Unit 4 Macro: Prospects for UK growth - A New Survey

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 about 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 Centre for Macroeconomics (CFM) – a partnership between the University of Cambridge, the London School of Economics (LSE), University College London (UCL), the Bank of England and the National Institute of Economic and Social Research (NIESR) – is today publishing the results of a new monthly survey to inform the public about the views held by leading UK based macroeconomists on important questions about macroeconomics and public policy. The survey will shed light on the extent to which there is agreement or disagreement on these questions among our panel of experts.

The first survey focuses on the growth potential of the UK economy.

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.

OUTPUT GAP
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% (OBR, 2014); and the Bank of England’s measure of spare capacity is currently estimated to be around 1-1.5% of GDP (Bank of England, 2014). 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

Question 1
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?

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 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.

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.

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.