Down, down, deeper and down

New data released on 25/7/12 by the Office for National Statistics showed that the UK economy shrank by a further 0.7% in the second quarter of 2012. This makes it the third quarter in a row in which GDP has fallen – and it is the steepest fall of the three. Faced with this, should the government simply maintain the status quo, or does it need to take new action?

The construction sector declined the most steeply, with construction output 5.2% down on the previous quarter, which in turn was 4.9% down on the quarter previous to that. The output of the production industries as a whole fell by 1.3% and the service sector fell by 0.1%. (For a PowerPoint of the following chart, click here.)

The immediate cause of the decline in GDP has been a decline in real aggregate demand, but the reasons for this are several. Consumer demand has fallen because of the squeeze on real wages, partly the result of low nominal pre-tax wage increases and partly the result of inflation and tax rises; the government’s austerity programme is holding back a growth in government expenditure; export growth has been constrained by a slowing down in the global economy and especially in the eurozone, the UK’s major trading partner; and investment is being held back by the pessimism of investors about recovery in the economy and difficulties in raising finance.

So what can be done about it?

Monetary policy is already being used to stimulate demand, but to little effect (see Pushing on a string. Despite record low interest rates and a large increase in narrow money through quantitative easing, broad money is falling as bank lending remains low. This is caused partly by a reluctance of banks to lend as they seek to increase their capital and liquidity ratios, and partly by a reluctance of people to borrow as individuals seek to reduce their debts and as firms are pessimistic about investing. But perhaps even more quantitative easing might go some way to stimulating lending.

Fiscal policy might seem the obvious alternative. The problem here is that the government is committed to reducing the public-sector deficit and is worried that if it eases up on this commitment, this would play badly with credit rating agencies. Indeed, on 27/7/12, Standard & Poor’s, one of the three global credit rating agencies, confirmed the UK’s triple A rating, but stated that “We could lower the ratings in particular if the pace and extent of fiscal consolidation slows beyond what we currently expect.” Nevertheless, critics of the government maintain that this is a risk worth taking.

The following articles look at the causes of the current double-dip recession, the deepest and most prolonged for over 100 years. They also look at what options are open to the government to get the economy growing again.

Articles
Britain shrinks again The Economist (25/7/12)
Shock 0.7% fall in UK GDP deepens double-dip recession Guardian, Larry Elliott (25/7/12)
UK GDP figures: expert panel verdict Guardian, Frances O’Grady, Will Hutton, Sheila Lawlor, Vicky Pryce and John Cridland (25/7/12)
GDP shock fall: UK growth in 2012 ‘inconceivable’, warn economists The Telegraph, Angela Monaghan (25/7/12)
UK recession deepens after 0.7% fall in GDP BBC News (25/7/12)
UK economy: Why is it shrinking? BBC News (25/7/12)
UK GDP: A nasty surprise and a puzzle BBC News, Stephanie Flanders (25/7/12)
Tough choices for Mr Osborne BBC News, Stephanie Flanders (26/7/12)
David Cameron in pledge to control UK’s debt Independent, Andrew Woodcock and James Tapsfield (26/7/12)
David Cameron defends economic policies BBC News (26/7/12)
The GDP number is awful – and it’s the product of the Government’s amateur policies, not the euro crisis The Telegraph, Thomas Pascoe (25/7/12)
UK recession: have we heard it all before? Guardian, Duncan Weldon (25/7/12)
US economic growth slows in second quarter BBC News (27/7/12)
GDP data trigger debate on economy Financial Times, Norma Cohen and Sarah O’Connor (25/7/12)
Does weak UK growth warrant more QE? Financial Times (25/7/12)
The recession: Osborne’s mess Guardian editorial (25/7/12)

Data
Gross Domestic Product, Preliminary Estimate, Q2 2012 ONS (25/7/12)
Preliminary Estimate of GDP – Time Series Dataset 2012 Q2 ONS (25/7/12)

Questions