Britain and Sweden, Part 2:

It serves me right for not doing my homework.  I checked some data and it’s not clear that Sweden’s recession was milder than Britain’s.  Sweden saw RGDP fall more sharply, and recovered more strongly.  On balance they probably have done a bit better, but not much.  More importantly, I should never make assumptions based on a few numbers pulled out of the air.  I recall reading that Britain has high CPI inflation, and the pound is sharply lower.  I assumed that meant Britain had followed an easy money policy in the recession.  Nothing could be further from the truth.  Here are some British real and nominal GDP changes during the downturn:

2008:2 to 2009:2   NGDP fell 5.1% and RGDP fell 5.9%.

That’s a much tighter monetary policy than in the US, and only 0.8% inflation.  And the most recent year isn’t anything to write home about either:

2009:1 to 2010:1   NGDP rose 1.46% while RGDP fell 0.34%.

That means inflation bumped up to 1.8%, but NGDP is still far below the 2008 peak.  Again, monetary policy in Britain seems much tighter than the US.

Memo to myself:  Never again trust CPI data.

The next question is; “How can money in Britain be so tight with the pound depreciating so sharply?”  As I indicated in the previous post, there are probably real weaknesses in the British economy.  The post elicited a lot of great comments, some of which supported my view that Britain is more of a service/banking economy, whereas Sweden exports lots of manufactured goods.  Sweden may be recovering faster for the same reason Germany has done pretty well.  But note that even Sweden isn’t doing all that well in absolute terms. The commenter named tatonnement had some excellent data on Britain’s trade problems.

The commenter Marcus found data showing the Canadian government spending 40% of GDP and the UK government spending 52%.  I presume both numbers are inflated by the recession.  Nevertheless, Britain looks like a country where both the public and private sector spend too much and save too little.  That means they first need monetary expansion to get out of the recession, and then fiscal retrenchment to shrink government (as Canada did in the 1990s.)  And more Singapore-style incentives to save.

The commenter Jon linked to a paper which argued that expectations of higher taxes in Britain would lower AD.  In my view the dominant effect would be to lower AS, not AD.  But in either case output falls.

Statsguy points to the need for Britain to devalue, and also mentions that British manufacturing workers have much higher unit labor costs than Swedish workers.  I agree. Econoclast mentioned that the Labour government felt that they needed to spread around the wealth created in the City, so that London didn’t end up looking like Hong Kong.  Is there a ‘golden goose’ analogy that comes in here?  After living in Britain for 5 months in 1986, my impression is that there is a large skill (and attitude) gap between the lower and upper classes (relative to a country like Sweden.)  I don’t see why the British lower classes deserve part of the wealth created by the City, merely because their homes are located closer to the City than those of Swedish workers.  Perhaps I am again drawing mistaken inferences based on a tiny bit of data and some personal observation.  If so, please set me straight.



22 Responses to “Britain and Sweden, Part 2:”

  1. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    18. June 2010 at 09:21

    1. Some Swedish data:
    2008:2 to 2009:2 NGDP fell 4.7%
    2009:1 to 2010:1 NGDP rose 3.5%
    (I won’t post RGDP data because we need to abolish the concept of inflation :))

    2. British data is a good indication of gap between the current policy of targeting CPI (with overshooting by BoE) and the proposal of NGDP targeting

  2. Gravatar of Indy Indy
    18. June 2010 at 10:19

    Quick question, only semi-related to an earlier conversation (my apologies).

    Looking at the last 10-year TIPS auction (15-April-2010) the yield was 1.709%. On the same day, 10-year Notes yielded 3.900% (though, the 15-June-2010 auction had them much lower, at 3.242).

    But doesn’t that mean that, at least back in mid-April, the markets really did expect something equivalent to a leveled-inflation target of 2.181% for the next decade, or, in other words, the price level on April-15-2020 to be 24.1% higher than it was three months ago?

    Looking at the similar 30-year auctions back in February – the split was even larger at 4.720-2.229 = 2.491% level inflation.

