Today’s GDP growth figures act as a Rorschach test; the coalition government and its supporters see growth at 0.8% in the third quarter of 2010, and growth for the last six months at 2%. What the opposition will see is a drop of 0.4% when between April and June growth was positioned at 1.2%.

It’s hard to portray the strongest third quarter growth in a decade as anything other than good news really – especially when the majority of the growth has been in the private sector. Add in the fact that S&P have taken the UK off its negative watch for AAA rating, and it’s a jolly good day for the country.

redundancies are a reality now

They have been a reality since 2008.

1

Better than expected growth is bound to be good news…. but don’t we have to take account of the terrible state we were in beforehand before we get too carried away…?

Maybe best to keep the champers on ice a while longer eh?

The economy was recovering before the last election, but the tories lied that we were a basket case and the sheep fell for it.

Schroders European economist Azad Zangana says that fears that private sector growth can’t replace cutbacks in the private sector are “overdone.”

The UK has been in recovery for a year and economic growth has been about 2.8% since the latest recession’s end.

The economy has already generated 343,000 new private sector jobs in the first half of this year, and by the growth numbers published today, it appears that this trend will continue. Even using pre-crisis measures of trend growth, GDP running at 0.8% a quarter is a above trend.

As the Lady said: Rejoice!

This has hurt labour badly, but it’s early yet we could see a down turn, then again it may well be over and the Tories will be seen as the party that pull us out of them mess.

But as i said it’s a bit to early about whether it’s working or not, the housing market is still slipping, jobs have to be made, and people will need to see life changing.

But Labour will be praying the next set of figures will be bad otherwise it’s a long long time in opposition

Am I the only one who finds it slightly bizarre that these figures are taken as a vindication of the Tories’ position?

To me, there are two take-home messages here:

1 – Plainly it’s crap that the state needs to be cut back drastically in order to allow the private sector to flourish. It seems to be flourishing quite nicely even *without* hundreds of thousands of people being thrown onto the dole queue and tens of billions of pounds of Government spending being hastily withdrawn. (Gosh – it’s almost as if Government spending can actually *promote* growth!)

2 – If GDP is set to be around 1.6% higher at the end of this year than we thought, the deficit must be set to be around – what – £12 billion lower? (Due to higher tax revenues and a lower welfare bill.) Both Labour and the Government should therefore go back to the drawing board and revise their deficit reduction plans accordingly. The *structural* element of the deficit must be at least £12 billion lower than we thought (since growth is doing that much more to reduce the overall deficit than we thought it would); and plausibly, if conditions for growth can be expected to remain just as good or better for the next few years, the structural deficit is in fact tens of billions of pounds lower than we thought. If that’s the case, the level of cuts required to halve or eliminate the deficit within the next four years has been hugely overestimated.

Labour shouldn’t be maintaining an embarassed silence about these figures – they should be saying ‘look – this is the sort of deficit reduction we can achieve without drastic cuts, just by helping the economy to grow – and this is what next year’s cuts are putting at risk’.

A nice tactic might be to put the Government on the spot and say – in light of the fact that the structural deficit now looks to be £X billion lower than you thought, will you now reverse these £X billion of cuts/tax rises that are no longer needed in order to hit your target?

GO @ 6

It would certainly be hilarious if the Left, after stridently warning that the government’s growth forecasts… oops, the OBR’s… were too optimistic, were suddenly to do a u turn and say they’re too pessimistic.

“It would certainly be hilarious if the Left, after stridently warning that the government’s growth forecasts… oops, the OBR’s… were too optimistic, were suddenly to do a u turn and say they’re too pessimistic.”

Ah yes… I made a similarly hilarious U-turn the other day: didn’t think it was likely to rain, then saw a huge grey cloud overhead and changed my mind. Boy, did I look foolish, revising my forecast in the light of new data!

Also worth pointing out that there’s no logical tension between noting that official forecasts for growth *this* year (before the cuts bite) were too pessimistic, and maintaining that official forecasts for growth in *future* years (after the cuts bite) are too optimistic. It all depends how much you think current spending (and other current conditions) are promoting growth, and how much you think future cuts (and other future conditions) will depress it.

This is just an example of why I hate party politics. They all want to take credit for things that are invariably driven by other forces, and blame the last lot for any negative stuff. Politicians in the short-term only influence expectations. Nearly every macro thing they do is subject to lags. It will be at least Q2 if not Q3 2011 before we are living in what could be described in any meaningful way Mr Osborne’s economy.

