Where do the upwards revisions to UK GDP leave the “output gap” and “labour market slack”?

4th September 2014 by Shaun Richards

Today the Bank of England Monetary Policy Committee meets to make its latest decisions and deliberations on UK monetary policy. It may even spend a little time discussing how its policy might change if later this month it becomes responsible for rUK should Scotland vote for independence. We know that last month there were two votes for an interest-rate rise and we also know that in general the economic data since has been a little weaker overall. Perhaps this is best illustrated by the way that the NIESR reduced its estimate of rolling quarterly economic growth to 0.6% in August. However something major happened yesterday as the Office for National Statistics made some fundamental changes to our record of the credit crunch era and to our current position.

The Credit Crunch in the UK

Firstly let us consider why this is happening which is explained below.

New information is available on the UK’s National Accounts, incorporating significant improvements in response to revised international reporting practices and a number of other methodological improvements.

Such “improvements” and revisions of practice make me nervous but also some changes are required. For example the advent of smartphones and tablets in recent years means that some weights and numbers need to be altered to reflect this. However there have also been changes related to the ESA 10 international standard which I have reviewed much less favourably. For example in 2012 illegal activities or what has been called “coke and hookers” were responsible to a boost of £8.4 billion to recorded economic output. The way that Research and Development is now counted as an input and under investment rather than waiting to count the fruits of such work in extra output added another £25.7 billion.

Something  from the past has happened

One of the features of economic slow downs is that they are initially estimated to be more severe but are later revised downwards in severity. Up until now that had not been a feature of the 2008/09 slowdown in the UK but yesterday that changed.

GDP growth is estimated to have been slower on the approach to the economic downturn, and slightly faster during 2009. As a consequence, the peak to trough decline in GDP is now estimated at 6.0%, shallower than the previously published estimate of 7.2%.

Some care is needed here as you note that some of the slow down has been reshuffled backwards in time. Actually that is probably sensible as output back then in sectors like finance and banking was probably over -recorded.

Since the shock effect of the credit crunch we have also done better in economic growth terms than we previously were told.

The strength of the recovery has been affected – both by new methods and new data. Annual GDP growth from 2008 to 2012 has been revised up in each year.

The year which was revised up the most was 2009 where there was a 0.9% upwards revision from -5.2% to -4.3%. In terms of a simple addition then since 2008 some 2.5% has been added in total. Thus we find ourselves not only reviewing a shallower dip but also a stronger recovery than we had thought.

A (Space) Oddity

The improvement in 2008 and 2009 is particularly intriguing as we have also been told that there was a drag on those years. Specifically our balance of payments performance has been revised substantially downwards for those years. The cause is a downgrade to what is estimated that our banking sector contributed which has been shifted downwards under a concept described by the acronyms FISIM or Financial Intermediation Services Indirectly Measured and FDI or Foreign Direct Investment. Anyway the changes here are substantial as highlighted below.

 but more marked downward revisions during the economic downturn (2.9% and 1.5% of nominal GDP in 2008 and 2009 respectively) that reflect a sharp reduction in the income balance.

In terms of the Balance of Payments picture this is quite a shift as is admitted below.

The changes to the trade and income balances act to alter significantly the overall picture of the UK’s current account position over the financial crisis; where previously 2008 saw a large narrowing of the current account deficit, there is now a large widening of the deficit at this time.

I have argued in the past that trade figures are very unreliable and now we see basic up is the new down evidence for a period which is now six years ago! Many of these numbers feed into our estimates of economic growth and therefore we should add more grains to the pinch of salt we take when we look at them. However we also move on noting that economic growth was uprated by a total of 0.4% in 2008 and 0.9% in 2009 in spite of a considerable extra drag from foreign trade which was £12 billion in 2008 and £5 billion in 2009.

Whatever happened to the rebalancing that Bank of England Governor Mervyn King kept promising us? Also just to be clear this data has only been revised up to 2009 as we wonder what may have happened next and whether the numbers are any sort of relaible guide at all.

Where do we stand now?

We do not quite know that but we do have the latest estimate of how we stood in 2012.

Improvements to National Accounts methods and new data have increased the level of GDP in current prices by 4% on average between 1997 and 2012.

So we were better off than we were told at the time and the impact of this increased as we get nearer the present day.

The difference between these estimates widens over the period, from £24.8 billion (2.6%) in 1999 to £97.0 billion (6.2%) in 2012.

The narrative poses several problems

If we accept that the economy was always larger and economic growth has also been better than we thought we then hit some problems. For example if output and presumably incomes are higher on an aggregate level, why are we not collecting more taxes and why does the public-sector deficit continue to disappoint? It should have improved in response to all of this.

