How vulnerable are your finances to the next economic recession?
Nobody knows for sure when the UK economy might next enter a period of recession. Based on historical economic cycles, we do appear to be long overdue a recession; various technical indicators and some commentators have suggested that the process has already begun.
New research by the Resolution Foundation has concluded that the income squeeze that followed the global financial crisis has left low and middle income households more vulnerable to the next recession than they were in 2008.
In their new report, A problem shared?, Resolution Foundation analysed the distributional impact of economic recessions following the financial crisis.
Ten years of low-income growth has meant lower-income families are more vulnerable today than they were when the global financial crisis hit back in 2008.
This vulnerability is the result of having less scope to reduce non-essential
spending should incomes fall again.
There is also a higher proportion of families today, compared to 2008, with no savings on which to fall back should a recession hit and cause a loss of jobs.
Based on this analysis, and warnings that the risk of recession is now at its highest level since 2007, the Resolution Foundation is calling on the new Chancellor to prioritise preparations for recession.
Received wisdom ahead of the 2008 global financial crisis was that lower-income families bore the brunt of recessions. This was demonstrated in the 1980s when unemployment rose by 1.9 million and the distribution of this unemployment rise was distributed towards lower-income households.
Lower-income households experienced six times more unemployment back then when compared with the highest-income households.
By way of contrast, the economic impact of the 2008 recession was more evenly distributed, with workers across the board losing out. Average real earnings fell by £32 a week between 2008 and 2014, demonstrating a lasting impact from this most recent recession.
According to the research, it was the social security safety net, which played a crucial role in protecting lower-income households during the last recession.
The lowest-income households benefited from the tax and state benefits system more than offsetting their loss of employment income.
But it’s the longer-term impact of the last recession that has fascinated the researchers at the Resolution Foundation, who found that lower-income households were hit hardest over the longer-term.
It was lower-income households who were forced to retrench their spending habits following the global financial crisis, and they are yet to shake off this impact, in preparation for the next round.
The bottom quarter of the income distribution cut spending by £61 a week between 2008 and 2014, compared to the average spending cut of £20 a week.
Something else that changed following the last recession was allocation of spending towards essentials, with a far higher proportion now directed at essential spending. This means there is less scope to cut non-essential spending in the face of a new recession.
With limited cash savings available to help weather the next economic storm – nearly 60% of lower-income households have zero cash savings – the research raises some worrying findings as the current economic cycle draws to a close.
The Foundation is calling on the government to ensure that any policy response to prepare the country for the next recession takes households across the income distribution into account.
It notes, for example, that a fiscal policy response focused on income tax cuts would overwhelmingly benefit higher-income households, even though lower-income households are likely to need the most support.
Britain is facing the highest risk of recession risk since 2007, and we know from previous downturns that it is lower-income households that bear the brunt of economic downturns when it comes to their living standards.
The deep income squeeze that followed the last financial crisis may have been more equally shared than previous recessions. But its depth and length has had a disproportionate impact on the resilience of lower income households, who now have less scope to reduce non-essential spending or draw down on savings to weather a further recession than they did after the 2008 crisis.
The global slowdown and continued Brexit uncertainty are making recession preparedness even more urgent. In its response, the government should consider policies that limit and mitigate the effects of the recession, particularly for the most vulnerable in society.”James Smith, Research Director at the Resolution Foundation, said:
From a Financial Planning perspective, the best time to fix the roof is when the sun is shining. Now is the ideal time to review household budgets, cut back on debt, and boost cash savings, all in preparation for the next recession.
By working with a Financial Planner, it’s possible to model potential economic scenarios, including a cut in income or a temporary fall in the value of investment markets, to understand the impact of these events on your longer-term financial objectives.