How bad is the UK recovery dynamic?
Bottomed out -- let's hope so! Can things get any worse?
Here's what real (inflation adjusted) GDP per capita looks like for the U.K. (1992:1 - 2013:2)...
Because the real GDP is flat, any rise in the nominal GDP is attributable entirely to inflation (increases in the general level of prices). From 1992-1997, the BoE targeted the RPIX inflation rate at 2% per annum. In 1997, the target was raised to 2.5%.
In 2003, the UK switched to targeting CPI inflation at 2% per annum.
So unlike in many other countries, inflation appears to be running at a robust rate. Is this helping, hurting, or innocuous as far as determining real economic activity? (Would like the NGDP targeters to weigh in on this question.)
The following diagram decomposes real GDP (total, not per capita) into consumption (private and public), investment (public and private) and net exports.
So both domestic (real) expenditure components, consumption and investment, took a big hit in the recession. If we take the same data and normalize each series to 100 in 1992, we see that investment grew relatively faster during the boom, and took the bigger hit in the bust.
Now let's break down the (real) expenditure components between the private and public sectors. Again, normalize the levels to 100 in 1992. Here is what consumption looks like:
The big drop seems to be in private consumer spending. Government purchases of consumption goods appears to have held pretty steady through the downturn. What about capital spending? Here, we can only get a breakdown between private and public investment going back to 1997. Government investment is small relative to total investment, but has nevertheless remained elevated relative to private capital spending through most of the sample period:
Note: In April 2005 British Nuclear Fuels plc (BNFL) transferred to the Nuclear Decommissioning Authority (NDA) nuclear reactors that were reaching the ends of their productive lives. BNFL is classified as a public corporation in the National Accounts and the NDA as central government.
In terms of the UK's much publicized austerity measures, the data here suggest that most of any cuts in government spending must have been in the form of reduced transfer payments. Government spending on goods and services seems to have held up relatively well throughout the contraction in economic activity.
Bottomed out -- let's hope so! Can things get any worse?
Here's what real (inflation adjusted) GDP per capita looks like for the U.K. (1992:1 - 2013:2)...
Because the real GDP is flat, any rise in the nominal GDP is attributable entirely to inflation (increases in the general level of prices). From 1992-1997, the BoE targeted the RPIX inflation rate at 2% per annum. In 1997, the target was raised to 2.5%.
So unlike in many other countries, inflation appears to be running at a robust rate. Is this helping, hurting, or innocuous as far as determining real economic activity? (Would like the NGDP targeters to weigh in on this question.)
The following diagram decomposes real GDP (total, not per capita) into consumption (private and public), investment (public and private) and net exports.
So both domestic (real) expenditure components, consumption and investment, took a big hit in the recession. If we take the same data and normalize each series to 100 in 1992, we see that investment grew relatively faster during the boom, and took the bigger hit in the bust.
Now let's break down the (real) expenditure components between the private and public sectors. Again, normalize the levels to 100 in 1992. Here is what consumption looks like:
Note: In April 2005 British Nuclear Fuels plc (BNFL) transferred to the Nuclear Decommissioning Authority (NDA) nuclear reactors that were reaching the ends of their productive lives. BNFL is classified as a public corporation in the National Accounts and the NDA as central government.
In terms of the UK's much publicized austerity measures, the data here suggest that most of any cuts in government spending must have been in the form of reduced transfer payments. Government spending on goods and services seems to have held up relatively well throughout the contraction in economic activity.
A minor correction for the history: the UK's inflation target was 2.5% RPIX from 1992 to 2003. What changed in 1997 is that responsibility for execution of monetary policy was moved from the Treasury to the BOE, and the BOE was given "instrument independence" in how it (attempted to) hit the target.
ReplyDeleteThe CPI inflation data is somewhat distorted by three significant changes to the VAT rate (which was lowered in 2008, raised in 2010 and 2011), but the CPI ex indirect tax tells a similar "story" of a price level raised above pre-2008 trend. There are other "excuses" for above-target CPI, notably raises in "administered prices" set by the government.
From an NGDP-targeting perspective my narrative would be that above-target CPI has repeatedly forced the BOE to push down NGDP growth so as maintain inflation closer to target.
A deeper discussion of the UK supply-side is unfortunately necessary: there has been a collapse in productivity since 2010; market sector output per hour is 3% lower in 2013 than in 2010, hours worked is up 6% over the same period.
So you get three choices: 1. Slow NGDP growth (tight money). 2. Fiscal austerity (tax rises, etc). 3. Productivity. Mix as appropriate.
In my opinion the collapse in productivity predates 2010.
