These initial estimates are not exact enough even to say where in a range of
plus or minus 1 per cent the change occurred. Later revisions – which go on
for years after the period in question – could be in either direction.
Our hypothetical citizen ought to be doubly disenfranchised if the intended
vote is changed by similar decimal percentage point movement in the estimate
for the first quarter of 2010 due a few weeks before the most likely date of
the general election, May 6.
The fact is that estimates of real gross domestic product are not nearly
accurate enough to measure fine changes. All that one can reasonably say is
that output was roughly stable in the last quarter after having fallen by
perhaps 5 per cent in the year as a whole.
Even that is an optimistic assessment of what can be known. Ideally, one
should take a moving average of several quarters, assuming that the
direction of bias in the reporting has not changed radically. Taking
everything into account, including recent surveys and other data, it looks
as if the UK economy has stopped contracting.
Recession over
Does that mean the recession is over? Yes, if you choose to define a recession
in terms of falling output and keep your fingers crossed against the
possibility of a double dip. But that gives us little insight.
What surely matters is the gap between actual output and the trend consistent
with non-inflationary growth. You may think that that is like looking for a
black cat in a dark room; and in future articles I shall suggest a slightly
different approach. Meanwhile, however, the Goldman Sachs UK Economics
Analyst makes a heroic attempt to limit the range of argument.
It first assumes that output was on trend in 2005 and that potential output
has been growing at an annual rate of 2.6 per cent – a little below the
long-term average. On that basis the “output gap” is in excess of 10 per
cent.
At the other extreme, a statistical method (known to its friends as
Hodrick-Prescott filter), based on smoothing out past cyclical fluctuations
suggests an output gap of “only” 3 per cent. You can find respectable
estimates for all stations in-between.
The Organisation for Economic Co-operation and Development, for instance, has
a figure of 6½ per cent. Goldman Sachs itself looks at separate estimates of
labour and capital growth to yield a gap of 5 per cent, which is similar to
the British Treasury’s own view.
Looking ahead, Goldman Sachs believes that the output gap is likely to
contract – if it is not doing so already. Its starting point is that
unemployment has been some 2½ percentage points lower than would be expected
on the basis of past relationships with GDP.
Labour hoarding
A popular explanation is that this reflects labour hoarding, in contrast to
the US where unemployment has risen much more. One implication of the labour
hoarding view is that in the absence of an unexpectedly rapid recovery there
are many more job losses in the pipeline.
An alternative explanation is that the surprisingly small rise in unemployment
already reflects the adverse effects of the credit crunch on physical
investment, which fell by an astonishing 14 per cent in 2009. The fact that
inflation has been slightly surprising on the upside reinforces the view
that spare capacity has been declining.
This may be benign from a short-term point of view, but it suggests that the
scope for a long-term improvement in employment is very much less than might
have been thought. Indeed, Barclays economists suggest that the sustainable
rate of unemployment (sometimes known as the Nairu) will rise from 6 to 9
per cent. Actual unemployment is now 7.9 per cent, suggesting that it has to
rise further in the medium term.
They also suggest, for good measure, that underlying growth rate of the
economy is now an annual 1¾ per cent, compared with the Treasury’s assumed
2¾ per cent. This seemingly small difference becomes of great importance
projected ahead.
Those economists who emphasise these physical constraints tend to believe that
demand may now grow faster than potential supply, and that policy should and
will become less accommodative from here.
Worried
Economists with a more monetary bias, however, are worried by the sluggish
growth in some measures of the money supply and bank credit. They are
obviously represented inside the Bank of England, whose statement this
Thursday can be paraphrased as saying in Fed parlance: “Steady as she goes
with a bias towards easing.”
My own view is that there is little case for action just yet. But the cat may
jump in either direction. (Whoever said that macroeconomics was an exact
science?) In any case, I would base policy on the state of the economy –
real growth and inflation – rather than on a narrow view of the government’s
own finances, and avoid like the plague the draconian spending cuts and tax
increases set out as “options” by the Institute of Fiscal Studies.
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