Guide to Economic Indicators
Page 9
Consumer credit. Easier consumer credit may encourage borrowing, which translates directly into higher spending.
Wealth. A rise in asset values, such as share or house prices, may make consumers feel wealthier and inclined to spend more. 7.1 Consumer spending
Source: IMF
Stock level and price of durables. Consumers tend to regard durables such as cars and electrical appliances as wealth. A sudden end to a period of restricted supply of durables as in east Germany in 1990, or a fall in their prices, may encourage a temporary consumer boom. This may set up replacement cycles, with bouts of spending on durables every few years. 7.2 Growth in current consumer spending
Source: IMF
Table 7.2 Consumer spending
Social factors. These may encourage saving to allow bequests or retirement spending.
The cycle
There is a cyclical pattern in consumer expenditure. The most volatile component is spending on durables: goods with a life of over one year such as washing machines, furniture and cars.
When economic conditions are tight, spending on durables can be cut more readily than spending on non-durables such as food and heating. Thus there is a stable core of spending on non-durables, and a fluctuating level of spending on durables which moves in line with the economic cycle.
International comparisons
Total spending is affected by the level of services provided by the state. For example, in Belgium and France, where health care is initially paid for by the user, the outlays are included in consumer expenditure. Where health services are more or less free at the point of use, as in Britain and Nordic countries, no entry appears under consumer spending. In developing countries a greater proportion of spending is on essentials such as food.
Interpretation
The focus should be on real percentage change. Some countries, such as America, publish monthly figures in nominal terms, which may be deflated by consumer prices to obtain a feel for the real growth. For example, if nominal personal spending grows by 6% and consumer prices rise by 4%, spending has risen by about 2% in real terms. Changes in spending on durables can be an early signal of developments.
Retail sales (page 129), car sales (page 123) and consumer confidence (page 98) also provide leading indicators of spending patterns.
Personal and household savings; savings ratio
Measures: Savings by households.
Significance: Key component of total national savings.
Presented as: Money totals and as a percentage of disposable income.
Focus on: Trends.
Yardstick: The OECD average savings ratio has been about 6.5% during the 2000s.
Released: Quarterly or annually; frequently revised.
Overview
Personal savings, an important chunk of national savings (see page 109), are personal disposable income less personal consumption. Many governments also produce savings data for households alone. The household savings ratio is household savings as a percentage of household disposable income.
The household or personal sector’s financial deficit or surplus (the net balance of deposits and loans) is different from savings. For this reason consumer borrowing – which influences spending and saving – can be considered separately (see page 92).
International comparisons
Household savings ratios are shown with national savings in Table 8.3. Household savings ratios vary widely between countries. For example, in 2008 net household savings were 2.7% of household income in the United States and 11.8% in France (see Chart 7.3). There are a number of reasons for this.
7.3 Net household savings
Source: OECD
As far as definitions are concerned, the calculations depend on the treatment of consumer durables, private pensions and life insurance payments, social security, household interest payments, capital transfers and depreciation. Adjusting for such factors can change savings ratios by several percentage points.
Other factors which account for differences in savings ratios include the age structure of the population and the labour force; the distribution of incomes; the availability of consumer credit; the tax treatment of savings; the social security system; and economic variables such as those discussed below.
Influences on household savings
The experience of the industrial countries in recent decades highlights some factors which affect savings. Note that savings appear to be relatively unaffected by changes in interest rates.
The 1970s
Economists were confounded by the rise in savings which accompanied the high inflation of the 1970s. Theory said that with falling real disposable incomes and negative real interest rates the savings ratio should have fallen. It seems that households save more during high inflation in order to maintain the real value of their savings.
The 1980s
Savings ratios fell in the 1980s for several reasons. There was lower inflation; stockmarkets were rising; in some countries higher house prices boosted personal wealth and so encouraged spending; financial liberalisation made borrowing easier; public pensions improved; and the population was ageing (older people save less).
The 1990s and 2000s
Perhaps the most striking feature of savings trends in the 1990s was the continuing fall in America’s already low household savings rates, which was 1.4% in 2005.Onereasonmaybethat Americans felt wealthier because of the rise in the stockmarket. Or prolonged economic growth may have made them more optimistic about future earnings. However, since the credit crunch of 2007–08 most OECD countries have seen a significant increase in their savings ratios.
Interpretation
See National savings, page 109, for hints on interpretation. Note that the ageing population (see Population, page 63) is likely to reduce savings rates.
Consumer confidence
Measures: Consumers’ perception of their economic well-being.
