Is the UK falling back into recession?
02 April 2012
By Andrew Sentance, Senior Economic Adviser
The OECD made the headlines last week by suggesting that the UK economy was heading back into recession. The definition of recession which underpinned their view is widely used by economists – two consecutive quarters of falling GDP. So because the OECD expects a further slight fall in GDP in the first quarter of this year (erroneously in my view) to follow on the 0.3% drop in the final quarter of 2011, that is taken to mean that we are “technically” back in recession – even though the projected fall in output is very modest.
I have never liked this definition of recession. It came to be widely used in the UK in the 1980s and 1990s, and its origins can be traced back to the United States in the 1970s.
There are four problems with it. First, the time period is relatively short. Two quarters is a period of six months, but data on GDP in one quarter can be heavily influenced by what happens in a single month. We saw this with the impact of the snow In December 2010.
Second, GDP figures are frequently revised. So the snap assessment which is made on the basis of one set of figures can be reversed by later revisions. This happened in the early 1990s, when initial figures suggested that the recession had continued through 1992 and into early 1993. With more data available, it now appears that the decline in GDP came to an end in late 1991.
Third, it is wrong to base your judgement of the state of the economy on a single economic indicator. GDP contains some useful information about the current state of the economy but it can also be affected by erratic factors like North Sea oil production. It helps to try and look at the underlying picture and take into account other relevant data like unemployment, business surveys, and retail sales.
The final problem with the widely used “technical” definition of recession is that economies vary greatly in their underlying growth potential, because of differences in population growth and trend productivity. An economy which has a low underlying growth rate (ie closer to zero) runs a greater risk of falling into “recession” simply due to normal fluctuations in GDP estimates.
So what can we do to come up with a better approach to defining recessions? One suggestion is to form a committee to do the job. In the US, the National Bureau of Economic Research (NBER) has the technical role of defining turning points in the economic cycle.
A less bureaucratic solution would be to follow two simple rules. First, focus on the underlying GDP picture and try and abstract from erratic factors influencing growth – like the volatile North Sea oil sector, where output is currently 25% down on a year ago – or the effects of weather. In the UK, services output was 1.8% up on a year ago in the final quarter of last year and recorded the same annual growth rate in January. This sector accounts for over 75% of total GDP and over 80% of employment, and its growth does not seem consistent with an economy which is in a sustained contraction.
Second, we should look at a range of economic data – including evidence from the labour market and business surveys – alongside GDP to judge whether an economy is in recession. So far this year, this wider set of indicators has been relatively positive about UK growth – contrary to the OECD’s gloomy forecast. And we will receive new business survey information from the British Chambers of Commerce and the Purchasing Managers’ survey (PMI) this week.
So it does not seem likely that the UK is falling back into recession, even on the widely used “technical definition” of two negative GDP quarters. But perhaps the main conclusion is to beware of this narrow and potentially misleading definition. When economies move in and out of recession it is normally apparent from a wide range of economic indicators. And that wider range of data for the UK points to a temporary phase of weakness last autumn, from which we are now emerging, not a sustained downturn.
Contact: Andrew Sentance | Tel: +44 (0) 20 7213 2068