Wednesday, 4 December 2013

Green shoots!

Britain is having an unusually robust recovery this year.

That is not 100% clear, as the GDP numbers are good but not awesome. Even so, I do see there seems to be lots of high frequency data suggesting that more good GDP numbers are on the way.  So let us take it as a working assumption and try to identify the causes.

I always start from an AS/AD perspective, keeping in mind the two can and often are “entangled.” So we need to start with the inflation/RGDP splits. It looks to me like inflation has averaged 1.8% during the first three quarters and RGDP growth has averaged 2.5%, for a total of 4.3%. I see two ways to interpret these numbers from a supply-side perspective:

1.  The split is not all that impressive from a supply-side perspective, at least for a deeply depressed economy such as Britain.

2.  The split is much better than the abysmal splits seen in recent years, where inflation was often much higher than RGDP growth.

Put them together and it suggests not so much a very strong positive supply shock, but rather an ebbing away of previous negative supply shocks. Perhaps oil production is falling more slowly, or contracting finance is no longer a net drag, or VATs and other fees are no longer being raised. When you stop hitting yourself with a hammer, you feel better!

Also on the supply-side there is the “self-correcting mechanism,” but that begs the question of why so much more this year than past years.

And finally, the top income tax rate was cut from 50% to 45%, which is a modest plus for the supply-side. If rich Frenchmen are drawn to London, that boosts AS.

The 4.3% NGDP growth rate does seem to be faster than in previous years, so demand-side factors probably play a big role in the speed up in growth. But this area is even trickier than the supply-side.

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