    Am I wrong to think that it seems that markets do in fact expect the Fed to allow some “catch-up” inflation after all, and that the markets aren’t particularly frightened by any belief that the Fed will become hawkish and overcautious when strong NGDP growth returns?

  3. Gravatar of Blackadder Blackadder
    18. June 2010 at 11:50

    Off topic, I know, but it looks like even North Korea may be giving in and embracing some neoliberal economic reforms (baby steps, of course).

  4. Gravatar of tâtonnement tâtonnement
    18. June 2010 at 12:27

    Statsguy’s post on unit labor costs was informative, as it underlined the futility of devaluation for the UK. After all, currency is only one input into the cost of exports and unit labor costs can explain why devaluation alone is not enough to restore competitiveness. The euro’s fall is great news for German exports, but I doubt anyone is expecting a big surge from Spain (unit labor costs explains all the difference there – in conjunction with the fact that when Spain does export it exports to the Euro Area, negating currency effects).
    I did some quick checking and it looks like growth in UK unit labor costs was (on average) 1.32% in excess of Sweden’s growth rate from 2004-2008.

  5. Gravatar of John Hall John Hall
    18. June 2010 at 13:38

    Since October, the weakness in the pound is primarily due to sympathy with the euro. Not a 1-to-1 correspondence, but good enough. People are worried that the Euro crisis extends to the UK and also due to the weaker expected growth of the UK as Europe slows down.

    Also, UK CPI is biased primarily due to the impact of taxes on prices. If you look at CPI-CT (available on the releases in bloomberg, not sure where else to find it), their price inflation is actually closer to 2%. Base effects are expected to push normal UK CPI back down to 2-2.5% by the end of the year as the impact from taxes in 2009 unwinds.

  6. Gravatar of Jon Jon
    18. June 2010 at 20:04

    Just to be fair, the paper does not specifically argue about Britain. It just argues that the expectation effects of future taxation can cause government expenditures to have the opposite from ordinarily assumed fact.

    What I read about Britain is that everyone is brace for some healthy tax increases to cover the public debt. There is some talk about cutting services too, which some people have a funny idea that that implies shrinking expenditure–but they are raising taxes to raise revenue, not to shrink it.

    Ergo, the argument applies.

  7. Gravatar of Leigh Caldwell Leigh Caldwell
    19. June 2010 at 04:25

    As illustrated by the currency discussion, the figures in this debate is strongly influenced by the choice of starting point.

    For example, nominal GDP in the UK has been growing at an annual rate of 6% for the last nine months.

    All of the problems in Scott’s figures come from a single quarter, Q1 2009. In Q1 of 2009 we were still in recession, with a 3% fall in NGDP in that quarter alone. I believe the CPI was also negative in that quarter (though I can’t find quarterly index figures for that, only annual changes).

    It was only in March 2009 that the Bank of England’s QE programme was announced (it was increased in May and again later in the year). The Bank clearly recognises the issues in this quote from its May inflation report:

    As discussed in Section 2, UK nominal demand growth has fallen to well below its average annual rate of around 5% since the MPC’s inception, a period over which inflation has been, on average, close to target. Growth in broad money, as measured by M4, has picked up since mid-2008. But as described in the box on page 13, that pickup wholly reflected strong growth in money holdings of institutions which intermediate between banks. Growth in a more economically relevant measure of broad money, which excludes such institutions, has slowed broadly in line with nominal spending (Chart 1.2).

    Do read the whole report if you have time, it gives some good insight into the Bank’s beliefs about NGDP and money.

    In other words, the severity of the recession became clear in Q4 2008, and the Bank cut nominal interest rates sharply. Q1 2009 was even worse; so the Bank cut interest rates to zero, and realised that a new policy (QE) was required. It immediately instituted that policy, and the effect of the policy was to create an annual NGDP growth rate of 6%.

    Does this not sound like a bank doing roughly the right things? Maybe they could have acted a bit faster, but did any mechanism exist in 2008 by which they could measure NGDP expectations?