We were not as Mr Osborne asserted on the brink of national bankruptcy. The economy is recovering well and has been since the end of last year and that should be welcomed as it impacts real people behind the numbers. There should be at least a ten billion undershoot on public borrowing for this year. Still big red numbers but not ‘ national bankruptcy’. The Darling growth forecasts were actually not optimistic enough. Although they were ridiculed as too optimistic by some of the same analysts who may themselves be too optimistic for next year. There is very little chance of a full scale double dip recession next year and it would be sad if some on the left were secretly hoping for one. However, at least one quarter of negative growth can’t be ruled out because they are taking too much tax out of the economy next year.

To me the fact that the economy is doing better than expected means the opposite of what the coalition are taking from the numbers. They believe the strength means the economy can take the strain of a fast consolidation. I see the strength as meaning they could go slower and a large portion of the deficit would be naturally eliminated by the faster growth. However, the decisions have been made and it will be their economy next year.

*However, at least one quarter of negative growth can’t be ruled out because they are taking too much tax out of the economy next year. *

I should say declining output rather than negative growth as that sounds a bit dim.

G O

I made a similarly hilarious U-turn the other day: didn’t think it was likely to rain, then saw a huge grey cloud overhead and changed my mind. Boy, did I look foolish, revising my forecast in the light of new data!

False analogy. A true one would look something like this:

I made a similarly hilarious U-turn the other day:
the Met office were saying it would be warm and sunny, but my party leader had predicted cold and rain, so I wrapped myself in a scarf, put on a heavy coat and carried an umbrella. Then the sun came out and it wasn’t just warm, it was hot. So I tore off all my clothes and ran around saying “phew what a scorcher…. we must be in for a heatwave. Silly Met office, they should have known.” Boy, did I look foolish.

Richard W

“To me the fact that the economy is doing better than expected means the opposite of what the coalition are taking from the numbers. They believe the strength means the economy can take the strain of a fast consolidation. I see the strength as meaning they could go slower and a large portion of the deficit would be naturally eliminated by the faster growth.”

Exactly.

That makes two of us – now, are we missing something or is this the line Labour should now be taking?

Flowerpower

Hmm. Don’t think much of your ‘true analogy’, for four reasons.

Firstly, I never suggested the OBR/Government (Met Office) had been silly for making too pessimistic a forecast. They may have had good grounds for it at the time, but new data has now come in.

Secondly, the implication that ‘the Left’ consists entirely of people parroting the views of a party leader on this issue is manifestly absurd given that Labour haven’t *had* a leader for much of the period under discussion and that people on the Left (incuding the Greens and others) have had very public debates about all this.

Thirdly, as I’ve already suggested, much of the Left’s pessimism has been about what happens to the economy *when cuts are made*. We still don’t know if that pessimism is misplaced; it depends how fragile current growth is, and how much it’s being propped up by Government spending.

Fourthly, I didn’t just glibly predict an economic heatwave. What I said was:

‘plausibly, if conditions for growth can be expected to remain just as good or better for the next few years, the structural deficit is in fact tens of billions of pounds lower than we thought. If that’s the case, the level of cuts required to halve or eliminate the deficit within the next four years has been hugely overestimated.’

It’s for economists to judge whether conditions for growth can be expected to remain just as good or better for the next few years. But predictions so far seem to have been based on the assumption that conditions for growth are likely to be somewhat better from 2011 onwards than they are this year, and off the top of my head I can’t think why that would have changed. (Assuming we leave the Coalition’s cuts out of the picture – I mean the ‘conditions for growth’ that are being taken into account *when deciding* what cuts to make, i.e. things like the state of the economies of major trading partners, UK rates of interest and inflation, etc.)

Plainly it’s crap that the state needs to be cut back drastically in order to allow the private sector to flourish.

The state has been cut back quite dramatically over this period:

the primary government deficit – the gap between spending and revenues, before debt interest, has fallen by more than 3% of GDP in the past 12 months (see my post of 13 October for the precise details). By that measure, fiscal policy has tightened more in the past 12 months than in any single year of the government’s plan. But somehow, the economy has managed to grow by 2.8%, roughly its long-term trend rate.

The *structural* element of the deficit must be at least £12 billion lower than we thought (since growth is doing that much more to reduce the overall deficit than we thought it would)

No, the structural deficit is that part of the deficit that is independent of recesion/growth fluctuations.

It would be quite amusing if Labour’s argument turned on a sixpence from ‘you can’t cut during a recession/growth is to weak to allow cuts’ to ‘we’re growing fine now, there’s no need to cut’ on the strength of one quarterly GDP announcement.

