are for federal government only and for France cover just central government. At the other extreme, those for Germany cover federal, Länder and local authorities, and Switzerland’s include federal, confederations, cantons and local government.
On or off budget. Many government activities fall outside the normal budget, including lending by government agencies and government farm crop or export insurance, as well as government-guaranteed borrowing by publicly owned enterprises and government-guaranteed lending by private-sector bodies. During the financial crisis that began in 2008, America was one of several countries that were forced to bail out banks and other financial institutions, with the rescue expected to cost around $350 billion.
Net savings
The balance of current spending and receipts indicates the public sector’s net savings: the extent to which the public sector is adding to or subtracting from the circular flow of incomes. This differs from the budget balance in that it includes only current, not capital, transactions. Britain’s current balance corresponds to the government’s net savings.
Monthly figures and targets
Budget balances are usually published monthly in nominal values. Erratic movements can be smoothed by taking several months together. They can be converted into real terms by deflating spending and revenue separately.
When comparing cumulative budget balances with projections, remember that deficits tend to expand if the economy grows more slowly than forecast.
National debt; government or public debt
Measures: Long-run cumulative total of goverment spending less revenues.
Significance: Inter-generational transfer, interest payments add to borrowing.
Presented as: Annual totals in current prices.
Focus on: Total, particularly as a percentage of GDP; trends.
Yardstick: Varies widely; see text.
Released: Mainly annually; not easily found.
Overview
The public or national debt is the cumulative total of all government borrowing less repayments. It is financed mainly by citizens and may be seen as a transfer between generations. This contrasts with external debt (see page 152) which has to be financed out of export earnings.
Size of debt
Chart 6.3 shows the relative size of various national debts in 2008. Italy and Japan headed the list with debt that was almost as much as their annual GDP.
6.3 Net public debt
Source: OECD
The debt is often understated since governments carry various liabilities which do not show on their balance sheets. For example, public-sector pensions are usually unfunded, that is, paid out of current income rather than from a reserve created during the individual’s working life as happens with private-sector pensions.
Oceans of red ink
Comparing rich-country budget deficits
Most rich-country governments will struggle with huge budget deficits in 2010. A decade ago small surpluses were common in many rich countries (although not in Japan), but these are long gone. As economies pull out of recession, government spending will have to be cut and, with luck, tax revenues will gradually rise again. But paying off debts will be an enormous and painful task, which could also prolong the pain inflicted by the economic slump. On Monday February 1st Barack Obama made a start for America, unveiling his budget for 2011 which proposes cutting or consolidated 120 programmes, with savings
expected to total $20 billion.
Economic theory provides few clues to the optimum ratio of public debt to GDP. Trends over time are often a better measure of a government’s creditworthiness than the absolute level of debt. A country with an ever-rising debt ratio is clearly heading for trouble. In 2010 Greece’s sharply rising debt triggered a sovereign-debt crisis that threatened to spread to other weaker euro-zone members. A €110 billion rescue plan for Greece from the European Union and the IMF was not enough to calm market fears, and was followed by a further package of up to $750 billion for the euro area.
Chapter 7
Consumers
Live within your income, even if you have to borrow money to do so.
Josh Billings
Overview
Consumers are important since personal consumption accounts for between half and two-thirds of GDP.
In general, if consumers’ incomes increase (perhaps because of wage rises or tax cuts) they will save some and spend the rest. The part which is spent becomes income for someone else, who in turn spends and saves. The process is repeated and the multiplier effect makes everyone better off, provided that the growth in spending goes into extra production rather than higher prices.
At the same time, the proportion of consumers’ income that is saved provides the finance for investment, which is essential for future production, income and consumption.
Consumers, persons and households
For the most part, economic analysis is most effective if focused on a clearly defined group of economic agents, such as households. However, national accounting practices vary and figures are not generally available for such neat units. Terminology can become cloudy.
Household. A group of people living under one roof and sharing cooking facilities.
Consumer sector and personal sector. These terms are generally used interchangeably and are usually defined to include: households and individuals; owners of unincorporated businesses; non-profit-making bodies serving individuals; private trusts; and private pension, life insurance and welfare funds.
Private consumption. The same as personal consumption since, by national accounts definition, companies do not consume. But businesses invest, so private (personal plus business) investment is different from personal investment.
Total consumption. Personal (private) consumption plus government consumption.
Personal income, disposable income
Measures: Personal sector total income and income after tax.
Significance: Basis for consumption and savings.
Presented as: Money totals.
Focus on: Growth rates.
Yardstick: 3% a year in real terms.
Released: Mainly quarterly, monthly in USA; 1–3 months in arrears.
Personal income
Current income received by the personal sector from all sources. The bulk is wages and salaries, but the total also covers rents (including the imputed rental value to owner-occupiers of their homes), interest and dividends (including those received by life insurance and pension funds), and current transfers such as social security benefits paid to persons and business donations to charities.
Personal disposable income (PDI)
Personal income after the deduction of personal direct taxes and fees (such as passport fees), and current transfers abroad. The figures in Table 7.1 give an indication of the composition of income and disposable income in the United States.
