Duncan’s Economic Blog

The UK: Demand, Supply, the Deficit & Rebalancing

Posted in Uncategorized by duncanseconomicblog on August 2, 2011

Since we learned that GDP grew by only 0.2% in the second quarter of 2011, we’ve had a blizzard of further bad economic data. The CBIindustrial and distributive trends surveys last week pointed to an economy slowing in August, the manufacturing PMI is pointing towards actual contraction, the construction sector is still weak whilst the money supply is falling.

The question becomes – what on earth is going on? Specifically does the UK have a demand problem or a supply one?

The answer is a depressing one – both.

In the short term the immediate problem is one of poor demand. Domestic demand is extremely weak:

  • The consumer is over indebted, cautious and not spending.
  • Corporations are constrained by banks not lending, pessimistic about their prospects and not investing.
  • Government is embarked on the largest fiscal tightening in decades.

Meanwhile external demand for exports is weak for reasons that a casual glance at the recent economic headlines coming out of Europe and the US will easily reveal.

But the UK does have a supply problem. Trend growth is almost certainly lower than the OBR estimate, we still don’t know quite how much the credit bubble led us to over estimate sustainable growth – but we do know that investment in  the real economy has been low for a long time and that much of the finance productivity miracle was actually a mirage.

All of this matters for government policy. George Osborne’s plans to eliminate the structural deficit in this Parliament are now hanging by a knife edge. Another large downgrade from the OBR and the more cuts or tax rises will be required to meet his own targets – as the IMF has now noted.

Meanwhile the Government’s second major macro aim – a rebalancing of the economy, also looks in jeopardy as the manufacturing sector slows down.

What is required is a combination of short run policies to maintain aggregate demand coupled with a medium term agenda to address supply side issues – in the long run this is the best way to both balance the budget and rebalance the economy.

Interestingly enough the State Investment Bank idea (long backed by me and supported by Robert Skidelsky and Gerry Holtham amongst others) may help to address both these issues by raising domestic demand in the short run and increasing investment in the medium term.



9 Responses

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  1. Paolo said, on August 2, 2011 at 12:14 pm

    Corporations are constrained by banks not lending
    Really? I heard this morning on the Today programme Peston reporting that Diamond (Barclays’ CEO) complained that even SMEs are ammassing record level of cash…

    • duncanseconomicblog said, on August 2, 2011 at 12:27 pm

      In aggregate corps are sitting on a huge cash pike and unwilling to invest.

      But there are also businesses reporting a problem raising funds.

      • gastro george said, on August 2, 2011 at 1:56 pm

        Yes, it’s both, surely. And bank lending is also being restricted by the bad terms that they are offering, higher interest rates and more security required.

  2. gastro george said, on August 2, 2011 at 12:14 pm

    Does Osborne care, as long as the media are full of the words default, debt and deficit, and he can offer some tax cuts just before the next election?

  3. Carol Wilcox said, on August 2, 2011 at 2:52 pm

    The banks need to be weaned off the land milch. Most bank loans are backed up by landed property. Land is in fixed supply and will always retain its value in the longterm. Thus banks do not have to worry about risk. Collect all land rent for public benefit and capital land values will tend to zero (whilst rental values will increase). This will force banks to have to do some proper work. Home loans will revert to the mutual sector where they belong. Banks can concentrate on lending to businesses which means they will have to actually get to know something about their clients – boring and less rewarding for them but of great benefit to our economy.

  4. […] growth by Chris Dillow     August 8, 2011 at 8:32 am In the economic debate between left and right, there seems to be a shared presumption which I find […]

  5. Gareth said, on August 11, 2011 at 2:41 pm

    1) Broad money is falling, but broad money velocity has been increasing since the middle of 2009.

    2) If you are going to separate demand and supply, why do you come out with tired cliches like “consumers are not spending” when this is not what the stats say?

    Retail spending is up 4% in the 12 months to June 2011; this is historically a fair growth rate in retail demand. We measure demand by nominal spending, of course.

    Prices have gone up by 3.7% over that same period. So, yes, there has been a supply shock: the VAT rise and commodity prices going up 50% would do that.

    • duncanseconomicblog said, on August 11, 2011 at 2:58 pm


      1/ I still worried by the growth rates of M4 and M4L (and especially M4-OFCs) regardless of velocity changes. As an aside my first proper job was doing money and credit at the BOE, I’m quite comfortable with the numbers.

      2/ Consumption (which is different to retail sales) fell in Q4 ’10 and Q1 this year. We don’t have Q2 figs yet.

      • Gareth said, on August 11, 2011 at 9:04 pm

        I referenced the retail figures because they are the only nominal spending figures that we have since Q1 as far as I can tell, I can’t find Q2 GDP-expenditure data, am I missing that?.

        What domestic consumption measure has been falling? Household final consumption expenditure (ONS ABJQ) grew 2.7% from 10Q3 to 11Q1. Annualized that is 5.4%, which is bang on the pre-crisis trend growth rate. Yes, prices also went up and the deflator is really high, and the VAT rise looks like an AS shock this year as expected, but those are all separable facts.

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