Hamish McRae: We need help to spend our way to recovery

Will it be a rise in real incomes or in house prices that will trigger a turnaround in the economy? If the former, we should be more comfortable quite soon; if the latter, we may have to wait. The question is raised by the very low levels of new mortgages and the continuing decline in house prices, both reported this week. The flow of funds into mortgages remains the lowest for more than 15 years, while house prices fell by 0.4 per cent on a three-monthly basis.

The point here is that half of the demand in the economy comes from private consumption. For four years that has been more or less flat. You cannot have a real recovery until consumption starts to rise, so what might lead to that? There needs to be confidence, so people feel it is safe to spend. What might cause this? The three candidates are rising employment, rising real incomes and rising wealth.

We have had rising employment for a year; indeed, the UK is creating new jobs almost as fast as the US. We are within a whisker of the peak employment reached in 2007. But many of these jobs are part-time or in self-employment and do not seem to boost confidence.

In money terms, incomes are rising at just under 2 per cent a year. Since inflation has been as high as 5 per cent, and even now is 2.5 per cent, real incomes are still being cut. We become a little poorer every month. But that may change by December, with the CPI dropping below 2 per cent and money incomes climbing a little.

The third candidate is rising house prices. During the boom years, people supported their consumption by withdrawing equity from their homes. Since 2007, the reverse has happened and people have been paying down their mortgages, cutting consumption to do so. If house prices started to rise, people might relax and become a little less keen on paying off debt. Were that to happen, that would give a sizeable boost to consumption.

What should we expect? Things need to come together to lift us from slow growth into something more solid – the virtuous circle where real incomes are rising, companies confident about investing, and consumers confident about spending. We have rising employment; we should soon have rising real incomes; if we also get modestly rising house prices, then the worst will be over. But it is a big "if".