Saturday, Jul 25, 2009
The UK can't measure the output gap
Investors Chronicle: Output gap points to deflation
This article has a chart showing output gap vs inflation which correlates fairly well from 1984. The BoE uses measurements of the output gap as a primary influence on inflation predictions (not so much money growth..). Currently deflation is predicted because the output gap, the difference between production and capacity production is large and growing. But, in this particular article but mainly elsewhere, there are mumblings that measurements of the UK output gap are highly inaccurate, namely that while we have floated on financial services GDP contribution, our actual production is very low. This seems reasonable because our high imports/trade deficit. The consequence of over-estimating the output gap to decide policy is high inflation (which will come as a surprise).
8 Comments
- If you do not have an admin password leave the password field blank.
- If you would like to request a password allowing you to add comments and blog news articles without needing each one approved manually, send an e-mail to the webmaster.
- Your email address is required so we can verify that the comment is genuine. It will not be posted anywhere on the site, will be stored confidentially by us and never given out to any third party.
- Please note that any viewpoints published here as comments are user's views and not the views of HousePriceCrash.co.uk.
- Please adhere to the Guidelines
1. stillthinking said...
I do sometimes wonder how long deflation in the UK will persist. My personal opinion is that our actual productivity is fairly low, because we cannot ever grow enough food for ourselves, as one example, but also clothing, shoes, electronics, going forward energy, furniture. As I sit here typing away, I don't think much of the stuff I can see is made in the UK.
So to what extent has the faux boom distorted measurements of the output gap. Probably this is a lot, because over the last ten years our production measurements have been distorted immensely by debt and financial services, both of which are now on the back burner.
Something for the inflationists.
2. japanese uncle said...
stillthinking
Output gap exists not only in the UK but also in the economies exporting goods to the UK and that to a greater extent, not least in China. So its not just another local deflation, but the global one.
Whatever amount of money is pumped into this economy by the 'Queen Elizabeth', will that money go to the pockets of the consumers and ordinary workers? Clearly not! Unless money is literally given away to the consumers, which is least likely to happen under this government or the next, 'when the money is gone, it's gone will always be the solid reality' Suppliers/makers will have to survive in the climate where people no longer afford to spend, by cutting prices further and further, by slashing costs (including staff costs) and dividends. Thousands of the so called executives will be out of job, and prepared to work with fraction of salary they used to receive (I would not say 'earn'), as a result of the dwindling corporate profits.
House prices do not seem to be dropping as drastically as we expect and hope, but that is simply because of the absence of main-stream movement in the market, ie purchase by FTBs and other non-speculative buyers. When the market reached the point when it can no longer be sustained without those main streamers, the crash will be even bigger than we saw in 2007-2008.
3. stillthinking said...
ju, I haven't changed my mind about a good and proper wallop of deflation, I just think that for the UK actual production versus capacity production, probably capacity production is estimated too high because capacity production if it can be known at all, must be some function of unemployment, skill base, infrastructure and apart from my personal suspicions, the last two are often pointed out as lacking in the UK. Further a bout of excessive debt based consumption must make it really tricky to see through the figures and estimate production figures, so if ever there was a time for inaccuracy must be now.
Also, if capacity production is marked up too high then the output gap, being basically smaller as a consequence, would be an explanation of why inflation thus far is sticky and also why house prices have not fallen faster.
4. shipbuilder said...
To me it's always been as simple (probably too simple) as - if (as JU said) printed money does not go straight to the pockets of consumers, then printing will not work. What the powers that be seem to be doing is trying to get the best of both worlds by effectively giving the printed money to the banks so that they can make more money by lending it rather than just giving it away. However the banks (and possibly the public, which remains to be seen) are not playing along.
Apart from all this, I cannot see how the money created is anywhere near the money so far written off, so even hyperinflation down the line when the created money eventually is spent seems unlikely.
In addition, governments stepping in to spend where the consumer won't or can't, cannot work in even the medium term, because they don't have the money to do it.
Imported inflation seems like the only likelihood, but as JU says, the problems are universal, so any companies looking to raise prices will eventually be defeated by lack of demand and any currency devaluation-based inflation will only result in further consumer cutbacks to save money for the essentials.
In effect, I don't see and have never been able to see, any other scenario than deflation, however I could well be missing another factor.
Faced with deflation, I feel that the best way for a society (meaning everyone) to react would be to allow prices to drop to their correct levels while ensuring that a poverty/violence cycle does not occur as a result. I do not buy that this is only the responsibility of government.
5. uncle tom said...
So The Treasury thinks that there is 2.75% p.a. potential growth...
What are we actually doing to achieve that? What are we actually doing to create more from the same amount of effort?
We have been getting loads of cheap goods from China, but have nothing like enough to offer them in return; and we have otherwise been borrowing cash from foreigners on an unprecedented scale.
There will have been a small amount of underlying growth, but it has been greatly extended by these unsustainable factors.
This article draws conclusions from a mistaken assumption.
6. icarus said...
He seems to be saying that capacity or potential output carries on growing even in a deflationary recession. So while actual output is falling, potential output carries on growing inexorably - because the Treasury says so - despite the lack of investment in capacity in a recession. So after a few years recession there'll be an enormous output gap. Nonsense.
7. devo said...
Look at those full-size headphones from Poundland.
The design
The materials
The ergonomics
The electronics
The sound quality
The graphic design
The packaging
£1
8. Clockslinger said...
JU @ 2...I don't understand! Surely an absence of activity by mainstrean purchasers (2FTB and non speculative")is the very thing that ought to cause prices to fall more quickly!