On Friday it was told here how the typical family’s discretionary disposable income has at last risen.

According to Ernst and Young, our income after tax and the bills we have no control of in the short term, such as utility bills and mortgage/rent, has seen a a big improvement over the last year.

Apparently, the average level of disposable income per household in June of this year was £1,075, compared to £772 a year ago.

It is good news, and on face value this improvement will provide the impetus for recovery.

It is just that there are a few snags. Below we take a look at how this all-important measure of our income is set to change over the next few years. It seems the keys lie in interest rates, tax, the cost of energy and, of course, our income. Read on:

First things first, tax is clearly set to rise. Public debt is such that any would-be government that says it can avoid tax rises is just not being truthful. Taxes will rise across the income spectrum – there is no avoiding it.

The future course of interest rates, however, may not be quite so worrisome.

Actually, there are two types of interest rate we need to concern ourselves with. There’s the rate of interest after inflation, or real rate of interest, and there’s the nominal level.

If you are one of those who think the return of inflation is around the corner, and therefore interest rates are set to rise, it is possible that even if you are right, it won’t affect our affordability by too much. Surely what really counts is the cost of debt after allowing for inflation. If our wages rise by say 10 per cent, and we pay 12 per cent interest, then really what counts is the difference – the 2 per cent bit.

If it looks like inflation may get out of control then it is possible real rates wil have to rise, and this will hurt.

But there is another factor that may be more significant.

In the long term the real rate of interest is determined by the demand and supply of money. Or to put it another way, the more people want to save, the lower the rate of interest.

There are two reasons to believe savings rates will rise for the foreseeable future. Firstly, the fall in asset prices means that most of us will want to compensate for this by saving more. Secondly, the imminent retirement of the baby boomers will lead to a rise in savings, too. In fact, this increase in the savings ratio has already begun.

A lot of people think low interest rates are unfair because they punish the prudent and reward the reckless. But then price always is unfair. The whole point about price is that it is supposed to be the mechanism for marrying demand and supply. And the next few years are likely to see supply rise.

For that reason, it seems there is good reason to believe real interest rates will remain modest – for some time. This will of course help our mortgage costs and reduce the government’s cost of servicing its debt – which will help our tax rates.

But there’s another factor. Low consumption and high saving will probably lead to a rise in unemployment.

The Ernst and Young report talked about changes in discretionary disposable income for families that were not affected by unemployment. The truth is, if we are set to move into an era of higher savings, this is likely to be accompanied by higher unemployment – just like in Japan for the last 20 years.

As for the price of oil. There seems to be a growing feeling that the recent rises in oil have been overdone, and the black stuff will fall back. But in the medium term, as the likes of China and India grow – it seems inevitable that oil will creep up above $150 again, and then go even from that level.

But actually, our real wealth creation is dependent on our ability to produce goods and services – if our productivity rises, then this will eventually lead to a rise in GDP, which in turn will make debt more affordable.

The key will rest in this. On the one hand, there will be low risk, low spending and high debt, which will suck growth out of the system. On the other hand, changes in technology are creating potential. Time will tell which side wins out.

© Investment & Business News 2013