Mediamacro Myth 3: The 2007 Boom

The alone agency y'all tin sack sustain the myth that Labour was fiscally profligate is past times suggesting that forthwith earlier the recession the Great Britain was experiencing a massive boom. In an economical blast revenue enhancement receipts are high in addition to spending on transfers low, thence the budget should live inwards surplus. If it is inwards fact inwards pregnant deficit, that indicates serious financial laxity.

There are 2 half-truths here. First, everyone remembers beak of a housing boom, in addition to a housing blast sounds pretty similar to a to a greater extent than full general economical boom. But to a greater extent than seriously, the thought that at that spot was a huge blast inwards 2007 appears to live backed upward past times information from the International Monetary Fund in addition to OECD. Let us receive got each inwards turn.

This nautical chart of solid prices clearly shows a housing blast inwards the middle of the in conclusion decade. But does it betoken a full general economical blast inwards 2007? There are 2 problems: at that spot is clearly an underlying tendency inwards the data, in addition to solid prices rose most chop-chop at the outset of the decade. When y'all receive got whatsoever tendency into account, the middle years of that decade expression similar a plateau.

The upward tendency inwards solid prices is probable to live due to 2 factors: a growing mismatch betwixt need (encouraged inwards business office past times inward migration) in addition to provide (very few novel houses existence built), in addition to lower existent involvement rates. (The argue why depression rates are of import is explained here, in addition to the link alongside need in addition to provide here.) As all these factors tin sack likewise vary inwards the curt term, this indicates that the solid cost bicycle ask non ever live correlated alongside the to a greater extent than full general economical cycle. The clearest indication of this is what has happened to London in addition to South East solid prices over the in conclusion 2 years, which are at nowadays good higher upward 2007 levels. Does that hateful the portion is inwards the middle of an fifty-fifty to a greater extent than massive boom? Of course of pedagogy not.

If y'all expression at both the OECD in addition to IMF’s electrical flow measures of the output gap (the divergence betwixt actual output in addition to the degree that would buy the farm along inflation constant), they advise a large positive gap for the Great Britain inwards 2007. (3.5% inwards the latest OECD Economic Outlook.) That is a pretty large boom. The job hither is that inwards 2007, the OECD only thought the output gap at the fourth dimension was less than 0.5%, which is no blast at all. Why the alter inwards view? The respond is the recession, in addition to the UK’s irksome recovery. To cutting a long story short, the OECD inwards effect retrospectively fit a gradually moving tendency through the information (for productivity rather than output, but it comes to the same thing), thence the longer the Great Britain fails to pick out grip of upward alongside its pre-recession trend, the to a greater extent than the OECD has to curvature that tendency over the past. The to a greater extent than it bends the trend, the to a greater extent than 2007 looks similar a boom.

Could the OECD live right at nowadays in addition to incorrect dorsum inwards 2007? The large job hither is that none of the to a greater extent than reliable measures behaved inwards 2007 equally y'all would hold back inwards a large boom. Inflation was happily bobbing unopen to the Bank’s 2% target. Interest rates were rising, but non rapidly. Unemployment was a niggling higher than a twosome of years before. Consumer debt was rising, but mainly because of rising solid prices in addition to mortgages. As the Bank’s Ben Broadbent points out, inwards the subsequent recession “losses on most domestic loans receive got truly been unexceptional. Instead, it is Great Britain banks’ substantial overseas assets that caused much of the damage.”

This gets us to the fundamental dot equally far equally Labour profligacy is concerned. What is relevant to this number is non what nosotros intend nearly the 2007 Great Britain economic scheme today, but what the full general consensus was at the time. As nosotros receive got already noted, the 2007 OECD Economic Outlook thought at the fourth dimension that the Great Britain economic scheme was pretty unopen to trend. As far equally I tin sack see, this was a consensus view. The IFS Green Budget for 2007 had an output gap of effectively zero. The IMF’s Article IV assessment published unopen to Budget fourth dimension inwards 2007 came to a similar conclusion. The argue this was the consensus persuasion is the information noted inwards the previous paragraph.

One in conclusion expression at the numbers. If nosotros assume existent increment of 2.5% (again a consensus persuasion at the time) in addition to 2% inflation, thence a debt to gross domestic product ratio of 40% would imply that the sustainable deficit was 1.8% of GDP. As the approximate of the output gap at the fourth dimension was unopen to zero, at that spot was no argue to conform this for the nation of the cycle. The actual deficits for financial years 2006-7 in addition to 2007-8 were slightly over 2.5% of GDP. The divergence is what I telephone phone mild imprudence, in addition to would receive got been fairly easily to right inwards subsequent budgets. By 2009-10 the deficit had risen to 10.2% of gross domestic product because of the recession. So the deficit inwards 2010 was a resultant of the recession, non Labour profligacy earlier the recession.

And if y'all cannot milkshake off that thought that Gordon Brown was profligate, 1 in conclusion laid of figures. Between financial years 1979 to 1996 (the xviii years of Conservative government), the deficit averaged 3.2% of GDP. From 1997 to 2007 it was 1.3%. Now perhaps the Conservatives were a chip unlucky alongside having 2 recessions on their watch, thence the equivalent cyclically adjusted figures are 2.6% in addition to 2.1%. One in conclusion time: Labour financial profligacy is equally mythical equally the unicorn.

Previous posts inwards this series

(0) UK mediamacro myths: an introduction

(1) 2010 Great Britain faced a financial crisis

(2) Labour profligacy

My New Statesman article that provides a summary of this serial is likewise at nowadays available online.