Could the post-lockdown boom in consumer spending lead to a long-lasting self-sustaining recovery?
We usually think of multipliers in the context of fiscal policy – how much output responds eventually to a rise in public spending or taxes. But we can think of post-lockdown spending in the same way: it will be an exogenous policy-induced rise in demand analogous to a discretionary rise in government spending.
Multipliers, though, are not fixed facts. They vary from time to time and place to place. How big this year’s consumer multiplier proves to be will depend upon several factors.
One is: how much spare capacity is there? The more that pubs and restaurants can accommodate increased demand, the greater the multiplier. If, on the other hand, they have to turn customers away or raise prices, the multiplier will be smaller.
Another is the policy response. We’ll not see rising interest rates until the Bank thinks that inflation will be “sustainably” on target, nor rising taxes until 2023. Which implies a bigger multiplier as there’ll be no offset to higher spending. What will keep the multiplier down, though, are the automatic fiscal stabilizers: as people work more they’ll see their tax credits fall and tax payments rise.
Yet another factor is the exchange rate. It’s possible this will rise as the pandemic fades simply because sterling is a risky asset, demand for which should increase as global investors’ mood improves. You might think this implies a low multiplier as exports will be crowded out. But it doesn’t, because exports aren’t sensitive to exchange rates. The OBR estimates that a one per cent rise in relative export prices cuts goods exports by only 0.4 per cent after two years and services exports by only 0.2 per cent. More likely, a stronger pound would reduce inflation, thus postponing interest rate rises and giving us a bigger multiplier.
Another issue is the employment response; the bigger this is, the higher the multiplier. But the OBR expects that total employment will only return to its pre-pandemic level in 2023. And many of these will be hospitality workers returning to low-wage jobs. Which points to a lowish multiplier.
And then there’s the question of how capital spending reacts to higher consumer demand. Here, I’m more pessimistic. Bank of England data show that small and medium sized firms have seen their debt rise 25.8 per cent in the last 12 months. Their priority will be to pay down this debt rather than to expand. And yet more entrepreneurs’ animal spirits have been dampened not just by the financial crisis of 2008 but also by the pandemic. A low response of capital spending to increased consumer demand means a low multiplier.
Overall, therefore, there are reasons for both optimism and pessimism about the size of the consumer multiplier.
It’s very possible that the end of the lockdown, the consumer boom and better weather in the spring will combine to produce a huge surge in optimism, to the benefit of equities. But given investors’ tendency to extrapolate current conditions and their own moods too much into the future, this rally might well go too far; in effect, investors will over-estimate the consumption multiplier. One challenge for this year therefore might well be judging when to jump off the bandwagon.