    If you want some annual figures, wait for the Q2-Q2 figures instead of Q1-Q1: they will be far better. In fact, I expect Q2 figures to be a good bit better than those of recent quarters, meaning that NGDP growth will probably be a good bit higher than 6%.

    Will the Bank allow NGDP to catch up to previous trend? That is a good question and we’d love to know the answer. The quality of Mervyn King’s public communication falls far short of the effectiveness of the Bank’s policy actions. But the Bank is not as delinquent as the Q1 2009 figures would suggest.

    Back in a moment and will talk about UK public sector spending.

  8. Gravatar of Leigh Caldwell Leigh Caldwell
    19. June 2010 at 05:35

    OK, British government spending.

    The first thing is to get the figures right. Where does this 52% come from? An OECD estimate – and the OECD, to say the least, has an unpredictable approach to economic data. The three other sources that I can find put the figure close to 45% (£645bn spend, £1410bn GDP):

    The percentage fell from about 40% to 38% in the late 1990s and then rose to about 41% during the 2000s – only reaching 43% in 2008-09 and (a projected) 45-48% in 2009-10.

    A large part of the rise in the last two years is due to falling nominal GDP (which as Scott points out fell 5% during the 2008-09 fiscal year – in the UK that runs from April to March). Real public spending has grown quite slowly in this period, with most of the rise coming from increased social transfers. Indeed, some of the differences in the above figures may come from the choice of denominator: is it annualised GDP at the start of the year, the end of the year or total GDP during the period in question? And do the figures reflect data revisions after the end of the period?

    Anyway, the point is that UK public spending is not much higher than Canada’s. Incidentally I’m not sure if I have a reliable figure for Sweden – this source says 52% and this unsourced figure is 53%. Maybe that’s why they have been doing better than the UK!

    About a third of UK public spending is transfers, so government consumption – a more meaningful concept – is around 30% of GDP. 8% of GDP goes on health, 6% on education, 3% on defence, 2% on police and justice, and the rest on a range of other stuff – there is an interesting breakdown here.

    None of this is to claim that the UK does not have problems.

    The effectiveness of lots of that public spending is lower than it should be. While the outgoing government had good intentions and (in my opinion) largely chose to spend money in the right areas, policy was too volatile for effective spending and management norms to develop. A bit of stability would allow civil servants, who are mostly pretty good at their jobs, to find mechanisms that work for delivering services efficiently.

    Outside of the public sector, a large proportion of the population has low formal education, although I think there are informal skills which partly compensate for this. We did have a low savings rate (private and public) for years, though in the last two years private saving has soared – largely financing the public deficit of course. The economy has been overweighted towards the property sector – though there is some justification for this in a high population density country.

    And government finances are strongly dependent on the degree of income inequality – in other words, on the finance sector. The collapse in finance sector profits and shrinkage of high wages since 2008 has resulted in a £50-80 billion fall in tax revenue, which will probably now have to be fixed by increasing taxes on the rest of the economy.

    On Scott’s final point – yes, I suppose philosophically the UK’s poor or unskilled people don’t deserve to benefit from public goods financed by the City of London; but unlike low-income African or Asian people, they are the ones who have a vote. Economically one can argue that the financing of public goods and social insurance is efficiently done within a relatively closed, coherent society. But I would certainly much rather see higher transfers – or even better, productive investment – to other parts of the world. This, however, is just a dream right now.

    Frankly, like most countries, the UK is a complex mix of strengths and weaknesses, and the simplistic adjustment of government spending numbers up or down is not going to make a lot of difference. Probably the one thing the government can best do is take Scott’s advice and manage NGDP growth. Whatever happens, we will gradually feel our way towards a more productive, wealthier and better society, along with the rest of the world.

  9. Gravatar of scott sumner scott sumner
    19. June 2010 at 06:38

    123, Thanks. That does show Sweden a bit better off, when framed that way. And I agree this example shows how NGDP is much more informative.