DeleteReal labor productivity per hour worked peaked at 28.1 pounds (2005 pounds) in 2007Q3 and 2007Q4. After falling to 26.8 pounds in 2009Q1 and 2009Q2, it recovered to 27.3 pounds by 2010Q2 before falling back down to 26.8 pounds in 2013Q2:
http://appsso.eurostat.ec.europa.eu/nui/show.do?query=BOOKMARK_DS-055410_QID_-50591C15_UID_-3F171EB0&layout=TIME,C,X,0;GEO,L,Y,0;INDIC_NA,L,Z,0;UNIT,L,Z,1;S_ADJ,L,Z,2;INDICATORS,C,Z,3;&zSelection=DS-055410UNIT,NAC_HRS;DS-055410S_ADJ,SWDA;DS-055410INDICATORS,OBS_FLAG;DS-055410INDIC_NA,RLPH;&rankName1=INDIC-NA_1_2_-1_2&rankName2=S-ADJ_1_2_-1_2&rankName3=INDICATORS_1_2_-1_2&rankName4=UNIT_1_2_-1_2&rankName5=TIME_1_0_0_0&rankName6=GEO_1_2_0_1&sortC=ASC_-1_FIRST&rStp=&cStp=&rDCh=&cDCh=&rDM=true&cDM=true&footnes=false&empty=false&wai=false&time_mode=NONE&time_most_recent=false&lang=EN&cfo=%23%23%23%2C%23%23%23.%23%23%23
The 4.6% decline in UK labor productivity from 2007Q4 to 2013Q2 is easily the largest such decline in the EU over this period, and compares with an increase of 2.7% in the Euro Area from 2007Q4 to 2013Q2, and a 5.6% increase in the US between 2007 and 2012 according to the Conference Board.
Mark - you are of course perfectly correct, and I did not mean to imply any differently.
DeleteIn fact you understate the issue, if anything. The decline in market sector output/hour is 8.3% peak to trough (2007Q2 to 2013Q1). This has been offset by a significant rise in government productivity.
I graphed it here
Very interesting.
DeleteHi J A Britmouse:
DeleteAbout your comment on:
“the UK's inflation target was 2.5% RPIX from 1992 to 2003”
I think the RPIX inflation target of 2.5% was not set up until 1997. There was not much information about the target at 1992. However, here is one piece of information I found:
In 1992, a letter to the Chairman of the Treasury and Civil Service Select Committee, the Chancellor, Norman Lamont, stated:
"I believe we should set ourselves the specific aim of bringing underlying inflation in the UK, measured by the change in RPIX, down to levels that match the best in Europe. To achieve this, I believe we need to aim at a rate of inflation in the long term of 2% or less."
"For the remainder of this Parliament I propose to set ourselves the objective of keeping underlying inflation within a range of 1-4%".
In some literature, scholars state that, during that period, instead of a target point, it was more of a range of 1-4%. We can also find this from BOE: http://www.bankofengland.co.uk/markets/Pages/sterlingoperations/timeline/timeline_no_flash.aspx#1992
Probably the chart should be changed it to a 1-4% bang instead of a 2% target point. But I think the RPIX inflation target at 2.5% was not introduced until 1997.
Lily
(The Sex Pistols' song was running through my mind as I read this.)
ReplyDelete"So unlike in many other countries, inflation appears to be running at a robust rate. Is this helping, hurting, or innocuous as far as determining real economic activity? (Would like the NGDP targeters to weigh in on this question.)"
The Party Line is: never reason from a price change!
For example, if (say) 5% NGDPLT had been the target, then (trivially) higher inflation would have hurt recovery in RGDP.
More generally, nobody can really tell what the counterfactual is to your question. If the counterfactual is: "If monetary policy had been tighter, so that inflation would have been slower than it actually was" then I would say that RGDP performance would have been even worse.
Nevertheless, the UK inflation rate has surprised me. The failure of inflation to fall more, and more quickly, around the world, has surprised me. The UK is just one of the more surprising. My conditional priors were wrong. My hunch is that inflation targeting itself made inflation stickier, and that we are only now seeing a very lagged reaction of falling inflation. But that's just a hunch, not a real explanation.
People follow rules of thumb for expected inflation. Doing so is not irrational, provided those ROT work OK in their environment. Inflation-targeting made the following ROT work very well: "expect target inflation, plus or minus changes in oil prices and indirect taxes, and ignore everything else". The experience of IT, plus the central banks' reinforcement of that ROT via communications, made expected inflation very sticky, which made actual inflation very sticky. IT sowed the seeds of its own destruction, by making inflation useless as a signal of excess demand/supply, and destroying divine coincidence.
Nick, that's funny -- I was thinking of the same song when I thought of the title to this post. I am struck by your concluding sentence. I am wondering in what sense the inflation rate should be relied upon to equate supply and demand, relative to other prices (interest rates, in particular). But if it is true, then yes, what sense does it make to peg inflation at any particular rate? Will have to think about this.
DeleteBased on my reading of the data, the UK austerity was headlined by a big increase in VAT that increased rates a lot but didn't increase revenues much at all. Transfers are up $13b (2005 PPP USD), taxes are up $33b, and non-transfer expenditure is down $40b. These aren't huge figures - that last is just a 7% change and incorporates all the cyclical factors. Brit GDP over the same period was up 3% (=$62b) to $2,069b.
ReplyDeleteBe careful on definitions: you interpret your plot of "FCE: Government" as government purchases of consumption goods (as is natural). But it also includes in-kind transfers, such as medical care. The line between transfers and G is blurry.
I appreciate the caveat, Macro Guy.
Delete