Significance: Determines short-term spending/borrowing/savings plans.
Presented as: Usually index numbers.
Focus on: Trends.
Yardstick: Watch for changes in direction.
Released: Monthly, one month in arrears.
Overview
Survey evidence of consumer perceptions is valuable as a leading indicator. In general, the more optimistic consumers are, the more likely they are to spend money. This boosts consumer spending and economic output.
Surveys of consumer confidence are conducted by private sector organisations such as the Conference Board in America and GfK in Britain and universities such as the University of Michigan. The results are presented in index form or as percentage balances (of consumers feeling more optimistic minus those feeling less optimistic).
Other indicators
Other popular indicators of consumer confidence include:
The misery index I: The rate of consumer-price inflation plus the unemployment rate.
The misery index II: The rate of consumer-price inflation plus annual interest rates.
In each case the higher the number, the more miserable consumers are assumed to be. However, once inflation falls below zero or close to it, the misery index becomes less meaningful. Falling prices can have damaging economic effects.
Chapter 8
Investment and savings
Saving is a very fine thing. Especially when your parents have done it for you.
Sir Winston Churchill
Overview
Investment deserves special attention because it is so important for the future health of an economy. It lays the basis for future production.
Investment is spending on physical assets with a life of more than one year. This should be distinguished from financial transactions which are known as investment in everyday language but which are-from an economic viewpoint-savings.
It is conventional to say that businesses invest while individuals consume. If a household buys itself a personal computer, this is recorded in the national accounts as personal co
nsumption. If a business buys the same model, the spending is classed as investment. The rationale is that the household uses a PC for “pleasure” while a business uses it in the production of future output. A company’s stocks of raw materials and goods are classed as investment.
The circular flow of incomes
Chapter 4 (page 42) outlined the concept of the circular flow of incomes. Savings and investment are often considered to be the most important leakage and injection. It is easiest to understand their significance through an example.
Imagine a simple system in which firms produce $100m of goods a year. Suppose that households save $20m. Output is $100m, incomes are $100m and consumption is $80m. Since the firms sell only $80m of their output, the remainder is left in stock at the end of the year. The $20m increase in stocks is classed as investment spending. In order to meet their wage bills, the firms have to borrow $20m from the banks where the households saved their $20m. Output is $100m, incomes are $100m, and total spending is $80m consumption plus $20m investment which equals $100m.
The leakage of $20m for saving is matched by an injection of $20m for investment. Investment (in stocks or fixed assets) can take place only when some consumption is deferred. By definition, investment = savings.
Of course there is no automatic mechanism which ensures that the amount that households wish to save matches the amount that firms wish to invest. Investment and savings are each determined by different factors which are discussed in the following briefs.
Economic effects of imbalance
Loosely, if planned savings exceed planned investment, stocks pile up and companies cut back their production: GDP falls. If planned savings are less than planned investment, companies produce more to meet the extra demand and GDP rises. (See Cyclical indicators, page 55.)
The golden rule
It is difficult to identify the ideal level of saving and investment. Less saving means more consumption today but less investment and so less future consumption. Economists talk about the “golden rule” which maximises the consumption per head of all generations. Significantly, an IMF study suggested that America’s national savings in the period 1986–1990 were only half the amount required by the golden rule.
National savings and investment
All sectors of the economy save and invest. Real life is not as simple as business investment and household savings. Table 8.1 shows flows of funds around the world. The following briefs discuss the topics in more detail.
Table 8.1 Investment and savings
Fixed investment and GDFCF
Measures: Spending on goods with a life of more than one year.
Significance: Contributes directly to GDP, lays basis for future output.
Presented as: Value, volume and index numbers.
Focus on: Volume trend.
Yardstick: OECD average fixed investment grew by 1.6% a year during the period 2000–08.
Released: Quarterly, 1–3 months in arrears; frequently revised.
Overview
Fixed investment is spending on physical assets. Total investment is fixed investment plus investment in stocks of raw materials and goods (see Stocks, page 107).
Physical assets include infrastructure such as roads and docks; buildings such as dwellings, factories and offices; plant and machinery; vehicles; and equipment such as computers. These generally provide the potential for higher output in the future. The economic (as opposed to the social) benefit of dwellings and some infrastructure is more arguable, but most infrastructure boosts economic efficiency. For example, new roads help to get delivery teams back for more work rather than crawling at 10kph through the world’s congested cities.
8.1 Real fixed investment
Sources: IMF, Eurostat
Investment and consumption
By convention, only businesses invest. All personal spending is consumption for national accounts purposes, except the purchase of new dwellings. These have such a long life that they are classed as investment. Most government spending, including that on defence equipment, is classified as consumption (see page 34).