    Indy, That’s a very good question, and it shows the problem with evaluating monetary policy when there is no explicit target path. Even before the recession the 10 year and 30 year inflation forecasts were somewhat above 2%. This is because monetary policy doesn’t have complete credibility (there is tail risk of governments being forced to inflate away debt, etc.) So even though the target was supposedly 2%, actual inflation had been slightly above 2% and was expected to say slightly above 2%. Then we fell below target. If you use the official 2% number, then yes, in the very long run we are expected to get back there gradually. But more realistically what happened is they always expected a bit more than 2% long run, and when we fell below target there is no expected catchup to what the markets actually expected. That’s why I prefer 2 and 5 year inflation estimates, they tell us more about any near term bounce back. Right now 2 year inflation forecasts are closer to 1%.

    Blackadder. Thanks for that article. It is actually a very big deal in terms of preventing suffering. Let’s hope they don’t backtrack again this time.

    tatonnement, I think there are two separate issues here. One is recession, which is caused by falling NGDP. Currency depreciation can address that issue, at least to some extent (obviously it can’t change the world environment in which the UK operates.) Then there is the British trade deficit. Oddly this is the area where currency depreciation cannot help. The Brits must save more.

    Thanks John, I take it that the CPI-CT is an index that excludes taxes.

    Jon, Yes, I agree that the paper’s model can be applied to Britain.

    Leigh, Well now I am more confused than ever. The figure I linked to shows much slower nominal growth (around 3% annualized) since 2009:2. So either my data source is completely wrong, or the article you linked to is incorrect. Perhaps my data was revised. But that would raise an additional question. How could Britain have 7.2% annualized inflation in the first quarter? Does that seem plausible? But the article implies this with its claim of a 2.1% rise in NGDP and only 0.3% rise in RGDP. Those are supposed to be non-annualized numbers.

    I’ll reserve my opinion on whether the BOE did the right thing until I have some sense of which numbers are right. My figures show NGDP far below its 2008 peak. That is very bad. But if you are right, then my figures are completely wrong.

    If nominal growth is indeed 6%, that would be better than the US, but not enough to offset 2008-09, when NGDP growth fell 9% below trend. They’d need 13% to catch up in one year to a 4% trend. Obviously 13% would be unrealistic, but something a bit higher than 6% would have been preferable–maybe 8% or 9%.

  10. Gravatar of scott sumner scott sumner
    19. June 2010 at 07:09

    Leigh#2, Again I’ll reserve judgment here until we can find some decent data. Shouldn’t there be a list comparing size of government among countries somewhere on the internet?

    When I looked at your links I was not able to find the data you referred to. In the first link I couldn’t find the data at all. In the second it said spending went from just under 35% of GDP to nearly 40% just before the crisis. I consider that a massive increase—it’s larger (in relative terms) than the entire US military budget. Why was that occuring when there was no recession?

    The 3rd data link you provide shows government going from 36.3% to 41%, again, a massive increase. I’m a bit puzzled by your comment that government spending only rose slightly before the current recession. Where does that data come from?

    I indicated that Marcus’s data was inflated (in both countries) by the recession. But I’ll reserve an opinion on whether Britain spends a lot more than Canada until we can find some accurate data that uses comparable techniques for both countries. There are all sorts of ways of manipulating this data, and obviously governments have an incentive to make themselves look smaller than they really are.

  11. Gravatar of Leigh Caldwell Leigh Caldwell
    19. June 2010 at 07:18

    The 7.2% inflation figure may come from tax changes. We had a VAT rise on 1st January 2010 which contributes about 1.7% of the current CPI figure – which would indeed be about 7% annualised. However, I’d expect VAT to have been taken out of both NGDP and RGDP figures. Having said that, there have also been jumps in energy and import prices in Q1 2010, so even without VAT this could be correct. A 7.2% annualised figure of course assumes that the fluctuations will be repeated each quarter, which is unlikely.

    You’re correct to highlight some discrepancies in the sources though. The Guardian’s data blog to which you linked has some quite different figures from the Telegraph, especially for Q1 2010.

    There are several possible reasons for this.

