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25 October 2012
Today’s GDP data in the UK showed a sharp rebound in activity in the third quarter, with the economy growing by 1.0%Q/Q. This was stronger than expected, but a significant rebound had been widely anticipated given that it followed three consecutive quarters of contraction, including in Q2, which saw a relatively sharp contraction exacerbated by an additional bank holiday. These third quarter GDP data were also boosted by the impact of the Olympics, not least the fact that the ticket sales were all booked in the quarter. Abstracting from the recent volatility of the data suggests that the economy has continued to move broadly sideways – even after the growth in Q3 the economy was the same size as it was a year earlier, while it remains 3.1% below its pre-crisis peak. And with external demand continuing to slow - yesterday’s flash PMIs pointed to a deepening recession in the euro area in October - consumer spending under pressure from both falling real incomes and household deleveraging, and fiscal consolidation set to continue for years to come, the chances of the UK returning to anything approaching pre-crisis trend growth in the near term are slim.
Of course, recovery from the most severe post-war financial crisis was always going to be slow – history teaches us that. But the evidence is stacking up that the UK economy has not just underperformed its peers, but also continues to do poorly relative to what would have been expected in the wake of the crisis. The charts below are from some recent work by two economists (Moritz Schularick and Alan Taylor). They show how the US and UK economies would have been expected to recover if this had been a normal recession (the blue line) and how they would have been expected to recover in the wake of the financial crisis. As can be seen, the US economy has performed better than their model would have expected it to. But the UK has taken a very different path – having broadly done what was expected in the early post-crisis years (2008-09), it subsequently fell well behind the US in 2010-11, while 2012 is expected to see it drop below the range of what the recovery should look like given the crisis.
Why the UK economy has been so weak is, of course, the focus of much debate. But it is no coincidence that, having basically followed the path of the US economy in the early years of the crisis, a time when policy responses were pretty similar, the paths have diverged only after the UK government announced plans to undertake the most aggressive fiscal consolidation programme outside of the euro area periphery. Certainly, there is no sign of the expected (by the government and its supporters) unleashing of pent up demand in the private sector that fiscal consolidation was supposed to deliver. Indeed, the evidence increasingly suggests that the damage to growth from tightening fiscal policy prematurely has been much greater than previously assumed (see IMF or Eichengreen and O’Rourke). Unfortunately there is no evidence that policymakers are willing to change tack despite the warnings provided by the economic numbers in both the UK and the euro area periphery. When Mervyn King set out his own very bleak assessment of the economic outlook earlier this week he argued that (in his opinion at least) monetary policy can only do so much to help. The coalition government, meanwhile, continues to repeat the mantra that there is no alternative to fiscal consolidation while the Prime Minister claims heroically that ‘the good news will keep coming’. For as long as this remains the default position of policymakers, today’s GDP number will prove the exception, not the rule.
The US and UK economies, 2007-2012: Actual versus predicted paths
Source: Moritz Schularick and Alan Taylor
Grant Lewis, Head of Research
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