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Building economic policy for improving times

How would an improving UK economic performance affect political debate? We might be about to find out. As I’ve noted previously, there have been signs of growth in the UK economy. The past few weeks have supported that view. At the beginning of July the June Markit Purchasing Manager Index  survey figures were released. The aggregate figure for the UK rose for the fourth month in a row, continuing to point to expansion and suggesting GDP growth in the second quarter should be better than the first. Expansion appears to be occurring across the economy, with the PMI figures for manufacturing, construction, and services all rising and new orders growing at the fastest rate since September 2007. The services sector, which represents almost 79 per cent of GDP, registered the highest reading for over two years and reports business confidence at a 14-month high.

A word of caution: we need to look for evidence that increased optimism is having an impact. For example, manufacturing output actually fell in May and industrial production was flat. There is still a lot of debt in the economy and the eurozone retains its potential to dent confidence. With inflation at almost three per cent per year but wages rising around one per cent, household resources continue to be squeezed. Moreover, the Office for National Statistics last month revised its GDP data: there was no double-dip recession but it now believes GDP fell much further than previously thought and we are still 3.9 per cent below pre-recession output. That’s not a great record internationally.

Nevertheless, if the optimism in the surveys is sustained, we might expect increased output to follow. The IMF certainly believes the outlook has improved, having revised its UK 2013 GDP growth forecast up 0.6 per cent to 0.9 per cent (though it keeps its 2014 forecast at 1.5 per cent).
We are seeing some signs of life in the housing market as the Funding for Lending Scheme pushes mortgage rates down: the average mortgage rate reached its lowest level in May, at 3.34 per cent, with the average floating rate mortgage much lower. Restarting the housing market comes with risks – and with little improvement in small business lending there is little sign of ‘rebalancing’ – with any negative consequences probably felt after the 2015 general election.

It may be that the trend rate of growth of the UK economy has fallen from the 2.5 per cent+ pa approx of pre-crisis years. But even if the trend has dropped to, say, 1.5 per cent pa, we should still expect quarters (or even years) of much stronger growth as the economy catches up. So we could see growth in future quarters but we won’t know for some time to what extent the economy is permanently recovering. It might be after the 2015 election before we can be sure.

It is highly likely that if forecasters become more optimistic about growth they will conclude that the loss of output was more cyclical in nature (less permanent) than they had previously stated. In such circumstances, for example, expect the Office for Budget Responsibility to become more optimistic on deficit reduction. Expect some political (and premature) talk of tax cuts: many Conservatives will see this as a once-in-a-generation opportunity to roll back the state by keeping spending cuts going while cutting taxes. And expect the need for Labour to say more about how a One Nation economic policy applies in improving times as well as bad to become more apparent.

This article was first published by Progress on 16 July 2013.
Progress, 16 July 2013, 16/07/2013

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Responding to Brian Griffiths' article in The Article on the risks of inflation.