What does a recession look like? | 17
demand, then their inventory levels will start to build up. These
have to be put up for sale before new production can go on to the
market, and therefore the necessary adjustment to output has to
be larger than the fall in demand. Without changes in the level of
stockbuilding, the drop in output from peak to trough would have
been smaller in all three of the UK's post-war recessions.
Once the shock to the economy has been unleashed, the main
driving force behind the economic slowdown is the behaviour of
individual consumers, whose spending accounts for more than 60
per cent of GDP. Households will naturally be wary in how they
spend their income if the economy turns for the worse, and they
fear that their incomes may grow more slowly, or even that their
jobs could be at risk. And if they have loaded themselves with
debts during the preceding upswing, they will behave more
cautiously still.
Each of the three post-war UK recessions saw a sharp
slowdown in real income growth from an annual rate of 5-8 per
cent to something close to zero. But they
also featured a pronounced jump in the
saving ratio � the proportion of their
incomes that households save � reflecting
their more cautious attitudes. On each
occasion, the saving ratio rose by at least 4
percentage points as a share of disposable
incomes. As a result, consumer spending
growth slowed from around 5 per cent
immediately prior to the slowdown to
something close to zero � equivalent to
taking 2-3 percentage points off the annual
rate of GDP growth.
The precise pattern of consumers'
expenditure, and the speed with which
they react to adverse economic conditions, will depend on a range
of factors, including the state of the housing market. But the
prime determinant of spending is household income, the most
important element of which comes from wages and salaries. A loss
of employment will therefore cause affected households to react
quickly and harshly by cutting back on their spending on
discretionary items.
But unemployment tends to lag the economic cycle, as
companies are slow to adjust employment to changes in demand
and output. We therefore have little guide as to how
unemployment will behave in the early stages of the downturn.
For instance, in 1990 it only started to edge up from the middle of
1990, a few months after output had peaked.
Companies are initially reluctant to lay off workers in case the
downturn is short and shallow, so they choose instead to reduce
their working hours by cutting overtime, etc. The number of
hours worked therefore may give a timely indication of an
imminent downturn in the economy. But it is not a reliable
leading indicator of recession. If a downturn is short-lived, cuts in
hours can quickly and easily be reversed without any impact on
employment and unemployment.
Each of the three
post-war UK
recessions featured a
pronounced jump in
the saving ratio

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