The British recovery: unusual events often have multiple causes

I’ve previously argued that unusual macro events generally have multiple causes. Think about it.  If there were monocausal explanations of unusual events then they probably would not be unusual.  If a single factor could cause the Great Depression then we’d probably have many Great Depressions, not just one.

Tyler Cowen tells us that Britain is having an unusually robust recovery this year. That’s not 100% clear, as the GDP numbers are good but not awesome.  Even so, I’ll take his word for it, as there seems to be lots of high frequency data suggesting that more good GDP numbers are on the way.  So let’s take it as a working assumption and try to identify the causes.

I always start from an AS/AD perspective, keeping in mind the two can and often are “entangled.”  So we need to start with the inflation/RGDP splits.  It looks to me like inflation has averaged 1.8% during the first three quarters and RGDP growth has averaged 2.5%, for a total of 4.3%.  I see two ways to interpret these numbers from a supply-side perspective:

1.  The split is not all that impressive from a supply-side perspective, at least for a deeply depressed economy such as Britain.

2.  The split is much better than the abysmal splits seen in recent years, where inflation was often much higher than RGDP growth.

Put them together and it suggests not so much a very strong positive supply shock, but rather an ebbing away of previous negative supply shocks.  Perhaps oil production is falling more slowly, or contracting finance is no longer a net drag, or VATs and other fees are no longer being raised.  When you stop hitting yourself with a hammer, you feel better!

Also on the supply-side there is the “self-correcting mechanism,” but that begs the question of why so much more this year than past years.  Hence my previous explanation.

And finally, the top income tax rate was cut from 50% to 45%, which is a modest plus for the supply-side. If rich Frenchmen are drawn to London, that boosts AS.

The 4.3% NGDP growth rate does seem to be faster than in previous years, so demand-side factors probably play a big role in the speed up in growth.  But this area is even trickier than the supply-side.  I can see 3 possible explanations:

1.  My “entanglement theory.”  If you have a badly run central bank, which targets interest rates, then stronger supply-side fundamentals will lead to a higher Wicksellian equilibrium real interest rate, which will then automatically trigger a more expansionary monetary policy and faster NGDP growth.

2.  Some types of austerity are inflationary.  As I already noted, rising VAT and other government fees are an example.  If a central bank targets inflation, even loosely, a lower rate of “supply-side inflation” (from VAT and fees raising business costs) will automatically trigger a more expansionary monetary policy.  They can do more in terms of NGDP growth, for any given inflation rate.  One way that we know it’s not a 100% demand-side story is that even as NGDP growth has increased, inflation has fallen from above 2% to below 2%.

3.  The announcement of Mark Carney as the new BoE Governor in early 2013, combined with his dovish statements on things like NGDP targeting and forward guidance, may have made investors more bullish on faster NGDP growth.  As Britmouse recently pointed out (some people will hate this) faster NGDP growth is caused by expectations of faster NGDP growth.

Yes, that’s deeply unsatisfying to a certain type of mind.  But then so is quantum entanglement, and they are both true.

So I’ve ended up with my favorite explanation, but I honestly think all of the factors I mentioned play at least a small role, and probably some I missed as well.

PS.  Dirk asked me about a recent Tyler Cowen post that seemed to suggest increased use of barter is deflationary.  I’d be interested in Tyler’s reasoning, as one normally assumes that factors that reduce the demand for money (like barter) are inflationary.  Perhaps he was thinking of something else in the article.

PPS.  I highly recommend Nick Rowe’s post on causality in monetary economics.



12 Responses to “The British recovery: unusual events often have multiple causes”

  1. Gravatar of Saturos Saturos
    3. December 2013 at 07:58

    I thought the WSJ article was about increased resale, not barter, which diverts spending from newly produced goods to previously produced goods…

  2. Gravatar of Mark A. Sadowski Mark A. Sadowski
    3. December 2013 at 08:04

    “I highly recommend Nick Rowe’s post on causality in monetary economics.”

    Nick Rowe:
    “Update: as I was driving down Autoroute 5, pressing the gas pedal, watching the speedo, I suddenly remembered Andy Harless had made a similar point a couple of years back about umbrellas not causing rain. Sorry Andy. (But cars are cooler than umbrellas.”

