Gross Domestic Product (GDP) is a measure of the total value of goods and services produced in the domestic economy. It gives us an idea about whether national output is growing or falling and by how much. A recession represents a period of 2 consecutive quarters where economic growth is negative. Following the quarters of declining growth, the UK economy slowly began to pick up, but in the final quarter of 2010, economic growth once again turned negative. Data first showed a decline of 0.5%, which was then revised down to 0.6%. However, the most recent data from the ONS has put the decline in economic growth back to just 0.5% and the snow we experienced is supposedly to blame. Still a decline, but not as much as previously thought.
What does this mean for the economy? It might be better than previously thought, but it does little to change the economic outlook for the economy. Furthermore, the UK’s position remains relatively weak compared to other nations. As Chris Williamson from Markit said:
“The decline [in growth] overstates the weakness in the economy, reflecting the bad weather at the end of last year, but is nevertheless still a dire reading compared to the UK’s peers.”
The UK also saw a declining trade balance in the final quarter of 2010 to £27bn, showing that the UK was importing more than it was exporting. This was the second biggest deficit since the second quarter of 2009. Whilst the data for growth is a little better, the key for the UK economy will be what happens in Q1 of 2011, especially given that inflation is so far above the target. In order to get inflation back to its 2% target, interest rates need to rise, but this may put the economic recovery in jeopardy. The key is likely to be confidence. If confidence returns to the economy, aggregate demand may begin to rise and put the economy back on track to achieve its 1.5% forecast rate of growth.
UK GDP less bad than forecast at end-2010, Q1 key Reuters (29/3/11)
UK GDP figures show smaller fall BBC News (29/3/11)
UK GDP shrinks by less than expected: reaction Telegraph (29/3/11)
UK growth figures: what the economists say Guardian (29/3/11)
Disposable income falls by 0.8% The Press Association (29/3/11)
British economy shrank 0.5% in fourth quarter Associated Press (29/3/11)
UK GDP figures revised higher The Economy News (29/3/11)
Questions
- What is GDP? Is it a good measure of the standard of living in a country?
- To what extent does the revised figure change the economic outlook for the UK economy?
- How do you think the Monetary Policy Committee will be affected in their decision on changing interest rates, given this new GDP data?
- What factors are worsening the UK’s relative to other countries who also suffered from the recession?
- How were financial and currency markets affected by the revised GDP data? Was it expected?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. Since then it has remained at the same level. Interest rates are used by the Bank of England, which aims to keep inflation at the 2% target within a 1% gap either side. However, inflation has been above 3% for some 15 months and the latest figures for February 2011 show that inflation is rising. In January, it was 4%, but data for February calculates an inflation rate of 4.4% – significantly above the Bank of England’s target rate of 2% and above the forecast rate for the month.
One of the causes of such high inflation is the price of fuel, food and clothing. No-one can have failed to notice that petrol prices are higher than ever and this is one of the factors contributing to an increase in the level of prices throughout the economy. Clothing and footwear costs, which rose by 3.6% after the January sales have also contributed to this rising figure and will put increasing pressure on the MPC to raise interest rates in the not so distant future.
In the February 2011 meeting of the Monetary Policy Committee, interest rates were kept at 0.5%, despite markets pricing the chance of a rate rise at 20%. The negative growth experienced in the final quarter of 2010 is likely to have influenced this decision, but will the inflation data we’re now seeing influence the next meeting of the MPC. This undoubtedly puts pressure on the central bank to increase interest rates to try to get inflation back on target. The cost? It could put the recovery in jeopardy and create the possibility of a double-dip recession. There is a conflict here and whatever happens to interest rates, some groups will say it’s the wrong decision. As David Kern said:
“The MPC must be careful before it takes action that may threaten the fragile recovery, particularly in the face of a tough austerity plan.”
Perhaps the Budget will provide us with some more information about how the government intends to cut the hole in public finances, ensure that the economy does not fall back into recession and keep inflation under control.
