UK economic data — not your standard AD story

by on April 27, 2012 at 2:51 am in Economics | Permalink

Richard Williamson, a loyal MR reader, writes to me:

I think there has been a lot missing from the discussion of the UK in the blogosphere. We are a bit of a puzzle on a purely AD-based explanation of the recession.

1) We didn’t have deflation (on annual basis at least), and even stripping out the effect of the VAT rise in 2011 should still show persistent inflation over 3% since 2010
http://www.tradingeconomics.com/united-kingdom/inflation-cpi

2) UK inflation expectations seem to be significantly higher here (if falling away a little recently)
http://www.bondvigilantes.com/2012/03/19/markets-start-to-think-about-inflation-again/
http://uk.finance.yahoo.com/news/uk-inflation-expectations-drop-1-093038319.html

3) If you look at table EMP02 here, you can see that the public sector as share of total employment the same in the UK today as in Q1 08, and almost all the decline in *total* employment has been in the private sector (the increase in public sector employment in Q4 08 was due to bank nationalisations)
http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/april-2012/index-of-data-tables.html#tab-Employment-tables

I’m not really sure what is going on. But based on my twitter feed today, a lot of other people seem to be. If we were to just look at inflation (at expectations thereof), the country that ought to be having an AD-driven double-dip recession would appear to be the US.

Richard writes again to me:

I would also like to add that any demand issue we have would not appear to be due to ‘austerity’, but rather that we are explicitly targeting inflation in the context of some (as-yet unspecified) supply side problems…

Ps I also think there’s a weird thing about the ‘confidence fairy’ rationale for austerity, where we might expect a government that believes this to tactically *exaggerate* the amount of actual cutting they’re doing, a reversal of usual government incentives.

1 Nathan Tankus April 27, 2012 at 3:20 am

Price levels often don’t coordinate with recession. especially in smaller countries like the UK. I see no contradiction between inflation being at 3 per-cent, and thinking the country is an an effective demand led recession. It all depends on the structure of Industries and firm costs.

2 Matthew April 27, 2012 at 4:05 am

Oh our inflation rate suggests we have a “supply-side” problem that nobody other usual “industrial-base-blah-blah” types can explain.

The problem with a supply-side explanation for unemployment and “high” inflation WHERE THE FRACK IS THE WAGE INFLATION?

Also like so many anti-keynesians Williamson thinks its total amount of government spending or total deficit that is the measure of stimulus/austerity, but growth is about rates of change (i.e. how much are government purchases contributing to growth in output/spending) and the problem is that in a private sector deleveraging crisis even modest austerity can send economies tail-diving (see Japan circa 2001).

3 UnlearningEcon April 27, 2012 at 6:28 am

‘Also like so many anti-keynesians Williamson thinks its total amount of government spending or total deficit that is the measure of stimulus/austerity, but growth is about rates of change (i.e. how much are government purchases contributing to growth in output/spending)’

+1

4 Andrew' April 27, 2012 at 7:50 am

What if the required return on employment increased. Then you’d have real wage inflation without nominal inflation.

5 dcomerf April 27, 2012 at 4:15 am

The price inflation’s caused by currency depreciation since 2008 (as well as the VAT mentioned). There’s very little wage inflation.

6 Tyler Cowen April 27, 2012 at 7:10 am

There is plenty of inflation in non-tradeables, and in any case it seems that a falling real wage isn’t helping so much…

7 Frederic Mari April 27, 2012 at 4:37 am

What your previous commentators said.

It would bear looking into it more closely but I think inflation in the UK is purely ‘imported’ inflation i.e. as commodity prices rise and as the currency depreciates, all the goodies from abroad we’re relying upon end up costing more… thus supply-led inflation.

I am not sure how CPI/PPI figures compare but another interesting thing about London (which is most of the UK, economically speaking) is that rich foreigners love buying properties there (artificial supply constraints helping keeping the prices constant/constantly rising) and love to locate there due to its advantageous tax rates combined with decent nightlife/glamour coefficient.

