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.
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