In a previous blog, Anyone got a crystal ball?, we reported on the Bank of England’s and other agencies’ difficulty in making forecasts. As the Governor, Mervyn King, said, “There is just enormous uncertainty out there.”
The Bank of England has just published its November Inflation Report. This quarterly publication gives forecasts of inflation, GDP and other indicators. It is clear that forecasting hasn’t become any easier. In his opening remarks, Dr. King says:
Continuing the recent zig-zag pattern, output growth is likely to fall back sharply in Q4 as the boost from the Olympics in the summer is reversed – indeed output may shrink a little this quarter. It is difficult to discern the underlying picture. It is probably neither as good as the zigs suggest nor as bad as the zags imply.
The Inflation Report looks at the various factors affecting aggregate demand, inflation, unemployment and aggregate supply. It is quite clear on reading the report why there is so much uncertainty.
A salutary lesson is to look back at previous forecasts and see just how wrong they have been. The chart above shows the forecasts for GDP made in the Inflation Reports of Nov 2012 and Aug 2011. You can see that they are significantly different and yet just 15 months apart. You might also like to compare the forecasts made a year ago (or even two!) about 2012 with the actual situation today. A good source for this is the Treasury’s Forecasts for the UK economy. This collates the forecasts from a range of independent forecasters.
The inaccuracy of forecasting is an inevitable consequence of a highly interdependent world economy that is subject to a range of economic shocks and where confidence (or lack of it) is a major determinant of aggregate demand. But when firms, governments, individuals and central banks have to make plans, it is still necessary to project into the future and try to forecast as accurately as possible – even though it might mean keeping your fingers firmly crossed.
Articles
Bank of England downgrades growth forecast for 2013 Daily Record (14/11/12)
A gloomy picture from the Old Lady Financial Times (14/11/12)
Will Britain’s post-recession economy be resurgent, stagnant or greener? The Guardian, Larry Elliott (11/11/12)
Economics must heed political risk Financial Times, Sebastian Mallaby (6/11/12)
European Commission autumn forecast: overoptimistic and in denial Social Europe Journal, Andrew Watt (7/11/12)
Bank of England gets long to-do list for overhaul Reuters, Sven Egenter (2/11/12)
Data
Inflation Report, November 2012 Bank of England
Index of economic forecasts European Commission DGECFIN
Economic Outlook Annex Tables OECD
World Economic Outlook Reports IMF
Forecasts for the UK economy HM Treasury
Questions
- What was being forecast for economic growth and inflation for 2012 (a) one year ago; (b) two years ago?
- What are the main reasons for the inaccuracy of forecasts?
- How might forecasting be made more reliable?
- If sentiment is a key determinant of economic activity, how might politicians increase the confidence of firms and consumers? What are the political constraints on doing this?
- Explain the following statement from the Guardian article: “The problem … is that last decade’s tailwind has become this decade’s headwind.” Why is it difficult to forecast the strength of this ‘headwind’?
- How useful is it to use past trends as a guide to the future course of the economy?
The story of the UK economy over the past few years has been one of bad news and worse news. With a double-dip recession having kept confidence low in the UK, positive news for the economy was seemingly a distant hope of government ministers. However, official statistics show that that in the 3 months from July to September, the UK economy emerged from recession, with growth of 1.0%.
This positive GDP figure (click here for a PowerPoint of the chart below) was undoubtedly helped by the London Olympics over the summer, which may have added as much as 0.2 percentage points to GDP, according to the ONS. Millions arriving in London and other venues, spending money on countless things. Yet, other factors have also contributed to this welcome growth. Stephanie Flanders said:
The positive ‘surprise’ in these figures is largely to be found in the service sector, which is estimated to have growth by 1.3% in the third quarter, after shrinking by 0.1% in the three months before.
Further to this, in Stephanie Flanders’ ‘Stephanomics’, she says that ‘it confirms that the last three months of this latest recession were brought to you by the Queen. Or at least, the extra Bank Holiday to celebrate her Jubilee.’ The Bank of England suggests that the Jubilee took 0.5 percentage points from official GDP statistics. So, the news so far is positive, but the economy is far from being back to its pre-recession size.
The 2008-2009 recession knocked 6.4% off the UK economy. Since then, the total growth (over the past 4 years) has reached only half of that – 3.2% and that includes the 1% figure just published. Thus, while we may be on ‘the right track’, there is still a long way to go. Economists differ in their interpretations of what this means for the overall recovery: some say that this is a sign of what’s to come; others argue that this recovery has been driven by one-off factors.
What is certain is that government policy over the next few months will be crucial in keeping the economy on the right growth path. The following articles consider the implications of this new economic data.
A special recovery BBC News, Stephanomics, Stephanie Flanders (25/10/12)
UK GDP rises 1pc: economist reaction The Telegraph (25/10/12)
Nick Clegg warns economic recovery will be ‘fitful’ The Guardian, Daniel Boffey (28/10/12)
GDP figures set to show UK economy has exited double-dip recession The Telegraph, Philip Aldrick, Emma Rowley and Jessica Winch (25/10/12)
UK economy returns to growth with help from Olympics BBC News (25/10/12)
U.K. posts quarterly gain in GDP, lifted by Olympics Wall Street Journal, Cassel-Bryan Low (25/10/12)
GDP figures show UK emerging from recession: full reaction The Guardian (25/10/12)
UK growth signals move out of recession Financial Times, Sarah O’Connor and George Parker (25/10/12)
Questions
- How do we define a recession?
- How is GDP calculated and what does it measure?
- Which factors have contributed towards lower GDP data towards the beginning of this year?
- Which factors have helped boost GDP in the 3 months from July to September?
- Why is there disagreement about the likelihood of positive GDP figures continuing throughout the rest of the year?