All of this combines to make inflation persistent while there is no wage inflation (on the contrary) and thus AD-related issues. Stagflations aren’t all that easy to analyse/explain within many standard theories but they do occur in real life and aren’t that difficult to describe.

8 Saturos April 27, 2012 at 5:07 am

What does NGDP say?

9 Wimivo April 27, 2012 at 9:10 am

NGDP growth, UK
Source: http://www.guardian.co.uk/news/datablog/2009/nov/25/gdp-uk-1948-growth-economy

2003 Q4 6.47%
2004 Q4 5.33%
2005 Q4 4.44%
2006 Q4 5.84%
2007 Q4 5.87%
2008 Q4 -1.53%
2009 Q4 -0.14%
2010 Q4 4.87%
2011 Q4 2.81%

CPI really is a bad indicator, and I’m at the point where I often tune out when I see it utilized for any persuasive purposes.

10 Saturos April 27, 2012 at 10:07 am

So we’re behind on NGDP growth – it’s below normal, let alone catch-up growth. We are below the trend path of NGDP levels in the UK. That is a demand problem.

11 John Hall April 27, 2012 at 10:12 am

I just took nominal UK GDP from 1992 through March 2008 and drew a trend line and extended it to the present. It would suggest that nominal GDP is nearly -15% below where it would be to be consistent with the earlier period’s growth. I would guess Scott Sumner would say that it is an aggregate demand story.

12 a April 27, 2012 at 5:45 am

The UK has experienced a large number of aggregate supply shocks.

Taxation:

1) Changes in VAT and taxation: in 2010 VAT was increased from 15% to 17.5%, so constant tax CPI (ONS:EAD6) was below 2% for the entire year. So monetary policy was kept relatively tight to compensate for increases in inflation due to tighter fiscal policy.

2) In 2011, there was a further increase in VAT from 17.5% to 20%, other taxes were also increased (for example employers’ national insurance rates (payroll taxes)). Despite this constant taxes CPI only exceeded 3% for three months in 2011, September-November. Note that the constant taxes CPI does not adjust for changes in payroll taxes.

Assuming that monetary policy cannot reverse tax changes does it make sense for central banks to target a measure of inflation that includes one time tax increases? I guess Mankiw would be the authority on this?
Investment

3) Business investment since 2008 has been low, (ONS:NPEN). Business investment has fallen from £136bn to £119bn, £116bn and £117bn in 2009-2011 respectively in 2008 £s. There is little sign that business investment is increasing.

4) Why has business investment fallen?

a. Whilst monetary policy has been relatively easy in the past, it is expected to tighten in future, the BoE aims for headline inflation to fall back to 2%. This suggests the BoE has little intention of increasing aggregate demand in the future.

b. Fiscal policy has been forecast to be relatively tight since 2010, in particular public sector investment has been cut from £46bn in 2009 to £31bn in 2011 (ONS:ANNW adjusted for 2011 £s).

c. Financial sector impairments. British banks have been instructed to increase their capital ratios, this works against expansionary monetary policy such as quantitative easing.

d. Consumer demand is forecast to be low due to consumers paying down debt.

Output:

5) North sea oil production has fallen by 38% since 2007, (ONS:K226), (note Osborne unexpectedly increased the rate of taxation on North Sea profits from 20% to 32% in the 2011 budget). Also electricity generation is down 5.7%, manufacturing is down 8.3%.

The UK has also experienced aggregate demand shocks:

6) The government and Sir Mervyn King have been at pains to encourage the public to pay down their debts. This has occurred. The household savings ratio has increased from 2.7% in 2007 to 7.4% in 2011. Households are paying off mortgages. The total stock of mortgage debt (BOE: LPMVTXK) has decreased by 10%, from a peak of £1.13tn in December 2008 to £1.02tn in February 2012, in real terms (£2005). This is a shock to aggregate demand.

