In analysis of any issue it is crucial to distinguish between factors that are of primary or decisive importance and those that are secondary or lesser matters. This applies to economic analysis as much as other disciplines. There is a vast amount of economic data which is produced by innumerable public and private agencies internationally, and an almost endless number of ways of configuring the data supplied.
The most important issue facing the British economy is how to end the slump. No other issue, employment, incomes, government finances or anything other question can be resolved without it.
Therefore it is extremely important to analyse the trends and prospects for growth in a sober fashion and to focus on the most decisive factors. It is unhelpful or even misleading to focus primarily on secondary matters.
The recent Bank of England Inflation Report contained an assessment of the trends in growth of the British economy. Chris Giles, the economics editor of the Financial Times has provided a very useful chart showing changes in the Bank’s growth forecasts over time. The chart is shown below.
This is described as a ‘hedgehog’ chart because of the various lines indicating the changes to the Bank forecasts over time. Chris Giles highlights the fact that this is the first time since 2007 that the Bank has produced an improved forecast, which raises projected GDP growth from 0.9% to 1.2% in 2013. This is shown on the chart as the difference between the orange and green spikes on the chart.
In reality, the Bank’s forecasting record is an extremely poor one. The November 2007 forecast (the purple line in the chart) was made just a few months before recession began in the 2nd quarter of 2008. This was the deepest recession since the 1930s. Yet the Bank was not forecasting any contraction in output at all. The various ‘hedgehog’ spikes arise because it has continually forecast a rapid return to growth that did not materialise.
The upward revision to the forecast this year is minimal, comprising just 0.3% of GDP. For many people, and not just supporters of austerity like Chris Giles, there is a hope that this upward revision to forecasts is the beginning of a trend and that there will be a continuous upward revision of forecasts as the outlook improves.
Yet the focus on such a slight revision to the growth outlook seems misplaced, and not just because it could be altered in either direction. Even before the slump the British economy was not growing at a fast pace by international standards. A return to prosperity would imply a rejection of permanently lower growth and a return to the previous trend. Instead the Bank’s forecasts imply a further widening of the gap between the future growth of the economy and its pre-recession trend.
This is the real scale of the economic crisis and the issue which is of primary importance. Currently the gap between the level of output and the economy’s former trend is approximately 16% of GDP.
This gap will continue to widen so that any new government will be faced with a shortfall in output of approximately 20% of GDP. In current prices these are in the region of £250bn to £300bn.
This is a measure of the effects of both recession and austerity. Therefore it is also a measure of the scale of the task facing any new government that wants to end them.