Tim J

I said:

“The *structural* element of the deficit must be at least £12 billion lower than we thought (since growth is doing that much more to reduce the overall deficit than we thought it would)”

You said:

“No, the structural deficit is that part of the deficit that is independent of recesion/growth fluctuations.”

No it’s not. The structural deficit is that portion of the overall deficit that we don’t expect to be eliminated by growth, *given that we expect the economy to grow at a particular rate*.

If the economy actually grows more slowly than that, the structural deficit is larger than we thought and the cyclical deficit is correspondingly smaller. If it grow more quickly than that, the structural deficit is smaller than we thought and the cyclical deficit is correspondingly larger.

How could the question of how fast the economy is growing be irrelevant to the question of what portion of the overall deficit is cyclical (= will be eliminated as a result of growth) and what portion is structural (= won’t be eliminated by growth)?

G.O. @ 14

You have correctly dealt with Tim J’s point about the definition of structural deficit, but I’d be interested in your response to his main point raised in the Stephanie Flanders quote, viz:

fiscal policy has tightened more in the past 12 months than {it will} in any single year of the {Coalition} government’s plan {from now to 2015}.

The bits in square brackets are there to show how I have interpreted it. Perhaps I’ve got it wrong – please do set me straight, if so.

It seems to me that, as Tim J has recognized, this totally undermines one of Labour’s main arguments: that the healthy growth we’re now seeing is the fruit of “Labour spending” and that, therefore, what we need to keep doing is spending with the same insouciance.

The structural deficit is that portion of the overall deficit that we don’t expect to be eliminated by growth, *given that we expect the economy to grow at a particular rate*.

No, I’m afraid that isn’t correct. There are, of course, people who dispute whether such a thing as a ‘structural deficit’ exists at all, but for those that don’t a structural deficit is, definitionally, independent of GDP growth or decline. As the FT defines it:

A budget deficit that results from a fundamental imbalance in government receipts and expenditures

Or Reuters:

The portion of a country’s budget deficit that is not the result of changes in the economic cycle. The structural deficit will exist even when the economy is at the peak of the cycle.

GDP growth will shrink the overall budget deficit, but not the structural element of it. That’s the whole point of the structural deficit. As I say, you can argue that it’s not a useful concept, but its definition is pretty clear.

Tim J

“a structural deficit is, definitionally, independent of GDP growth or decline”

I don’t think the definitions you cite bear this out.

“As the FT defines it:

A budget deficit that results from a fundamental imbalance in government receipts and expenditures”

Sure – but such an imbalance is judged to exist precisely when underlying growth is judged to be too low to bring receipts and expenditures into balance over the course of the economic cycle.

“Or Reuters:

The portion of a country’s budget deficit that is not the result of changes in the economic cycle. The structural deficit will exist even when the economy is at the peak of the cycle.”

Yes – but *how large that deficit is* will depend on how large the economy is at the peak of that cycle, and how large the economy is at the peak of that cycle will depend on how fast it has grown during that cycle.

Can I ask how you think we can judge the size of the structural deficit, if it’s wholly independent of growth?

I’d have thought you’d have to do something like this: start with the overall gap between receipts and expenditure. Then subtract the amount by which you expect growth to close that gap, based on an informed judgment about the likely rate of growth. (That’s the cyclical deficit.) The amount that’s left over, you should judge to be ‘structural’.

I am stumped as to how someone could judge the size of the structural deficit *independently* of judging the size of the cyclical deficit (on the basis of projected growth).

Flowerpower, Tim J –

I’ve looked at the 13 October post Stephanie Flanders was referring to, and what she says is this:

“Using three month rolling averages, economists at Goldman Sachs have calculate that this measure of borrowing [the primary fiscal deficit] is now 3% of GDP lower than it was 12 months ago. Think the return of VAT to 17.5%, the bank bonus tax, and the new 50p rate.

Some of that fall in the primary deficit is simply due to the fact that inflation has pushed the denominator (nominal GDP) up more than expected. But more than two-thirds of the change seems to be structural. If true, that would suggest that fiscal policy has tightened more in the past year than the coalition is planning to tighten in any single year of its plan.”

In other words: more fiscal tightening (more of a reduction in the primary fiscal deficit) has been achieved over the past 12 months as a result of Labour’s measures on tax than the Coalition expects to achieve as a result of its spending cuts in any of the next four years – and it’s apparently been achieved without damaging growth in the slightest.

This is fascinating; thanks for calling my attention to it. It completely demolishes prominent Coalition myths – that Labour was slow to act on the deficit, that raising taxes is a poor way to bring down the deficit because it damages growth – and vindicates Labour’s view that we can and should rely more on growth and tax rises and less on spending cuts to get the deficit down.