    1. All the recent quarterly figures have been revised upwards, and I think Q1 2010 has already been adjusted upwards to 0.3% but that is not yet reflected in the Guardian data.

    2. Perhaps the Telegraph is adjusting the real figures using the CPI, which include VAT, while the Guardian is using underlying NGDP figures which do not.

    3. The Guardian is simply wrong or out of date. Note that their Q1 2010 figure is a “Guardian estimate”.

    The Telegraph does agree with the latest release of official figures from the Office of National Statistics, so I think it is more likely to be correct. If you replace the Guardian’s estimate for Q1 2010 with the official figure, the discrepancy goes away.

    I guess to be sure, we will have to wait and see what happens in Q2. If only there were some quarterly nominal GDP futures we could look at!

  12. Gravatar of scott sumner scott sumner
    19. June 2010 at 07:27

    Leigh, I don’t think import prices count in NGDP, but given that I have been consistently wrong, perhaps I am wrong there as well. All I know is that there is no logical reason for import prices to affect NGDP because imports aren’t a part of GDP.

    Did the UK cut the VAT about a year before they raised it? If so then the recession may have been less bad (in nominal terms) than the official figures show, and the recovery might also have been much slower then the official figures show. There is certainly something bizarre going on with the numbers.

  13. Gravatar of Leigh Caldwell Leigh Caldwell
    19. June 2010 at 07:35

    As you say, public spending figures are hard to find and get right. In the first (Treasury) link, they are there in the tables at the end, but not in an easy to use format. And there are all sorts of different definitions – do we include investment or not? Do we include the bank bailouts (about 8% of GDP, but a one-off)? Do we include this year’s accumulation of future public pension liabilities (which are partly on a pay-as-you-go system)?

    Anyway you’re right to point out my 38% was a bit wrong – in fact public expenditure fell to about 35-36% in 1999-2000, and gradually rose back to 41% in around 2007. Yes, a big increase, but it only takes us back up to about the same as the 40% Canadian level we’re supposedly being compared with. The Labour government had an explicit policy of increasing spending closer to the European average after it was essentially frozen in real terms during the 1990s.

    In the crisis it has jumped again, to about 45-48% this year, which certainly does feel like it’s too high. Again there are definitional questions: for example does an income tax credit count as expenditure, or a fall in tax revenue? I don’t know. But I think it’s accurate to say the underlying “structural” level of public expenditure is currently about 40-41%, with a further 5-7% directly resulting from NGDP shrinkage and a recession-related rise in transfers.

    I did find one list comparing public expenditure across countries, here. It’s out of date though (based on the CIA World Factbook 2007), and disagrees with all the other sources above, so I’m not sure what to make of it. Even the author says in the comments to the post that (s)he doesn’t put much stock in the figures.

  14. Gravatar of Leigh Caldwell Leigh Caldwell
    19. June 2010 at 07:43

    Agree that import prices probably don’t come into NGDP, but they do affect the CPI. The same would apply, I think, to VAT. But then again, both VAT and imports do have an impact on the cost of living, which affects wages, which affects NGDP. With a long and variable lag, to coin a phrase.

    I assume the government statisticians are practised at removing these effects as far as possible when estimating NGDP, but, after all, all of these figures are still just estimates, even in the final revisions years later.

    Yes, VAT was cut in December 2008, 13 months before it was raised again. It’s an interesting idea that this could exaggerate the apparent nominal size of the recession.

    If I can figure out anything more authoritative about the NGDP figures from the ONS publications, I will let you know.

  15. Gravatar of ssumner ssumner
    19. June 2010 at 08:27

    Leigh, Yes I found that silly table as well, It is laugably inaccurate. It has the US at 19%–we are actually in the 30s.

    For what it’s worth, The Economist has Britain only about 2.5% higher in 2007. But I’ll reserve judgement until I can get some figures that seem relaible.

    Interestingly, that puts Canada almost precisely half way between the US and Britain.

    Based on that data, Australia’s the country I actually should have pointed to. I lived in both Britain and Australia for about 5 months.

