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| The Economic Cyle Revisited |
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| Written by Giles Wilkes |
| Friday, 01 May 2009 10:37 |
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The IFS have produced an analysis that is long-overdue, IMHO: re-estimating the economic cycle and therefore questioning whether we really were having a bust without a boom (as is asserted in some government circles). If you can remember back to the halcyon days of Brown’s last few budgets, he would always confidently claim that “the golden rule will be met”. This meant that the current budget (e.g. without investment) was balanced over the economic cycle. But this required estimating what was and was not “normal” economic growth. The Treasury cut down a few forests working on this one (see e.g. here), and were willing to court some considerable controversy when they scientifically adjusted the dating of the cycle retrospectively in 2005. A convenient shift, as we mentioned in our piece on the discredited fiscal rules. I won't go into great detail about what Brown's Treasury thought was the country's cyclical position, because it now seems so gloriously irrelevant. Enough to say that, just before the economy fell of a cliff last year, we were meant to be somewhere near capacity - neier too hot nor too cold. In brief, there was nothing unsustainable about the previous 15 years of growth. This was not a matter of the country operating above capacity and so suffering an inevitable setback. But the economic revisions since have assumed that 4% of the country's economic capacity has been permanently lost. This means we will not automatically close the gap that is being opened up by our growth falling from 2.5% to minus 4%. The alternative approach would have been to assume that the idle productive capacity would have built up and enabled us to grow above trend to catch up for lost work. When this happened, Martin Wolf wrote that 'the Treasury is telling the world that the view of the structural fiscal position of the UK it held last March was nonsense’. As we were writing our Fiscal Rules piece, I decided to re-work out what the economic cycle position would have been had the sustainable growth rate since 1993 (the first full year of recovery) been adjudged to have been 2.5%, rather than the 2.8-3% that actually happened. This assumption worked rather well to suit the average from 1993 to 2011, the presumed end of a shallow recession. If this conservative assumption had guided Brown, by 2002 he would have looked back on 10 years where the economy had been growing on average at above 3.1%. While the small slowdown that occured from there would have looked like a minor movement below trend (and therefore would have justified some sort of increased current deficit), there would have been far less of the "justified splurging" that has ended up bequeathing this country such a large structural deficit. Compare the chart above that I made in November (but which never made it to the Fiscal Rules piece) with the Treasury's estimate for the cyclical position. Now it is fashionable to see 1993-2007 as a period of unsustainable growth. A truly prudent Chancellor would have taken the same view. |
| Last Updated ( Thursday, 21 May 2009 12:45 ) |
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