- Prior to the official release of the GDP figures, David Cameron hinted at positive news. Given that the market is so sensitive, what effect might this suggestion have had?
- Given this positive figure, what implications does this have for the government’s quantitative easing programme?
- If we translate this latest growth data onto an AD/AS diagram, how would you show what has recently happened?
Although every recession is different (for example in terms of length and magnitude), they do tend to have a few things in common. The focus of this blog is on consumer income and how it is affected in the aftermath of (or even during) a recession. According to data from the ONS, real national income per head has fallen by more than 13% since the start of 2008.
This latest data from the Office of National Statistics shows that in the aftermath of the 2008 recession, UK incomes have fallen by much more than they did in the 2 previous recessions experienced in the UK (click here for a PowerPoint of the chart). We would normally expect consumer incomes to fall during and possibly directly after a recession, as national output falls and confidence tends to be and remain low. However, the crucial thing to consider with falling consumer incomes is how it affects purchasing power. If my income is cut by 50%, but prices fall by 80%, then I’m actually better off in terms of my purchasing power.
The data from the ONS is all about purchasing power and shows how UK consumer incomes have fallen at the same time as inflation having been relatively high. It is the combination of these two variables that has been ‘eating into the value of the cash that people were earning’. Comparing the incomes in the four years after the 2008 recession with similar periods following the early 1980s and 1990s recession, the ONS has shown that this most recent recession had a much larger effect on consumer well-being. Part of this may be due to the rapid growth in incomes prior to the start of the credit crunch.
It’s not just the working population that has seen their incomes fall since 2008 – the retired population has also seen a decline in income and according to a report from the Institute for Fiscal Studies, it is the wealthiest portion of older households that have taken the largest hit since 2007. According to the IFS, the average person over 50 has experienced a fall in their gross wealth of about 10%, or close to £60,000. Of course for these older households, the concern is whether they will be able to make up this lost wealth before they retire. The concern for everyone is how long until incomes and purchasing power increase back to pre-crisis levels. The following articles consider this latest data on economic well-being and the impact the recession has had.
UK wellbeing still below financial crisis levels Guardian, Larry Elliott and Randeep Ramesh (23/10/12)
National income per head ‘down 13% in four years’ BBC Newsd (23/10/12)
Financial crisis hits UK retirement income Financial Times, Norma Cohen (23/10/12)
Over 50s ‘left £160,000 out of pocket by the financial crisis’ The Telegraph, James Kirkup (23/10/12)
Those near retirement in UK hit hard by crisis Wall Street Journal, Paul Hannon (23/10/12)
Living standards down 13pc since start of recession The Telegraph (23/10/12)
Questions
- Why is net national income per head said to be the best measure of economic well-being?
- Why is it so important to take into account inflation when measuring wellbeing?
- What explanation can be given for the larger fall in consumer incomes following the 2008 recession relative to the previous 2 recessions?
- According to data from the IFS, the richest portion of older households have suffered the most in terms of lost wealth. Why is this the case?
- What is meant by purchasing power?
- GDP has fallen by about 7%, whereas national income per head, taking inflation into account is down by over 13%. What is the explanation for these 2 different figures?
- How can recessions differ from each other? Think about the length, the magnitude of each.
- Is GDP a good measure of economic well-being? Are there any other ways we can measure it?
With the winter fast approaching, consumers have already begun to stock up on warmer clothes. This has contributed towards consumer spending increasing faster in September than it has in the past 3 years. According to Visa Europe’s UK expenditure index, sales in August increased by 1.2pc, but in September they rose month-on-month by 3pc.
But whilst sales on the high-street increased, sales on-line and over the telephone declined. It seems that the recent decrease in temperature is just what the retail sector ordered, as people took to the high streets.
Furthermore, recent improvements in consumer income, together with lower inflation and rising employment have all contributed towards a growth in spending. However, as consumer confidence remains at a relatively low level, it is unlikely that the winter will bring much of a change to growth in the economy. The Chief Economist at Markit said:
However, consumer confidence remains historically low as uncertainty about the economy and job security persists, suggesting that the bounce in spending seen in the third quarter could be as good as it gets for the foreseeable future.
Although the lower temperature has caused a boost in consumption, once people have made their ‘investment’ in warmer clothes, retail spending may once again decline. Hence the above comment by Markit, which suggests that further sustained increases in consumer spending may still be some way off.
The following few articles look at the latest data on retail spending.
UK consumer spending ‘rose in September’ BBC News (5/10/12)
Consumer spending increases by 3pc The Telegraph (5/10/12)
Consumer spending increases by 3% The Press Association (5/10/12)
UK retail sales: what the analysts say Guardian (20/9/12)
Online sales and wet weather boost John Lewis Scotsman, Peter Ranscombe (5/10/12)
Questions
- Which factors typically affect consumer spending?
- Using a diagram, illustrate the impact of this increase in consumption on national output and the price level.
- Is it possible that a multiplier effect may occur with the August and September rise in retail sales?
- Why is consumer confidence remaining low? Which components of aggregate demand does it affect?
- Explain why (a) lower inflation, (b) the colder weather and (c) rising employment have caused consumer spending to rise.
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
- What are the causes of the deepening of the current recession in the UK?
- Search for data on other G7 countries and compare the UK’s performance with that of the other six countries (see, for example, the OECD’s StatExtracts.
- Compare the approach of George Osborne with that of Neville Chamberlain in 1932, during the Great Depression.
- Does weak UK growth warrant more quantitative easing by the Bank of England?
- To what extent can fiscal policy be used to stimulate the economy without deepening the public-sector deficit in the short term?
- What is meant by ‘crowding out’? If fiscal policy were used to stimulate demand, to what extent would this cause crowding out?