Table 7.1 Personal income, outlays and savings in the United States, 2008 $bn
Source: US Department of Commerce
Wages and salaries
of which: 6,545.9
Private industries 5,404.6
Government 1,141.3
Proprietors’ income
of which: 1,106.3
Farm 48.7
Non-farm 1,057.5
Rental income 210.4
Interest income 1,308.0
Dividends 686.4
Transfers 1,875.9
Less social-insurance contributions 990.6
Less taxes, etc 1,432.4
Personal disposable income (PDI) 10,806.4
Total deductions
of which: 10,520.0
Personal consumption 10,129.9
Interest payments 237.7
Transfers to government 87.9
Transfers overseas 64.5
Personal savings 286.4
Savings ratio (savings as % of PDI) 2.7
Real personal income and PDI
Personal incomes and personal disposable income are occasionally quoted in nominal terms, that is, before allowing for inflation. Real personal income and real PDI are incomes adjusted for inflation. Consumer prices can be used if no other deflator is available. Loosely, if incomes rise by 5% and prices increase by 3%, real incomes are 2% higher.
International comparisons
International comparisons are affected by differences in the provision or treatment of private pensions, life insurance, social security, household interest payments, and current and capital transfers.
In general PDI is reasonably consistent internationally, but personal income is less so. For example, British personal income includes employers’ social security contributions and excludes employees’ contributions. Both sets of contributions are deducted from personal income to arrive at PDI. In America social insurance payments are excluded from both total income and disposable income. Thus British personal income is inflated slightly relative to that in America, but PDI is on the same social security basis in both countries.
Similarly, personal income in Britain includes net interest receipts. In American income includes interest received on savings but interest paid on loans is treated as part of expenditure. In this case American income and PDI are both inflated relative to Britain’s.
Interpretation
Incomes are affected by the economic cycle. In general it is advisable to look for sustainable growth in real incomes – too rapid an increase may be inflationary (see Chapter 13). The main components are as follows.
Income from employment
The major influence on personal income. The total depends mainly on the number of people in employment, hours worked (see Chapter 5) and their pay (see Chapter 13).
Income from self-employment
The next most important component of PDI. Self-employed incomes are linked to the general health of the economy. They will increase when nominal GDP rises.
Interest and dividends
Dividends are sensitive to company profits and the state of the economy, while interest payments obviously move in line with interest rates. When borrowing is high relative to savings, an increase in interest rates can mean a fall in net interest income. Generally an increase in interest rates boosts PDI because in most countries (Britain is the main exception) the personal sector has more assets with adjustable interest rates than liabilities.
Taxes and benefits
Changes in the rates of tax or benefits have a rapid effect on PDI (but not, of course, on personal income). The magnitude will depend on the nature of the change; see Chapter 6.
Consumer and personal expenditure, private consumption
Measures: Spending by persons.
Significance: Key component of GDP.
Presented as: Money totals.
Focus on: Growth rates.
Yardstick: The OECD average real growth in consumer expenditure was 3.2% a year during the late 1970s and 1980s and 2.5%during the l990s and 2000s.
Released: Quarterly with GDP figures, monthly in USA; frequently revised.
Overview
Consumer expenditure is personal (mainly household) spending on goods and services. Thus it includes imputed rents on owner-occupied dwellings; the outlays which would be required to buy income in kind; and administrative costs of life insurance and pension funds. It excludes interest payments; the purchase of land and buildings; transfers abroad; all business expenditure; and spending on second-hand goods, which reflects a transf
er of ownership rather than new production.
Strictly speaking, expenditure takes place when goods are purchased, while consumption may take place over several years. For example, the benefit derived from a car or television is enjoyed (consumed) over several years. In practice it is hard to measure consumption and the term is used loosely to mean expenditure. Thus consumer expenditure, personal expenditure and private consumption are all the same thing.
Significance
Spending by consumers accounts for between half and two-thirds of GDP. Arithmetically a 1% rise in consumer expenditure contributes to around a 0.6% increase in total GDP, all else being equal, which it rarely is of course. In particular some of the extra consumer spending will go into higher imports.
Spending decisions
Personal income is either spent or saved. Decisions about consumption are intertwined with decisions about savings (see next brief).
The best guesses at what determines spending and saving are the broadly similar permanent-income hypothesis and life-cycle hypothesis, which suggest that consumption is linked to income over a lifetime. Young and old households have a high propensity to spend their income, while those in mid-life save for retirement. In addition, households tend to run down savings or borrow to maintain consumption during a recession (spreading spending over their lifetimes).
Major influences on the level of consumption include the following.
Incomes. In general higher personal incomes allow more spending.
Price expectations. Experience shows that consumers tend to save more (and spend less) during periods of high inflation (see next brief). They may bring spending forward, however, if they expect a one-off increase in prices because of inflation or higher indirect (sales) taxes.
Interest rates. Higher interest rates push up the cost of existing loans and discourage borrowing and, perhaps, encourage savings, all of which depress spending. Nevertheless, higher interest rates also redistribute income from young mortgage payers to their elders whose deposits are greater than their borrowings and who may spend their additional interest income.