In 2010 as the coalition was being formed Sir Mervyn King met with Cameron and Clegg. He encouraged them to implement “austerity” to address the deficit. I presume King thought he could use monetary policy to offset the planned fiscal tightening. However, he did not explain this, and clearly businesses either did not believe that the BoE could maintain aggregate demand or were unable to raise finance for investment.

Turns out King was wrong, the UK is paying the price for his mistake.

Expectations matter, back in the 90s and early 2000s, politicians would avoid even mentioning the word recession, now they appear to wallow in it. All this is rather depressing and predictable, makes me wish Jed Bartlett was our PM rather the public relations lightweights we find ourselves burdened with.

Still you have to give it to Krugman, the relative performance of the US and UK is a pretty comprehensive vindication of his arguments over the last four years.

Just a shame so few of the British press, or indeed British economists, have been able to articulate the same arguments, (Martin Wolff of course excepted).

13 Bill April 27, 2012 at 8:43 am

This is interesting and worthy of comment.

Here is what the author of Tyler’s post says about Tyler’s post if you now go to his website:

“First, I would like to make clear I am not ‘pro-austerity’ – not in the UK and certainly not in Europe. But we control our own monetary policy here and that makes all the difference. If you have a problem with the level of aggregate demand in the UK, please take it up with Mervyn King, or with our monetary policy objective which is much more heavily biased towards stable prices than full employment.

Second, there are an enormous number of people in the world who are suffering right now due to deficient aggregate demand. I am one of those people who has a problem with Mervyn King and our monetary policy objective. More aggregate demand, please.

However, I am becoming steadily less convinced that this is the whole story, at least for the UK. Back in November, Karl Smith made the clearest statement I have ever read of the New Keynesian explanation of a recession: {quote omitted}

Right now, unemployment remains at over 8% in the UK while real wages are lower than they were 7 years ago and are continuing to fall. Yes, you read that correctly. Which immediately leads one to ask: on this explanation of a recession as expounded by Karl, how much further do real wages have to fall to eliminate disequilibrium unemployment?

I am not a political person, I’m trying to ask an intellectual question here. As an interested observer of (and, I stress, not remotely an expert on) the economy, I am finding the aggregate demand narrative an increasingly unsatisfying explanation of all that is happening in the British economy. Supply-side suffering is suffering too, and I think we need to take very seriously the chance that it is happening.”

you can find it here : http://shewingthefly.com/

14 Bll April 27, 2012 at 10:25 am

Here is the next shoe to drop:

After the British economy drops some more, you will hear the calls for stimulus–but in the form of “tax cuts”, and probably for the wealthy.

15 awfulconcoction April 27, 2012 at 9:55 am

The Olympics have temporarily boosted spending and demand to a certain degree. Don’t forget that…

16 Doc Merlin April 27, 2012 at 5:30 pm

I dispute this.

17 Jason April 27, 2012 at 11:29 am

The only two people in the economic blogosphere AFAIK with models that existed before the recession that have coherently used them to explain what is happening since the recession are Scott Sumner and Paul Krugman. As they are both Americans, the confusion in the UK blogosphere is understandable.

[And AFAICT the difference between the models is that Sumner believes that fiscal policy will be immediately offset by monetary policy and Krugman believes fiscal policy will be eventually offset by monetary policy.]

18 Wimivo April 27, 2012 at 11:47 am

fiscal policy will be immediately offset by monetary policy

Eh, not immediately and only on average; IIRC he admits that the Fed’s response to fiscal stimulus will never be exact and so fiscal stimulus may have some small multiplier, negative or positive.

19 Alex April 27, 2012 at 3:54 pm

What others have said (particularly the commenter known as “a”).

I’d also add to the tax rises, that there has been a number of increases in fuel duty (that’s a tax on gas to Americans reading).

Also, I seem to remember Krugman doing a post where he compared UK and US inflation when tax rises had been stripped out, and he showed the rates were pretty similar.

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