Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 20 January 2012

Counterfactuals and UK Growth in 2011

                Macroeconomists have a familiar complaint when it comes to how the media sometimes assesses the impact of particular policy measures. Popular comment often tries to link the measure to outturns and draw conclusions. For example, did the 2009 Obama stimulus package (ARRA) work? We cannot say that the policy did not work because U.S. unemployment did not fall through 2010, because there were lots of other influences on unemployment over this period. We have to try and work out what would have happened if the policy had not been implemented. That is what the CBO (the Congressional Budget Office - the independent fiscal council for the US) does, and it estimates that the impact on jobs was positive and substantial. (Fiscal stimulus works!)
                In the UK we can get into the same confusion. Was 2011 a bad year for growth because of the greater austerity announced in 2010? We will have the Office for National Statistics’ first guess at the outturn for 2011 as a whole soon, but they should not be too far from the forecast made by the OBR in November. The OBR (Office for Budget Responsibility) is the UK’s equivalent of the Congressional Budget Office, although it is much smaller and has a much more limited remit. Brian Ashcroft, in his new blog, runs through the OBR’s estimates with some nice charts. Overall UK GDP growth in 2011 is expected to be just less than 1%, but the contribution of government spending to that growth is expected to be positive. Does that mean additional austerity had nothing to do with the recovery stalling in 2011?
                The answer is no for a number of reasons. First, as Ashcroft notes, government spending in the UK and elsewhere is typically countercyclical. We normally focus on transfers like unemployment benefits when thinking about why the budget deficit goes up in a downturn, but there is evidence (for example this study by Julia Darby and Jacques Melitz) that government spending is also countercyclical. In other words, without austerity the contribution of government spending to growth might have been bigger still. Second, one of the government’s key austerity measures was an increase in VAT at the beginning of 2011. As this was preannounced, I would expect a lot of expenditure switching from 2011 into 2010, and indeed falling consumption (-1.1%) is the major reason why expected growth in 2011 is low. Third, people look forward and adjust their current plans accordingly. The OBR expects the direct effect of government spending to reduce growth in a major way over the next five years. That inevitably means job losses in the public sector: the OBR expects general government employment to fall by about 700,000 (about 2.5% of total employment) between 2011 and 2017.  It would be very surprising if this had not led to an increase in precautionary saving in 2011.
                What we really want to know is what GDP growth would have been if the new coalition government in 2010 had not announced additional austerity measures. To do that you need a macroeconomic model, like the one the OBR uses to make its forecast. In fact the OBR are the obvious people to ask, but unfortunately – and unlike their US counterparts - they are not allowed to tell you, or even do this kind of analysis. Read this to find out why.

1 comment:

  1. "and indeed falling consumption (-1.1%) is the major reason why expected growth in 2011 is low."

    The OBR said in the Autumn statement EFO that 2011 real consumption is well below forecast because the deflator was much higher than expected, not because nominal spending was lower. This is in-line with a supply shock from (unexpected) commodity price shocks, not a demand problem.

    If the VAT rise brought forward consumption to 2010, it must have shown up in Q3 or Q4. Nominal household final consumption rose at a low rate in those quarters (0.6% and 0.4% quarter on quarter, as opposed to 1.6% and 2.2% in the Q1 and Q2), so the effect is not obvious.


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