UK inflation revives talk of early interest rate rise Reuters, David Milliken and Christina Fincher (22/3/11)
How to inflation-proof your savings Telegraph, Emma Simon (22/3/11)
UK inflation rate rises to 4.4% in February BBC News (22/3/11)
Interest rates: What the economists say Guardian (10/2/11)
Q&A: Impact of rising inflation Guardian, Phillip Inman (22/3/11)
Inflation soars to over double target rate Sky News, Hazel Baker (22/3/11)
Inflation and public borrowing add to budget 2011 headaches Guardian, Larry Elliott (22/3/11)
Inflation cutting savers’ options BBC News, Kevin Peachey (22/3/11)
Inflation: What the economists say Guardian (22/3/11)
Questions
- Is inflation likely to continue going up? What might stop the rise?
- Why are interest rates such an important tool of monetary policy?
- What is the relationship between interest rates and inflation?
- What are the costs of high inflation? Does anyone benefit?
- Who would gain and who would lose if interest rates are increased in the next MPC meeting?
- Which factors have contributed towards rising inflation in the UK? Is it cost-push or demand-pull inflation?
- Why does this pose a dilemma for the government in terms of public finances and the recession?
An interesting article by Stephanie Flanders, the BBC’s Economics editor. She asks just how much (or how little) the pound in our pocket is now worth. With inflation above target, growth very slow and tax and benefit changes to cut the government deficit, everyone is feeling the squeeze. A key fact that Flanders identifies is that only those in the highest income quintile have actually lost from changes in the tax and benefits system: everyone else has (or will) gain. A very interesting read!
The shrinking pound in your pocket BBC News, Stephanomics (21/3/11)
Questions
- What are the main factors that have contributed to lower living standards this year? Explain how each factor works.
- What changes to taxes and benefits have occurred and what changes can we expect over the coming months and years? Who is likely (a) benefit and (b) lose from each change?
- Is it right that the richest families have been affected the most? Find an economic argument for both sides of the debate.
- Why have pensioners lost relatively more than other groups?
We’ve had numerous examples in recent years of the economic turmoil that natural disasters can have and unfortunately, we have another to add to the list: the Japanese earthquake and tsunami. As Japan tries to take stock of the damage and loss of life, the economic consequences of this disaster will also need considering. The previous Kobe earthquake cost the economy an estimated 2% of GDP, but this did hit a key industrial area. The economic consequences of the 2011 earthquake were originally not thought to be as bad, but the economy will undoubtedly suffer.
The Japanese economy, like the UK, shrank in the final quarter of 2010, but was expected to return to growth. The devastation of the earthquake and tsunami is now likely to delay this economic recovery. Many car companies are based in Japan and are expected to take some of the biggest hits. Nomura analysts suggested that annual operating profits of companies such as Toyota, Nissan and Honda would be dented by between 3% and 8%. You only have to look at some of the footage of the disaster to see why this is expected. Supply chains will undoubtedly be disrupted, many of whom are located in the exclusion zone and financial markets across the world have fallen, as the possibility of a nuclear disaster threatens. As Louise Armistead writes:
‘By lunchtime in Britain £32bn had been knocked off the value of the FTSE-100 dropped, which fell by more than 3pc in early trading but recovered later to close down 1.38pc at 5,695.28. Germany’s DAX plunged 3.19pc, recovering from a 4.8pc fall, and France’s CAC ended the day 3.9pc lower, while on Wall Street, the Dow Jones Industrial Index dropped 2pc shortly after opening.’
A key question will be whether Japanese reconstruction will push the economy out of its deflationary spiral or make it even worse.
GDP measures the value of output produced within the domestic economy, but it is by no means an accurate measure of a country’s standard of living. Whilst it will take into account new construction that will be required to rebuild the economy, it doesn’t take into account the initial destruction of it. As output and growth are expected to fall in the immediate aftermath, we may see a boost to growth, as reconstruction begins.
The problem of scarcity is becoming more and more apparent to many survivors, as they begin to run short of basic necessities, which has led to various rationing mechanisms being introduced. Despite the devastating conditions which survivors now find themselves in, when supplies are delivered, the efficiency of Japan is still very evident. As noted by BBC Radio 4 coverage, as soon as the supplies arrived, a line was in place to unload the van in minutes. Teams have been set up to help everyone get through the tragedy. Even in the most devastating of times, Japanese efficiency still shines through and undoubtedly this will be a massive aid in the huge re-construction projects that we will see over the coming months and even years. Analysts say that there will be short term pain, but that the investment in construction will boost the economy later in the year.
