(Not) Too Clever by Quarter?
Today’s preliminary 2011 quarter 2 GDP release showed that the UK economy was still growing, but that the rate of growth had slowed (from 0.5% in 2011Q1). By June 2011, the economy was just 0.7% larger than it was in June 2010 and the Government’s forecast growth in GDP for 2011 of 1.7% is likely to be revised down. Overall, the UK economy is still 3% smaller than it was before the recession began in 2008.
The Office for National Statistics cited “one-off factors” (as there are every quarter, but get used to hearing that phrase each time growth disappoints!) such as April's extra bank holiday for the royal wedding and the effects of the Japanese earthquake and tsunami. Critics, including the Opposition, reiterated previous arguments that the Government is cutting “too far, too fast” (output of government services was flat in 2011Q2) and that the January 2011 VAT increase is dampening consumer demand.
But are politicians and commentators right to attach so much significance to one quarter’s worth of data? And how many quarters worth of data do we need before we can be confident that we are witnessing a trend (and not simply a series of one-off events)!?
The purpose of a GDP estimate is to provide a reliable picture of the condition of the overall economy, and quarterly estimates are of vital importance for the analysis of current economic conditions and for the conduct of supports fiscal and monetary policy making. Growth that is slower than forecast would have implications for tax revenues and, in turn, borrowing requirements. This would, therefore, also impact upon the Government’s efforts to reduce public debt and the budget deficit. On the flip side, weaker growth should mean that the Bank of England keeps interest rates at 0.5% for the foreseeable future, in spite of the inflationary pressures in the economy (which some commentators believe could soon overtake growth as the main macroeconomic challenge).
The key question is what (if any) are the policy implications of today’s figures? Do they mean that the Government’s deficit reduction strategy is failing (or was wrong from the off) or does it simply show that any longer-term strategy will inevitably encounter some short term turbulence? Should George Osborne & co now start to devise a “Plan B” (ie a slower deficit reduction strategy) or will we now get additional austerity measures to reduce the deficit?
In the absence of other economic drivers, further cuts in spending could risk delaying a recovery, particularly if the knock on effect is a decline in business and consumer confidence. However, any Plan B is not without risks: attempting to spend our way back to growth risks putting further pressure on public finances and may not kick start the economy, especially if consumers and businesses simply anticipate even greater cuts and/or tax rises down the line and adjust their behaviour accordingly. Whatever the approach taken, fine tuning the economy so that an increase in private sector spending comes along at just the right time to offset or enable public spending contractions is extremely difficult.
In any case, in spite of its u-turns on other areas of policy, the Government appears to be standing firm on its approach to reducing the deficit. This suggests that other areas of policy (eg on tax, trade, business regulation, business support, innovation, access to finance etc) have a key role to play in stimulating economic growth. In addition, the Bank of England may now carry out a further round of quantitative easing after all (although this is a danger that this becomes an economic crutch, and an inflationary one at that).
With eurozone and US debt crises still being played out, the risks to the UK economy are clearly on the downside. A double-dip recession is by no means inevitable, but it does appear more of a possibility than it did a year ago. We should probably get used to reading about quarterly rates of GDP growth being below trend and forecasts being revised downwards. We may also hear the term “stagflation” entering the public debate for the first time since the 1970s!
Austerity is here to stay. Now, what to do about inflation…
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