Can I ask how you think we can judge the size of the structural deficit, if it’s wholly independent of growth?

Short answer: it’s difficult. See here for a dissection of how the Swiss structural deficit is calculated

http://www.oecd.org/dataoecd/0/5/44477987.pdf

This includes a description of how the OECD, the IMF and the EU calculate structural deficits. It’s hard and contains equations, so I don’t really understand it, having given up economics after A-level. But all methods are agreed that to find the structural deficit (or surplus) you have to eliminate cyclical factors.

At its very crudest, this would mean that long-term average tax revenues equal 35% of GDP, long-term average expenditure is 40% of GDP, there is a structural deficit of 5%. Some years the overall deficit will be lower, due to better than average tax receipts, other times it will be higher due to collapsing revenues and booming temporary expenditures – these cyclical fluctuations ought to be cancelled out by taking averages.

As I’ve said, some people challenge the relevance or even the existence of structural deficits (Chris Dillow of this parish is one of them). But they are an economic term of art with a specific meaning – and on that basis, GDP growth today won’t reduce the structural deficit. That needs fiscal policy measures, either to increase average tax revenues, or to reduce Govt expenditure.

This is fascinating; thanks for calling my attention to it. It completely demolishes prominent Coalition myths – that Labour was slow to act on the deficit, that raising taxes is a poor way to bring down the deficit because it damages growth – and vindicates Labour’s view that we can and should rely more on growth and tax rises and less on spending cuts to get the deficit down.

How much would you like to raise tax by? Remember that if you’re following Alistair Darling’s plan, you need to cut the deficit by 78 billion pounds by April 2014. Income tax as a whole only raised £134bn last year.

And I think most people noticed that Alistair Darling raised taxes in the budget in March.

Tim J

“all methods are agreed that to find the structural deficit (or surplus) you have to eliminate cyclical factors.”

Yes, but doesn’t that just mean taking a view on what the underlying rate of growth is, once you’ve ironed out cyclical ups and downs? – i.e. rather than just looking at snapshots of how much you’re borrowing in this particularly good year or that particularly bad year, you take a view as to how much you’d need to borrow in an average, on-trend year?

Which is what I take you to be saying here:

“Some years the overall deficit will be lower, due to better than average tax receipts, other times it will be higher due to collapsing revenues and booming temporary expenditures – these cyclical fluctuations ought to be cancelled out by taking averages.”

- point being: what you take those averages (or long-term trends) to be is subject to revision. If the higher-than-expected growth we’ve seen this year is not just a ‘blip’ – if it tells us something positive about long-term, average rates of growth – we should be revising those figures upwards and our estimate of the structural deficit downwards.

- point being: what you take those averages (or long-term trends) to be is subject to revision. If the higher-than-expected growth we’ve seen this year is not just a ‘blip’ – if it tells us something positive about long-term, average rates of growth – we should be revising those figures upwards and our estimate of the structural deficit downwards.

Except that it’s not GDP that you need to measure – it’s tax revenues and Govt. expenditure.

Tim J -

Yes, but GDP growth is hardly unrelated to increases in tax revenue and reductions in welfare and stimulus spending!

I take your point that there could be a structural gap between tax receipts and spending *as a percentage of GDP*, but I’m not sure how that would come about and I don’t see how that can be what’s going on at the minute. (The present 11%ish of GDP gap between revenues and spending was plainly caused by the recession; and if negative growth can open up a gap in percentage-of-GDP terms, presumably positive growth can in principle close such a gap. If the economy now grew so fast that it ended up back at the size it would have been if the recession had never happened – unlikely I know! – then the gap would end up back at 2.5% or so, surely?)

I take your point that there could be a structural gap between tax receipts and spending *as a percentage of GDP*, but I’m not sure how that would come about and I don’t see how that can be what’s going on at the minute.

Well, that is what’s happening at the moment – that gap is the structural deficit! And it comes about very simply through spending more than you’re prepared to raise in taxation. The OBR calculated the structural element of the deficit as some £80-90bn a year, and it’s this that the Coalition are committed to reducing. There’s no point vowing to eliminate the cyclical part of the deficit – it’ll take care of itself once growth returns.

Tim J -

But the deficit we have at the moment *is (largely) the result of the recession* – i.e. most of the gap between revenues and spending, in percentage-of-GDP terms, is there as a result of negative growth.

Therefore it is not ‘independent of growth’ – it doesn’t just stay the same size, in percentage terms, irrespective of whether GDP rises or falls.

In principle, if a gap between revenues and spending (as a percentage of GDP) can open up as a result of negative growth, it can also close as a result of positive growth.