    Interestingly, for various reasons, I happened to be rereading that very post last night, and guess who turns up in the comment thread to argue that umbrellas cause rain?

    “If the central bank targets the nominal interest rate at a low enough rate forever, you have to get deflation. By arguing against this you’re making yourself look silly.”


    P.S. I wonder, has Williamson ever read Friedman’s “The Role of Monetary Policy”?

    And if so, did Williamson think it made Friedman look silly?

  3. Gravatar of jknarr jknarr
    3. December 2013 at 08:35

    Talking expectations versus credibility is a sterile tautology.

    Nominal economic performance is not expected into existence: speculative expectation of better- or worse- growth fails all the time: investment or consumption very often puts entities into a net negative wealth position.

    If you want to spend your days debating Keynesians about liquidity traps, and whether speculatively higher interest rates kill off gdp expansions, expectations puts you on right path. This expectations-causes-growth is pure Keynes, and not monetarist.

    A better monetarist interpretation is that nominal levels of GDP is purely and only the result of actual on-the-ground provision of base money to the real economy.

    This puts expectations/speculation back into its real place as only a debt/borrowing/rates question: borrowing from the future, i.e. speculative leverage, which will ultimately be paid back in base money.

    As an aside, Britmouse may very well be misinterpreting the confidence versus GDP figures, for instance — what if confidence is simply a better real-time gauge of actual gdp activity, rather than a magical thinking confidence-creates-growth relationship?

  4. Gravatar of Michael Michael
    3. December 2013 at 08:47

    Regarding barter and deflation… couldn’t one look at both of them as “caused by tight money”?

  5. Gravatar of jj jj
    3. December 2013 at 09:12

    Including VAT in the inflation measure makes absolutely no sense to me. Because the government increased VAT, the central bank will try to jam down the price of everything to prevent the tax-inclusive price from increasing?

    Surely the BoE understands that logic, which is why they allowed higher inflation recently. But the media (and many commenters) don’t, so they wail about higher inflation…

  6. Gravatar of Gene Callahan Gene Callahan
    3. December 2013 at 10:21

    “I’ve previously argued that unusual macro events generally have multiple causes.”

    ALL historical events have multiple causes. For instance, the Great Recession was caused BOTH by the US lacking Canadian-type regulations, AND the fact that our economies don’t place people first, AND a myriad of other factors.

  7. Gravatar of ssumner ssumner
    3. December 2013 at 11:05

    Saturos, I read it differently. I thought they were talking about barter replacing the use of cash.

    Thanks Mark, I did a post.

    jknarr, 1933 proves you wrong.

    Michael, Yes.

    jj, I agree.

    Gene, Yes, but I meant multiple proximate causes.

  8. Gravatar of W. Peden W. Peden
    3. December 2013 at 11:18

    “If the central bank targets the nominal interest rate at a low enough rate forever, you have to get deflation. By arguing against this you’re making yourself look silly.”

    I have no problem with being so silly.

  9. Gravatar of Steven Kopits Steven Kopits
    3. December 2013 at 12:33

    UK oil production is up 8.6% for the three months ending October over the same period previous year. It is down, however, 19% compared to the same period two years ago. Thus Scott’s speculation that the UK performance is the fading of a negative shock is arguably correct, at least from the oil perspective.

    Also, I had stated that US oil consumption data suggested that Q4 or Q1 would post some big GDP data. Black Friday was essentially unhelpful to this argument, but today’s auto sales numbers were big, up 7.6% from November 2012, and up 8.3% from the sales rate last month. (Read more at

    Brent is also running hot, suggesting the US consumer has some firepower to deploy.

  10. Gravatar of ssumner ssumner
    3. December 2013 at 16:02

    Steven, Thanks, the ISM numbers were also strong.

  11. Gravatar of Assorted links Assorted links
    4. December 2013 at 07:11

    […] Scott Sumner on the British recovery.  And did the Glorious Revolution weaken English […]

  12. Gravatar of On Stephen Williamson and 'Deflationary QE' it's Mark Sadowski to the Resuce | Last Men and OverMen On Stephen Williamson and 'Deflationary QE' it's Mark Sadowski to the Resuce | Last Men and OverMen
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