Also whilst there is a narrowing of the gap between the labour market and economic output if we argue that output is higher than we thought, the continuing weak behaviour of wage growth is even more of a problem than we thought. Also I note that the official view of the UK “productivity gap” has just changed fairly substantially.

GDP revisions do not provide a solution to the ‘productivity conundrum’, and the level of output per hour worked at the end of 2012 was still around 12% below the projected path if the pre-downturn trend had been maintained.

Actually this represents more of  a change than it claims as previous estimates of what the Bank of England described as the “productivity puzzle” were larger. Also the use of “trend” magnifies the impact which if we look at in absolute terms looks rather different.

Subsequently productivity declined again to remain 2.5% below its Q1 2008 level in Q4 2012.

Comment

There are many implications from these revisions and quite a few of them provide food for thought for the Bank of England. Let me illustrate this by quoting two of the measures it is currently using to set its policy the “output gap” and “labour market slack”. As of 2012 the economy was some 6.2% larger than previously thought and was growing a bit faster too. So where is the “output gap” now? Remember back then MPC members were voting for more Quantitative Easing to combat a situation which may not have existed.

The situation with labour market slack is even more complex. The new higher output levels fit better with our employment numbers. But the serenity soon ends when we look at wage growth because with our economy being larger, it should be considerably higher now than it is. So we have problem and our happiness at overall output being higher is curdled somewhat by this reality.

While GDP per capita in the UK is now estimated to be a little stronger than previously published, it remains 5.1% below its Q1 2008 level in Q4 2012.

Tucked in there is why many people will be somewhat bemused by the latest update and the difference is between the aggregate and individual experience. Returning to the Bank of England the changes discussed above strongly reinforce the arguments I have made against “fine tuning” of the economy as we are not in a position to do that. Also how can we have “Forward Guidance” when our knowledge of the present and even the past is only patchy? This is highlighted one more time by our balance of payments current acount which has just been revised downwards by £43 billion as far back as 2008. As the Kaiser Chiefs so aptly put it.

Oh my god I can’t believe it
I’ve never been this far away from home

 

 

15 thoughts on “Where do the upwards revisions to UK GDP leave the “output gap” and “labour market slack”?”

  1. therrawbuzzin says:

    Market slack?
    My friend is a hooker, and she says she’s so busy that if she’d another pair of legs, she’d open in Aberdeen.
    Well, the government started it.

    1. forbin says:

      so are the personal services an export or an import ?

      seems HMG will count it twice anyways, going in then out (!)

      ooops sorry 😉

      Forbin

  2. anteos says:

    Hi Shaun

    Great article as always.

    You could argue that the lack of upturn in taxation is because the increases in GDP are pure fiction. Imputed rent (which increases every year) doesn’t actually exist and yet forms roughly 9% of GDP. Also double counting of R&D and the black economy will not add to the tax base.

    imho the revisions to GDP are to allow the government to manipulate the deficit/GDP figures. In reality the reduction in deficit is glacial, but with the new improved GDP figures, it will look better.

    The public are right to question the lack of ‘recovery’ but they’re ire is still directed at the bankers, energy companies, frackers etc. And not the charlatans in government/boe.

    1. Anonymous says:

      Hi Anteos and thank you.

      The improved GDP figures are at least to some extent to make us feel better I agree. However the improvement in national debt to GDP ratio will be very temporary as later this month they will formally announce that Eurostat has forced them to raise their estimate of the national debt.which will be around £130 billion higher. Thus they are in fact trying hard not lose ground and losing…..

      As to imputed rent there has also been an update on that stating that its (inflation) deflator rate will be similar to that underlying CPIH. This should cap its increase for now but as ever revisions are possible!

      Oh and here is a number for you “Therefore HHFCE on imputed and actual rentals is approximately 12 per cent of nominal GDP.”

  3. forbin says:

    Hello Shaun

    emergency interest rates still at 0.5% , the ECB pushing on wet string with their drop

    and here we have deceitfulness of our HMG over GDP/GNP , CPI and other financial figures , who are they kidding?

    Many of these figures feed on each other , and so its garbage in = garbage out

    If your measures of the economy are wrong , how can you plan?

    Two sets of books?

    Forbin

    1. therrawbuzzin says:

      ECB rate dropped to 0.05%

      1. forbin says:

        indeed and the ineffectiveness of the cut will be written in the dust of collapsed European economies…

        Forbin

        1. Anonymous says:

          Hi Guys

          Just to add that the ECB deposit and current account rate went further into negative territory as it is now -0.2%. The march of negative interest-rates is still on!

  4. Anonymous says:

    Hi Shaun,
    I’ve been enjoying your excellent, informative articles daily for nearly three years now. I will keep my first “coming-out” comment short.

