This morning the Office for National Statistics published preliminary estimates of an -0.2% fall in March quarter 2012 GDP. This follows a -0.3% contraction in Q4, so pulling the UK into a ‘double dip’ recession (the first since the 1970s). Below are some frequently asked questions, and my response.
Was the fall a surprise?
Most forecasters were expecting very modest growth in Q1, with the median estimate (according to Bloomberg) for a +0.1% increase. These forecasts were in line with most leading indicators and partial indicators, which pointed to sub-trend growth last quarter.
Though disappointed, however, I doubt many commentators (including myself) were that surprised. Preliminary GDP numbers are notoriously volatile, and there are several variables which can unexpectedly throw the result (more about that later).
Why did growth fall in Q1?
The services sector, which accounts for more than three-quarters of output, is not in recession - it rose a modest 0.1% in Q1 (a lot lower than business surveys and retail sales suggested). Industrial production fell by -0.4%, but that alone would not have been enough to produce a negative number. What dragged it lower was a -3% fall in construction output, which detracted 0.2 percentage points from the headline number. Without that fall, GDP would have been flat last quarter.
Should we believe these estimates?
Not particularly. Preliminary GDP estimates in the UK are based on less than half the data that go into the final national account estimates. The rest are extrapolated or imputed. They are frequently subject to large downward (or more commonly, upward) revisions. In a year or two’s time we could well discover there was no ‘double dip’ recession after all.
Former MPC member Andrew Sentance gave a powerful example in a March 30 blog:
In the early 1990s, the recession appeared to continue through 1992 and into early 1993. At the time, it was believed to be the longest recession that the UK had experienced since the Second World War. The most recent data show the decline in GDP coming to an end in late 1991, exactly when Norman Lamont declared he could see the “green shoots of recovery”. He was right, though ridiculed at the time.
Most economic commentators are likely to react with a degree of scepticism to today’s numbers, for three reasons. First, past GDP estimates have experienced major revisions. Second, there are serious quality concerns about some of the inputs, especially construction. Third, and most important, because these estimates are at odds with most of the other main indicators of economic activity. The numbers simply don’t gel.
So we shouldn’t be too worried?
Yes we should. There is a real risk that the headline contraction, reinforced by ‘doom and gloom’ stories the media will pump out over coming days, will weaken already soft consumer confidence and spending, discourage British business from hiring or spending, and deter foreign investment. If Britons talk themselves into a funk we could see what (to me at least) looks like a temporary soft patch into a more serious and protracted downturn. It’s all about Keynes ‘animal spirits’, as Akerlof and Shiller and others have noted.
How will the Government respond?
Calls for the Chancellor, George Osborne, to abandon (or at least modify) his fiscal austerity plans will grow. However ministers are terrified at the prospect of losing their AAA rating, and there are few signs of a ‘Plan B’ in the works. Indeed on Monday the Treasury chief secretary said he had asked Government department’s to identify another £16bn of cuts.
With the Office for Budgetary Responsibility set to downgrade its growth forecasts, larger spending cuts will be required simply to maintain the Government’s debt-to-GDP targets. So should the government cut even more, maintain its existing spending plans, or rethink its approach?
We can expect a protracted debate in the UK about whether the pace of spending cuts is too high, and hence self-defeating. It is a view forcefully made by Jonathan Portes, and even the IMF in their January 2012 World Economic Outlook Update (PDF):
Overdoing fiscal adjustment in the short term to counter cyclical revenue losses will further undercut activity, diminish popular support for adjustment, and undermine market confidence.