First a small point. Why is it so hard to find NGDP data for Britain? There’s been lots of press coverage of the 0.8% (annual rate) decline in RGDP during the 4th quarter, but I can’t find the NGDP data. Without NGDP data, RGDP is hard to interpret. “Never reason from a quantity change.” Of course that doesn’t stop people from doing just that, and in fairness the most likely explanation for the low RGDP is inadequate demand.
Some are now forecasting that Britain will slip into a recession next year. If America was expected to slide into recession next year due to insufficient demand, you’d see articles bashing Bernanke and the Fed all over the blogosphere. I’m not seeing articles bashing the Bank of England. Why not?
[Yes, there weren't any articles bashing the Fed for tight money as we slid into our 2008 recession, but that was before the rise of market monetarism. They'd never again get away Scott-free. :)]
Perhaps it’s the stoic attitude of the British. (“Mustn’t grumble.”) But I am seeing article after article claiming that the coming recession is due to fiscal tightening. I was curious to see just how tight British fiscal policy actually is, so I checked the “Economic and Financial indicators” section at the back of a recent issue of The Economist. They list indicators for 44 countries, including virtually all of the important economies in the world. Here are the three biggest budget deficits of 2011:
1. Egypt 10% of GDP
2. Greece: 9.5% of GDP
3. Britain: 8.8% of GDP
Egypt was thrown into turmoil by a revolution in early 2011. Greece is, well, we all know about Greece. And then there’s Great Britain, third biggest deficit in the world.
I suppose some Keynesians work backward, if there is a demand problem it must, ipso facto, be due to lack of fiscal stimulus. If the deficit is third largest in the world, it should have been second largest, or first largest.
A slightly more respectable argument is that the current deficit is slightly smaller than in 2010 (when it was 10.1% of GDP.) But that shouldn’t cause a recession. Think about the Keynesian model you studied in school. If you are three years into a recession, and you slightly reduce the deficit to still astronomical levels, is that supposed to cause another recession? That’s not the model I studied. Deficits were supposed to provide a temporary boost to get you out of a recession. At worst, you’d expect a slowdown in growth.
To get a sense of just how expansionary UK fiscal policy really is, compare it to France (5.8% of GDP), Germany (1.0% of GDP), or Italy (4.0% of GDP). Lots of people blame ECB policies for the recession, but Britain is not in the eurozone. Outside the eurozone you have Denmark (3.9% of GDP), Sweden (zero), Switzerland (1% surplus).
Obviously there must be some problem in Britain that isn’t affecting some of its more prosperous northern European neighbors. I suppose if you are a Keynesian you’d say that the housing/banking problems in Britain were worse, and hence you need more fiscal stimulus than Germany or Sweden. Fair enough, but if deficits are already near the largest in the world, trailing only Egypt and Greece, you’re taking a pretty big gamble to commit to an indefinite number of years of even more massive deficits in the hope it won’t be negated by slow NGDP growth produced by the BOE. After all, debts do need to be repaid (or at least serviced.) And the taxes required to service the enlarged national debt will eventually impose significant deadweight costs on the economy.
In contrast, monetary stimulus is costless, and indeed improves public finances by reducing the debt/GDP ratio. So why aren’t people demanding more monetary stimulus? In America, my conservative commenters tell me the liberal Keynesians have a hidden agenda to boost the size of the state. But the British government is already nearly 50% of GDP, with national health care for all. So that can’t be the reason. Some claim that when rates are near zero it’s impossible for the central bank to devalue its currency. But didn’t the Swiss National Bank recently puncture that theory?
My hunch is that the BOE has gotten a pass because of fear of inflation, which was quite high during 2011. But that would suggest Britain’s problems are supply-side, not demand-side. Of course fiscal policies like the recent increase in the VAT also affect the supply-side of the economy, but as this Financial Times graph shows, that doesn’t seem to be the main problem:
Following the latest national accounts revisions, one worry is that the year-on-year growth in nominal GDP in the second quarter was only 3 per cent. Low nominal growth implies semi-fixed cash variables such as public spending, borrowing and debt become a larger share of GDP when the denominator is growing slower than was expected. But that is not all, as the following chart shows.
Until the crisis, Bank of England monetary policy appears to be remarkably successful in keeping nominal GDP growth close to 5 per cent. It almost appears to be the target the Bank was following.
Then in the crisis nominal GDP plunged, but note that the fall in nominal GDP at market prices is greater than that at basic prices due to the temporary cut in value added tax to 15 per cent. Since the basic price adjustment abstracts from taxes and subsidies, the standard nominal GDP variable now stands higher than the basic price version, since it includes the rise in VAT to 20 per cent.
Strip out the VAT rise and underlying nominal GDP (at basic prices) grew by 1.9 per cent – split into 1.4 per cent inflation and 0.5 per cent growth. Worrying about inflation in this climate is crackers…
Unfortunately this data is out of date, but my hunch is that the 3rd and 4th quarter NGDP data isn’t much different. This graph shows a big fall in NGDP producing a big recession in 2008-09, and presumably the smaller recent drop in NGDP growth will lead to a much smaller recession in 2011-12. The FT then hints the BOE is allowing this because of a fear of inflation.
Here’s where fiscal policy really may play a role. The VAT increase seems to have opened up a 1.1% NGDP gap between the expenditure of the public for final goods, and the net revenue received by firms. But even gross revenue growth is falling sharply. If the BOE was still targeting 5% NGDP growth, the VAT increase would not trigger a recession—3.9% more net revenue would probably be enough to avoid that outcome. Instead you have the BOE sharply slowing headline NGDP growth, and then the fiscal contraction reducing net revenue by another 1.1%. It seems the combination will be enough for a mild recession.
Keynesians are focusing on the fiscal part of the problem, but with Britain already having the third biggest budget deficit in the world, I think people need to start paying more attention to errors of omission by the BOE. That’s the elephant in the room that almost everyone is ignoring.
And someone tell the British to start making NGDP data easier to find. You can’t calculate RGDP without knowing NGDP, so there’s no excuse for not publishing the data.
PS. The October 2011 FT article was entitled “A Nominal GDP Nightmare.” Bingo.