Here's a horrible chart:
It comes from ONS's Economic Review for July 2013.
There are a couple of key things that this shows. The first is systematic underestimation of the damage to the UK's economy. The 2008/9 recession was deeper than previously estimated and output remains lower. But the second is to my mind more interesting.
The 2008/9 recession was originally thought to be similar to the 1979 recession. We now know it was quite a bit deeper and lasted longer. But the shape of the curve was actually more like the 1990 recession, which unlike the 1979 recession involved a property market crash. Indeed the two lines parallel each other nicely - even with the revision - until the 10th quarter after the crisis. Then it all went wrong: even though the second dip shown on the original line has now turned into simply a flattening of the curve, the economy stopped recovering then and there has been little growth since.
It is all too easy to blame this on the Coalition government that took office in May 2010 with a deficit-cutting agenda. But at the time, the economy was growing and the big issues were government finances and inflation. No-one thought that GDP was at risk: the trajectory was for a recovery similar to that in the 1990 recession, and there was no particular reason to think that it would fail. Even when the economy tipped into recession in Q4 2010, the ONS review for February 2011 blamed it on bad weather.
The abrupt change of growth trajectory suggests that a pretty major exogenous shock hit the economy towards the end of 2010. But finding out what that shock was, and why it derailed the recovery so comprehensively, requires some detective work.
Despite numerous claims that the recovery was "killed by austerity", there is actually nothing very obvious on the Government's part to explain such a change at that time. The economy was already slowing in the third quarter of 2010, which is before any of the Government's spending cuts took effect. There was the increase in VAT to 17.5% - but really that should not have been sufficient to knock the economy off course, since all it was doing was reversing a previous reduction. And the second VAT rise didn't happen until January 2011.
There is one very obvious external shock - the Irish sovereign bailout in November 2010, to which the UK government contributed. Ireland is one of the UK's most important trading partners and the two financial systems are deeply interconnected. A major shock to the Irish economy would inevitably rebound to the UK. But....was that bailout really such a shock? It was widely expected, and the Irish banking system whose failure made the bailout necessary had already been moribund for two years. The conditions of the bailout would involve harsh austerity measures in Ireland, which would affect the UK's exports and the activities of UK companies in Ireland - but those would take time to kick in. And anyway, is the rebound from a shock to an economy the size of Ireland really capable of knocking the UK out of orbit? I am unconvinced. Ireland obviously had some impact, but I think we need to look elsewhere for the main cause.
In fact another look at these curves suggests an alternative explanation for the UK's trajectory change and stagnation. From Q4 2010 onwards, the curve looks less like the 1990 and 1979 curves, and much more like the 1973 one. It's bumpy - which suggests a series of shocks rather than one single shock. Now we know that the 1973 crisis was triggered by an oil price shock and was characterised by energy shortages, although it also had a bit of a banking crisis attached. And it involved high inflation - admittedly much of this was domestically generated due to loose monetary and fiscal policy fuelling a wage-price spiral, plus the devaluation of sterling, but the oil price shock itself also increased inflation due to the UK's external energy dependence. Do we possibly have a similar situation from the second half of 2010 onwards?
I think we do. The UK's CPI inflation at that time was surprisingly high and rising:
source: Trading Economics.
The ONS says that the principal cause of this was imported energy costs. Now, it is not the world price of oil so much as the domestic cost of energy and fuel that affects economic performance. Here is a nice graph showing UK road fuel prices from March 2010 to March 2012:
So from September 2010 to June 2011 road fuel prices - both petrol (gasoline) and diesel - rose by about 17%. That would particularly have hurt three groups: the haulage business; businesses that depend on frequent stock deliveries; and households where the principal earner(s) are essential car users.
Industrial fuel prices also rose considerably at this time. The graph shows actual prices rebased to 2005, which is not entirely helpful. So I have also shown the percentage increase from October 2010 to October 2011 for each fuel category and for total fuel:
Household energy prices rose even more (again the chart is rebased to 2005 prices, so I have included the table showing percentage year-on-year increase). The rise in domestic gas prices was a whopping 20.3% from Q4 2010 to Q4 2011, and the total rise across all types of fuels was not a great deal less, at 16.2%:
So the picture is one of a promising recovery being kneecapped by an energy crisis. The VAT rise in January 2011 only added to the problem.
