Monday, April 7, 2014
The long period of slow or negative growth might imply that there is a substantial output gap in the UK economy. Do you agree that there is currently a larger output gap than the OBR estimate to the extent that the shortfall in output relative to capacity is 3% or greater?
Do you agree that, in the wake of the financial crisis, any downward adjustment to the expected average annual long-term growth rate of the UK economy is likely to be by less than 0.25 percentage points?
Fears that the financial crisis will have a significant negative impact on long-term UK economic growth are unfounded, according to a majority of the UK macroeconomics profession surveyed by the Centre for Macroeconomics (CFM). What’s more, the CFM survey indicates some optimism of the UK’s immediate capacity for higher growth: while roughly half of the respondents share the views of the Office of Budget Responsibility, the other half is substantially more optimistic about the capacity for the economy to recover.
The global financial crisis has both exposed and contributed to the vulnerability of many financial institutions and markets, as well as that of private and public balance sheets. The UK economy seems to be finally gaining some momentum after years of negative or low growth. Real gross domestic product (GDP) grew by 1.8% in 2013. The Office of Budget Responsibility (OBR) forecasts growth of 2.7% in 2014, followed by 2.3% in 2015 and settling down to 2.6% over the subsequent two years.
There are many factors that have to be considered when assessing the state of the economy. This survey deals with two such factors.
- The first is the size of the current output gap, and
- the second is the long-term potential growth rate of the economy.
The output gap measures the extent to which the level of output is below the potential level of output of the economy. According to the OBR the output gap in the last quarter of 2013 was 1.7%.1 And the Bank of England’s measure of spare capacity is currently estimated to be around 1-1.5% of GDP.2
These estimates imply that the drop in GDP, relative to its pre-crisis trend, which may be as much as 10% on some estimates of trend, is for the most part permanent.3
Survey results on the output gap
The CFM survey indicates a broadly positive view of the UK’s immediate capacity for higher growth: UK macroeconomists either support the OBR view, or support the view that there is more spare capacity, indicating that part of the loss experienced during and after the financial crisis and recession could be recovered.
It is important to note that the assertion in the question is that the shortfall in output relative to capacity is noticeably larger than the OBR estimate of 1.7%, namely 3% or more. Nevertheless, 46% of the respondents either agrees or strongly agrees. An equal number disagrees or strongly disagrees, but in this latter group, there is extensive support for the OBR estimate as indicated in their comments.
Among those who agree with the assertion, the following arguments are given. Jonathan Portes (NIESR) points out that unemployment remains high and that there is little or no sign of unsustainable wage inflation. Regarding the possibility of the economy recouping losses experienced during the financial crisis and the recession, Morten Ravn (UCL) may be the most positive: ‘I find it hard to identify key reasons for why there should have [been a] permanent decline in the level of output’. A similar view is expressed by Andrew Mountford (Royal Holloway): ‘the hypothesis that the UK economy returns to trend after recessions looks reasonable’.
Costas Milas (University of Liverpool), who disagrees with the assertion that there is a large output gap, points out that quite a few different analytical techniques lead to low output gap measures. Similarly, George Buckley (Deutsche Bank) points out that the OBR estimate is consistent with estimates made by others and consistent with surveys of spare capacity indicating that firms are operating around normal levels.
Long-term potential growth and the financial crisis
Even though the UK economy is gaining momentum, it is possible that these vulnerabilities will have long-term consequences for the economy, for example, because of increased awareness of financial market risk and/or the response of policy-makers. It is also possible that the economy will be influenced indirectly, for example by long-lasting consequences of the financial crisis on the Eurozone.
Although, it seems likely that these developments will have a persistent effect on the level of GDP, it is less clear that they will have a long-lasting effect on the growth rate. In the following question, long-term growth refers to growth over a decade. Note that agreeing with the assertion allows you to think that the financial crisis will have a negative effect on future growth rates as long as it is not substantial.
Survey results on the impact of the financial crisis on growth
The CFM survey suggests that fears that the financial crisis will have a significant negative impact on long-term UK economic growth are largely unfounded. Among the respondents, 61% think that the financial crisis will either have no effect on long-term UK growth rates or a small negative effect that pushes GDP down by less than 2.5% in total over a ten-year horizon. In comparison, 31% disagrees or strongly disagrees. When we weight the responses by confidence levels, then the support for the assertion intensifies (67% agreeing and 25% disagreeing).
Martin Ellison (University of Oxford) and David Cobham (Heriot Watt University), who agree with the assertion, point out that past UK recessions did not seem to have had a long-term impact on growth.
Although respondents that disagree with the assertion are a minority, several reasons are given why the impact of the financial sector may be more severe. Tony Yates (University of Bristol) does not think that the financial crisis has an impact on long-term growth rates, but points out that this is conditional on intermediary balance sheets being repaired. George Buckley (Deutsche Bank) and John Driffill (Birkbeck College, London) say that growth before the financial crisis was unsustainable: the financial crisis can have then an impact on growth rates by bursting this bubble.
Luis Garicano (LSE) and Marco Bassetto (UCL) note that financial services have played an important part in past GDP growth in the UK. Marco Bassetto writes: ‘if the crisis leads to a prolonged decline of the industry, it could have an impact on growth for several years to come.’ Finally, Marco Bassetto (UCL) and Wouter Den Haan (LSE) highlight possible negative consequences related to the uncertainty of policy reform in the financial sector.
(1) OBR, 2014 http://cdn.budgetresponsibility.org.uk/37839-OBR-Cm-8820-accessible-web-v2.pdf. (2) BoE, 2014. http://www.bankofengland.co.uk/publications/Documents/inflationreport/2014/ir14feb.pdf.
(3) We find that current GDP is 15% below the pre-crisis trend path when a log linear model is used to estimate the trend.