And Generalissimo Francisco Franco is still dead (with apologies to the under 35 set).
Since in the U.S. we are currently embarking upon a program of reducing fiscal stimulus, it seems useful to examine whether this action would result in rapid economic growth as some have predicted. The UK is at the forefront of conducting this fiscal experiment.
Figure 1: UK real GDP (in Ch.2006 pounds) growth q/q SAAR (blue) and 4 qtr (red), both calculated in log differences. Note: reported at annualized rates, unlike in the UK official statistics. Source: FREDII and ONS and author’s calculations.
There were a number of special factors which may have affected economic activity in the second quarter, including the additional bank holiday for the royal wedding, the after-effects of the Japanese earthquake and tsunami, and the unusually warm weather in April and May. Following standard practice, no adjustments have been made to the published data to remove the effect of this (non-recurring) bank holiday.
It is not possible to state precisely what the net overall impact of these special events might have been. Estimates, using standard statistical techniques, have been constructed for what could have happened in April, May and June for each of the main aggregates in the service and production sectors, if the special events outlined above had not occurred. This has then been compared with the actual estimates that we produced. The results of this analysis indicate that Q2’s special events may have had a net downward impact on Q2 2011 GDP of:
- 0.4 per cent in the services sector
- 0.1 per cent in the production sector
These estimates must be regarded as broad brush and illustrative. There can be no certainty as to the impact of the special events and there may be other factors at play.
So it might be that the underlying strength of the economy in 2011Q2 is 0.5 ppts higher q/q (or 2 ppts on an annualized basis). However, even taking that into account, prospects going forward are not too promising. Before the recent turmoil in financial markets, growth forecasts were being marked down. From the FT
The UK is unlikely to hit [the government’s] target of 1.7 per cent growth this year, according to the head of the country’s independent budgetary watchdog, raising further doubts over the government’s deficit reduction plans.
Robert Chote, chairman of the Office of Budget Responsibility, said in an interview with the Independent that “there aren’t many people” expecting annual growth to reach the 1.7 per cent growth forecast made by chancellor George Osborne in March, and cautioned that current growth could be “relatively weak”.
Mr Osborne is already under pressure to accelerate tax cuts and step up supply-side reforms following meagre growth of just 0.2 per cent in the second quarter. The National Institute of Economic and Social Research on Wednesday downgraded its growth estimate for 2011 from 1.4 per cent to 1.3 per cent, arguing that subdued domestic demand, caused by low wage growth and contractions in consumer spending, would “hinder any meaningful recovery” this year.
The Treasury’s own comparison of forecasters’ estimates shows that the mean outlook in July was 1.4 per cent, down from 1.5 per cent in June.
The IMF’s Article IV mission to the U.K., completed in early June, already had less optimistic forecasts, at 1.5% q4/q4. That was the same as the OECD’s forecast, released at the end of May. Presumably, those too have been marked down.
Then yesterday, the Bank of England released its inflation forecast. In it, it reduced its 2011 growth forecast from 1.9% to 1.7%. This might be a bit optimistic. As the report notes, the outcomes have been a bit lower than the central tendency of forecasts, as shown in Chart 1.
Chart 1 from Bank of England, “Inflation Report,” (August 2011).
There is an interesting discussion of how revisions fit into this outcome on pages 22-23 of the report. One possibility is future data revisions would push up GDP growth.
On a side note, I will observe a time series plot of UK consumption through 2011Q1 is pretty unsettling.
Labor Force Indicators
Employment growth appears to be tailing off as well. Chart 3.3 from the Report is below.
Chart 3.3 from Bank of England, “Inflation Report,” (August 2011).
It’s interesting to consider what government policy is doing in this regard. From page 26-27:
Increased LFS employment has been driven by the private sector, where employment rose by around 540,000 over the four quarters to Q1. In contrast, general government employment fell by 125,000 over the same period (Chart 3.5). According to Office for Budget Responsibility projections, general government employment is expected to fall by around 400,000 over the next five years, although the majority of that reduction occurs from financial year 2013/14 onward.
The government has reiterated its commitment to reducing expenditures on the police force by 20%..
And back in the United States
…the hit from spending cuts across all levels of government has already been a major drag on growth. Indeed, these declines shaved 0.7 percentage-points on average from gross domestic product growth in the first two quarters of 2011. Typically, that would be no disaster. Trouble is, this recovery has been unusually weak. So the government cutbacks effectively halved real GDP growth in the first half of 2011, leaving it at just 0.8% annualized.
The pace of underlying growth is expected to pick up a bit in coming months. But so, too, is the pace of government spending cuts. A glimpse of this will come Wednesday with the release of July federal budget figures. These are expected to show a third month in a row of year-on-year declines in spending, or “outlays,” according to a preliminary analysis from the Congressional Budget Office. Their estimates show spending is down nearly 12% on average since May from a year earlier.
And the rate of fiscal retrenchment is only likely to grow. The debt-ceiling impasse underscores the degree to which Congress is unable to pass almost any legislation without agreeing on further cuts. That has already capped discretionary spending for fiscal year 2012, which begins October 1. Further cuts in 2013 and beyond will kick in if the so-called Congressional “super-committee” fails to come up with additional deficit-cutting measures by autumn.
The pressure to cut spending isn’t just internal. Standard & Poor’s just stripped the U.S. of its triple-A rating in part because cuts haven’t been deeper. Moody’s has indicated it may follow if costly stimulus measures like the Bush tax cuts don’t expire. Yet this casts further uncertainty on the growth outlook. The hit to first-quarter GDP next year could be as much as 1.5 percentage-points from government cutbacks alone if the payroll tax cut expires at year-end, notes Goldman Sachs.
More discussion of the inapplicability of expansionary fiscal contractions to the United States in 2011 here.
So, brace yourself for a lot of macroeconomic uncertainty, and possibly large amounts of fiscal drag in FY 2013 (after all, the United States is a large, quasi-closed economy, even more than before at zero policy rates for an extended period, and the consequent big multipliers go both ways).
This post originally appeared at Econbrowser and is reproduced with permission.
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