After seven long years, the UK economy might now be back where it used to be. We won’t know for sure until the National Institute for Economic and Social Research (NIESR) publishes its next monthly GDP figures, but there’s a decent chance that May 2014 will be the month in which GDP got back to its previous peak. While that’s good news for the government, as GDP matters for debt sustainability, ordinary people are lagging behind a bit – GDP per person is only likely to return to its pre-crisis peak in the next two or three years.

The problem, as I have mentioned many times before, is that growth is not the whole story. While the economy is now expanding at a healthy pace – albeit not a particularly strong one – it still shows little sign of making up the ground it lost during the past 7 years. In the economics jargon, it still looks like we’ve suffered a massive loss of productivity – that GDP per person will be permanently lower than its pre-crisis trajectory.

While that may be hard to notice – counterfactuals always are – there is one very real implication. The chunk of national income that has been permanently lost means that the spare capacity currently in the economy is much smaller than it otherwise would have been. If the crisis and subsequent austerity measures hadn’t hit potential supply so hard, the so-called ‘output gap’ would be bigger.

Rising Graph (PD)But sadly the economy was clobbered, and shows no signs of making up the lost ground. And the bottom line from that is clear – with a smaller output gap, growth will run up against capacity limits that much quicker. Underlying inflationary pressures will start to build, and then monetary policy will have to respond.

Put simply, this all implies that interest rates will go up sooner in the UK than in the US. While the Americans saw a shallower recession and a swifter immediate recovery, there is still plenty of spare capacity in their economy, which indicates that the crisis has left fewer long-term scars. That’s consistent with the bank bailout being implemented more effectively in the US, and especially with austerity being delayed there until growth had really got going.

Here in the UK, we are stuck with most people being permanently worse off than they otherwise would have been. And to cap it all off, rates will have to rise sooner here than elsewhere. While many will welcome that as a sign that things are returning to normal, the reality is that early rate rises will reflect UK policymakers’ poor responses to the crisis. And that is nothing to celebrate.

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