    I heard they’re raising the chocolate ration to 25g per week.

    Keep up the good work on your exceptional blog.

    1. Anonymous says:

      Hi XpatDE and both welcome and thank you

      Actually I feel that matters are coming to a head again although sadly not in a good way. In a way the ECB expressed this eloquently earlier today as 6/7 years in to the credit crunch it finds that it still has to ease policy…..

  5. Zummerzetman says:

    I have a theory about wage growth. The assault on the pay and benefits started decades ago. When I started working in financial services in the eighties my contract included a non-contributory final salary pension, mortgage subsidy, private healthcare, time and a half overtime, lunch allowance, bonuses and various expenses, in addition to a decent salary which was increased every quarter. In summary the list of delights nearly filled a sheet of A4.
    As the nineties rolled on the list of benefits were slowly eroded, overtime budgets were cut, bonus payments targets very hard to achieve, and the pension scheme was facing a black hole that could only be fixed by making us retire later and on reduced benefits. Finally when I left the industry 5 years ago new starters could enjoy a basic salary and entry to a defined contribution scheme with a small top-up from the employer, and that was it.
    Once the employers have removed nearly all the additional perks they then moved to recruiting more temps and putting in place rolling contracts to keep the wage bill in check.
    I think the next phase, which are in now, is to reduce actual wages; and what better catalyst for this than the financial crisis? Employers could freeze wages and use this as justification.
    Once this mind-set is in place it will be very hard to turn this round. It’s a depressing thought but I believe this a permanent re-adjustment, and wages will never recover to past levels for the majority.

    1. forbin says:

      yes it certainly rings a bell with me

      add in the collapse of the USSR and then the West could forgo the policy of showing the people that they were better off with capitalism ( I’d posit that actually the process started as soon as it was obvious the Soviets were falling behind) the Berlin wall was the final nail….

      Then later we had China , a Dictatorship of willing servant workers, join in with a low exchange rate.

      So the housing boom since 1999 seems obvious it was the only way to show the plebs they were better off . That could only last so long.

      Now look at what happened to the Banks when there was a problem caused by lax lending ….. yes the Western Governments bailed them out

      Just them though, everyone else got the cold hand of “capitalism”.

      Maybe I’m just nuts but it does really seem to be

      Governance of the people, by the Banks, for the Banks

      Cutting benefits and wages will not help revive the western world economy but it does keep the top 1% at the top !

      I suspect they dont want to “turn this around” , I think you cottoned onto the game plan

      Medieval or Dune ? your guess is a good as mine

      Forbin

      As I’ve said before pull up a chair , get some popcorn, the show must go on!

    2. Anonymous says:

      Hi Zummerzetman

      There is an irony in this. You describe the reduction in the number of final salary schemes which are fast disappearing in the private-sector and yet the latest revisions trumpet us as a nation of savers dues to this.

      “Changes to the treatment of employers’ pension contributions have raised the household saving ratio between 1997 and 2009 by between approximately 2 and 5 percentage points a year.”

      Perhaps they hope the new pension plans will fill at least some of the gap.

    3. Eric says:

      Yep, same here. Just add in profit sharing and the company wheels for a complete list.

      All of it gone today, including the company.

      The turning point was 1996. Nothing magical about the year but at some point we traded in wealth creation for debt creation.

  6. Anonymous says:

    Great column, Shaun. You understandably concentrate on the changes in the UK real GDP estimates and the Balance of Payments. There was also a paper published on September 3 on changes in the calculation of the deflator for imputed rents in Household Final Consumption Expenditure (HHFCE). It seems that the imputed rents component of real HHFCE did not change, so there was no impact on real GDP, but the revisions in the deflator are quite alarming: 13.3% inflation rate for 2010Q1 revised to 19.4%, 10.1% for 2010Q2 revised to 17.4% and so forth. The authors make a good case that the new series is an improvement on the old one. However, just how much confidence can one have in an approach where the estimates are data-sensitive to this extent? Also, it doesn’t seem that the revised estimates are free from weaknesses even if they are based on much larger rent samples. It is not clear, for example, how, if at all, rent quotes are adjusted for changes in quality (parking being included in rent one month and excluded the next for example).

    Where the imputed rents deflator in the HHFCE and the CPIH were quite different in their annual movements before, they will now be almost identical. This will make the CPIH series more useful in decomposing the difference in OOH treatment between the HHFCE deflator and the CPI than it was before. This is good, because it is the only serious use that the CPIH really has.

    On the other hand, one wonders if in doubling down on resources devoted to CPIH-related products, the ONS isn’t sending a message that it doesn’t want to consider other approaches to measuring OOH costs. I hope this isn’t the case, but fear that it might be. Andrew Baldwin

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