GDFCF
Economists pompously call new investment in physical assets “gross domestic fixed capital formation”. Gross because it is before depreciation; domestic because it is at home rather than overseas; fixed because it does not include stocks; and capital formation since it distinguishes physical from financial investment.
Fixed investment is rarely shown net because of the problem of accounting for capital retirements and obsolescence.
Interpretation
Fixed investment accounts for an average of around 20% of GDP in industrial economies. So as a crude rule of thumb, a 1% rise in fixed investment adds around 0.2% to GDP in the same period, all else being constant.
The potential for future output will also be boosted (see Productivity, pages 52–54), especially by investment in plant and machinery. Table 8.2 shows that this is typically 6–8% of GDP.
Table 8.2 Real fixed investment
The direct relationship between investment and output is complex. Investment is shown gross and the increase in productive capacity will be less after allowing for depreciation, and so on, but in developing countries at least, a given change in investment this year can be used as the basis for a moderately reliable forecast of the change in GDP next year.
The cycle
Investment is highly cyclical. Firms are more likely to invest if they are operating at a high level of capacity, if they expect demand to remain high and if interest rates are low. (See Business conditions and Capacity use, pages 115 and 118.) When these conditions are reversed, businesses are likely to cut back on fixed investment. However, investment projects have long lead times and a cut in new investment does not automatic ally imply a fall in total investment spending.
8.2 Growth in real fixed investment
Source: IMF
A 1% increase in demand may be translated into a greater than 1% increase in output if firms respond by increasing investment spending. (See “accelerator principle” in Cyclical indicators, page 55.)
Government intervention
Government incentives for investment should be treated with caution as they can be counter- productive in the long run. Tax subsidies make poor investment projects viable.
Changes in government investment spending should also be scrutinised. In more mature economies government expenditure can crowd out privatesector investment with detrimental effects, but in developing countries public and private investment are often complementary.
Other indicators
GDP investment figures are released with a lag. Other indicators should be used for advance signals, especially investment intentions, construction spending, housing starts, auto sales, manufacturing production and imports of capital goods.
Sectoral
Investment is classified by ownership rather than end-use. Sectoral investment figures should not be taken at face value. Investment by service companies may reflect spending on goods which are subsequently leased to industrial firms.
Investment intentions
Measures: Plans for capital spending, sometimes just in manufacturing.
Significance: Investment adds to current and future GDP.
Presented as: Value, volume totals or changes.
Focus on: Trend: planned volume increases.
Yardstick: Look for planned increases of several percentage points.
Released: Monthly, one month in arrears.
Overview
Governments and trade associations such as the US Institute for Supply Management and the Confederation of British Industry (CBI) publish the results of surveys of investment intentions. These may be wholly subjective (“Do you expect more or fewer capital authorisations over the next 12 months?”) or misleadingly quantitative (“How many dollars’ worth of capital spending will you undertake in the calendar year?”). See also Business conditions, page 115.
Value and volume
W
here surveys are in value terms, the first step should be to consider how closely the figures relate to volumes. Respondents tend to indicate the value of investment after allowing for any expected price increases, so the totals should be deflated to arrive at the planned volume increase. As a crude deflator use producer prices. If these are rising by 5% and companies expect the value of their investment to increase by 7%, the volume of investment will be about 2% greater. If inflation is accelerating or decelerating, use the consensus view (at the time of the survey) of expected inflation for the period ahead.
Outcomes
Intentions are rarely turned into spending on a one-for-one basis. Investment intentions surveys tell you something about future trends in the economy, but at the same time you should interpret the survey results in the light of developments in the economy. For example, a rise in interest rates after a survey may lead to a lower than announced level of investment.
Stocks (inventories)
Measures: Stocks held by producers and distributors.
Significance: Indicator of demand pressures; potential sales.
Presented as: Value and volume totals and changes.
Focus on: Totals in relation to sales, changes.
Yardstick: See text.
Released: Quarterly, sometimes monthly, 1–3 months in arrears; frequently revised.
Overview
Stocks or inventories are materials and fuel, work-in-progress and finished goods held by companies.
The book value of stocks changes for two reasons.
Stock appreciation is an increase in the money value of stocks owing to inflation. It adds to nominal income (the inventories can be sold at a profit) but there is no addition to real output.
Stockbuilding (or destocking) is a change in the physical volume of inventories. It reflects the production of goods and affects nominal and real output.