Now, enthusiasts of monetary policy will tell you that exogenous supply-side shocks don't have as big an impact on economic performance as they did in the 1970s because central banks can offset the damage. I think the entire world now knows that I am sceptical about the claimed benefits of unconventional monetary policy, but I'm prepared to be convinced that central bank intervention would have helped here. If the Bank of England was doing it, of course.
But it wasn't. The first round of QE was from March to November 2009. And the Bank of England did no more monetary easing until October 2011. Furthermore, in 2010 it withdrew the Special Liquidity Scheme that had kept the UK's damaged banks afloat. Simon Nixon of the Wall Street Journal claims that this amounted to a tightening of monetary policy which directly caused the slowdown of the UK economy in the last quarter of 2010. I'm not sure I would go quite that far, though it undoubtedly contributed to tight credit conditions for households and SMEs. But certainly the Bank of England did absolutely nothing to ease the tight monetary conditions caused by the exorbitant energy price rises for business. And the Coalition government, elected as it was on a deficit-cutting platform, chose to ignore the evidence that energy price rises were strangling businesses and crippling households. It imposed a sharp fiscal consolidation at the same time.
Personally I'm inclined to exonerate the Bank of England here. The usual response to high consumer price inflation would be to raise interest rates. But that would have been completely the wrong medicine for an economy in which private sector debt was very high and the financial sector badly damaged, and it would have been terrible for companies facing high and rising energy costs. For an inflation-targeting central bank, doing nothing amounted to monetary easing, since it involved turning a blind eye to the fact that CPI was well above target. The ECB did raise interest rates at this time, and some people have suggested that it was this action that triggered the Eurozone crisis itself - the catastrophic rises in bond yields that drove some sovereigns to near-default. Personally I think the ECB's rate rise was like the UK Government's VAT rise - it didn't cause the problem, but it added fuel to the flames.
But I'm not nearly so happy about the UK Government's behaviour. In my book, dealing with the consequences of a negative supply-side shock is the responsibility of the fiscal authorities, not the central bank. Osborne's programme of front-loaded fiscal austerity was similar in spirit to Geoffrey Howe's approach to dealing with the UK's economic problems in 1979. And to some extent the situation looked similar. There was an oil shock in 1979 which contributed to the recession, but the main issues at that time were fiscal discipline and supply-side reform. I suspect that the Government thought the situation was indeed similar and that therefore fiscal reform was more important for the economy than compensating for the negative energy supply shock by, for example, cutting fuel duty and suspending green levies on household and business energy bills. And to be fair, fiscal reform was also the principal concern of many economists, investors, market advisors and international institutions, not to mention the British public that had elected the Coalition government (admittedly with a very small mandate). So despite the evidence that the economy was weakening, the Government went ahead with its spending cuts and tax rises.
But the situation was actually very different from 1979. There was no sign of the wage-price spiral that had driven inflation throughout the 1970s: real wages were falling and people were even taking nominal wage cuts in order to stay in their jobs.
The private sector - companies and households - was highly indebted and desperate to deleverage. And the financial sector was badly damaged. In short, the economy was extremely fragile. So the combination of a negative energy supply shock with the tightening of lending conditions, the Irish bailout and the Government's austerity drive was enough to knock it from growth to stagnation. Perhaps some more monetary easing would have helped, but the prospect of even higher inflation was just too much.
Energy prices flattened out in the second half of 2011 then rose again from 2012 onwards, not continuously but in fits and starts. Businesses and households continue to face high and rising energy costs, a growing number of households are in fuel poverty - having to choose between heating their houses and buying food, and business expansion is hampered by the high cost of energy.
Energy consumption fell catastrophically due to the financial crisis and the oil price shock of 2008 (no, we don't talk much about that either!) then fell again from 2010 onwards, almost certainly due to high prices:
Environmentally this is maybe a good thing, but economically it is disastrous. When businesses cut energy consumption due to rising costs they also cut production. When households cut energy consumption due to rising costs they do fewer activities and travel smaller distances. So expensive energy is a serious drag on economic growth.
Even now, few people talk about the impact on the economy of rising energy costs. And yet the future is likely to see energy becoming ever more expensive until we finally accept that the hydrocarbon fuel industry is in terminal decline and the future lies with other, newer energy technologies. And while energy consumption remains constrained by high prices and scarcity, growth will remain a distant dream.
Economic Review, July 2013 - ONS
Economic Reviews 2010-11 (index) - ONS
UK Energy Statistics, March 2012 - DECC
How Mervyn King lost the battle of Britain's banks - Simon Nixon, WSJ
The Perfect Storm - Tullett Prebon