    Leigh#2, Wages should only be impacted by the non-import part of the CPI. This is disguised by the fact that wages tend to rise with the overall CPI. But if the US has 2% inflation, and then it spikes to 5% for a year because of high oil prices, wages are almost unaffected.

    The VAT increase you cite makes me smile. I guessed it solely by looking at a big drop in the NGDP deflator. That makes me even more confident that the VAT is distorting the NGDP data.

  16. Gravatar of Master of None Master of None
    19. June 2010 at 10:08

    “Never again trust CPI data.”

    Regardless of whether we should, most people do trust the CPI data, or at least consider it relevant.

    That gives us an opportunity – we can create higher expected NGDP growth by reverting to the pre-Clinton CPI calculation methodology, which would show ~5% y/y inflation vs. ~2% under the current regime.

    …Instant Inflation: Paging Sumner & Krugman…

  17. Gravatar of StatsGuy StatsGuy
    19. June 2010 at 17:23


    “I don’t see why the British lower classes deserve part of the wealth created by the City”

    I suspect a lot of the British lower classes don’t see why the City deserves any of the wealth ‘created’ by the City, in so far as they’re not sure it’s actually creating much wealth at all – though it certainly does consume a lot of wealth.

  18. Gravatar of Scott Sumner Scott Sumner
    19. June 2010 at 18:40

    Master of None, I can’t tell if you are joking, but I’ll treat it seriously anyway. Raising measured inflation doesn’t affect NGDP, it affects RGDP.

    Statsguy, The first thing I noticed when I moved to England was the vast class difference. The British working class seemed nothing like the American working class. On the other hand I didn’t notice much difference between the professional classes in the two countries.

    Perhaps I rely to much on impressions, and all those tabloid stories of drinking binges in Britain. But I do think there is some data to back up these impressions. I am pretty sure that income in Britain is less equally distributed than in places like Germany and Sweden.

    BTW, I hope this doesn’t come across as me bashing Britain, I liked the country a lot. Definitely one of my favorite places in the world.

  19. Gravatar of Mattias Mattias
    19. June 2010 at 23:35

    I think the big difference between Sweden and UK or USA for that matter is not the economic performance per se. It’s how we feel about it. When I read about the sentiments in many other countries I don’t recognize that here. Swedes seem generally more happy about their economy than other countries’ citizens, without tha data to back it up. There are several reasons for that contentment.

    1. We don’t have any big deficits.

    2. Most people have seen their taxes cut quite a lot the last couple of years. Not only the income taxes, but also really big cuts in the property tax. Inheritance and wealth taxes have been disbanded.
    3. It’s very common that people have adjustable rate mortgages based on the lower short term rates. That combined with lower taxes has made people who work feel richer than ever, despite the recession.
    4. We used to be the sick man in Europe so that is what we compare ourselves to.

    In all fairness there are big differences between different parts of Sweden. Our ‘Detroit area’ in the west, where Volvo and Saab have their production, has probably been hit harder and people are more pessimistic there.

  20. Gravatar of Scott Sumner Scott Sumner
    20. June 2010 at 05:16

    Mattias, Those are good points. Another advantage is that Sweden is much smaller than the US and UK. This means government policy better reflects the views of its citzens. In the US we have vast differences in ideology, so either the Republicans or Democrats are always very upset. And our government is too large to come up with sensible economic policies.

  21. Gravatar of Master of None Master of None
    20. June 2010 at 15:50

    “Raising measured inflation doesn’t affect NGDP, it affects RGDP.”

    Ex-post, that is correct (i.e. the drop in RGDP in the recent recession would appear more severe).

    However, my point is that raising measured inflation would increase inflation expectations, which would help raise future NGDP.

    Yes, it’s getting a bit cute with behavioral econ, but what is the downside? The only thing I can think of is that some gov’t liabilities that are indexed to CPI would grow faster.

  22. Gravatar of ssumner ssumner
    21. June 2010 at 09:15

    Master of None, Now I see your point. I guess I just don’t believe people are fooled by those sorts of things.

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