Japanese earthquake: Markets shed £1trillion amid nuclear fears Telegraph, Louise Armistead (16/3/11)
Panic over Japan triggers market turmoil Independent, Nikhil Kumar (16/3/11)
Japan quake: Economy ‘to rebound’ after short term pain BBC News (14/3/11)
Japan disaster: The cost of a crisis Guardian (16/3/11)
Global stock markets tumble in ‘perfect storm’ amid fears of nuclear disaster Mail Online, Hugo Duncan (16/3/11)
Japan’s earthquake will cause a global financial aftershock Guardian, Peter Hadfield (15/3/11)
Economists’ estimate of Japan quake impact Reuters (16/3/11)
Fukishima factor adds pressure to economic fallout from Japan’s crisis Guardian, Larry Elliott (15/3/11)
Questions
- What is the likely impact on Japan’s GDP?
- Why is the potential disruption to the supply chain important for a firm?
- How and why will this catastrophe affect global financial markets?
- What are some of the main problems of using GDP as a measurement for growth? Think about the impact on GDP of Japan’s destruction and their future re-construction.
- What types of production methods etc have Japan implemented to allow them to become so efficient in production?
- What are the arguments to suggest that this disaster might help the Japanese economy recover from its deflationary spiral? What are the arguments to suggest that it might make it worse?
- What are some other examples of natural disasters or human errors that have also had economic consequences?
The pensions problems facing many of the developed world are well documented and are largely caused by changing demographics, including rising life expectancy, more people in education, retiring earlier and the ‘baby boomers’ nearing or entering retirement. All of this has contributed to unsustainable pension systems and hence a need for reform. The latest review is by Lord Hutton and looks at public-sector pensions. It makes a number of recommendations about reform. The main thing to come out of the report is that public-sector workers will have to pay larger contributions. work for longer and may receive less in their pension.
Many public-sector pensions have been based on a final salary scheme, which gives workers an extremely generous pension on retirement. The proposal is to change these to career average pensions, which will reduce the generosity for some and hence play a role in reducing the pension deficit. He suggests that public-sector retirement age should be increased in line with the state pension age, which will simultaneously increase the number of workers and hence output, but also reduce the number of years spent in retirement and hence reduce pension payments.
The government will now consider the recommendations laid out in the Hutton Review, but will need to bear in mind potential reactions by the unions, which have already hinted at strike action if the proposals go ahead. As the TUC general secretary, Brendan Barber, said:
‘Public-sector workers are already suffering a wage freeze, job losses and high inflation. They are now desperately worried that they will no longer be able to afford their pension contributions, and will have to opt out.’
With such concern about these proposals, and yet an unarguable case for pension reform, this is certainly an area where we will undoubtedly see significant media coverage.
Articles
Hutton reveals his pension plan – and is blasted by unions Guardian, Polly Curtis (10/3/11)
Pensions anger from unions following Hutton review (including video) BBC News (10/3/11)
High-wire act fails to balance public and private Financial Times, Nicholas Timmins (10/3/11)
A fairer pension deal that is long overdue Telegraph (10/3/11)
Hutton: This changes the basis on which I accepted the job, says teacher Guardian, Jessica Shepherd and Jill Insley (10/3/11)
No winners over public sector pensions if ministers or unions rush to battle Guardian, Polly Toynbee (10/3/11)
Career-average pensions: How do they work? BBC News, Ian Pollock (10/3/11)
Hutton pensions review: Q&A Telegraph, Harry Wallop (10/3/11)
Tackling the intractable The Economist (10/3/11)
Trade unions: pension reforms are unfair and misguided Guardian, James Meikle (10/3/11)
Report
Independent Public Service Pensions Commission: Final Report Pensions Commission, Lord Hutton, HM Treasury, March 2010
Independent Public Service Pensions Commission: Interim Report Pensions Commission, Lord Hutton October 2010
Questions
- Identify the main causes of the pensions problem. Explain how each issue has added to the pensions deficit.
- To what extent is it equitable that public sector workers should pay more in contributions and retire at the same age as the state pension age?
- Who will benefit the most from a change from final-salary to career average schemes?
- How might higher contributions affect the incentive to work? What could we see happen to labour supply? Think about both income and substitution effects.
- What are the union’s main arguments against the proposals? To what extent Is striking likely to solve the problem?