A sideways look at economics
“Out along the edge
Is always where I burn to be
The further on the edge
The hotter the intensity
Highway to the danger zone
Gonna take you right into the danger zone”
Kenny Loggins, from the opening scenes of Top Gun, 1986
Yesterday, the Bank of England joined us, and many other organisations, in forecasting that UK growth next year would be somewhere between 0% and 1%. But as our chart shows, that is a dangerous place to be.
The distribution of UK growth has a pronounced negative skew. Above 1%, it follows something close to a normal distribution. Below 1%, it is almost uniform. Once growth drops below that threshold, almost anything can happen. If we look at the nine years since 1950 in which the UK economy expanded by less than 1%, we find that it contracted in seven of them.
We suspect it is no coincidence that the distribution of growth outcomes shifts dramatically either side of a figure that is around a percentage point below its historic average rate. Once growth falls materially below trend, then it is inevitable that unemployment will start to rise. At that point human psychology kicks in. If the downturn is expected to be severe, job insecurity will be high. Precautionary savings will rise, reducing domestic demand and with it economic growth, raising the likelihood that the downturn is indeed severe. Equally, if the downturn is expected to be mild, consumer behaviour may change relatively little, raising the likelihood that the downturn is indeed mild. This is perhaps just another example of a situation in which expectations can become self-fulfilling. In the economics jargon, once forward-looking behaviour becomes relevant, multiple equilibria can arise, and outcomes become indeterminate. Once the economy weakens sufficiently, anything can happen!
Perversely, we might actually take some comfort from the fact that, with near-stagnant productivity, trend growth is not what it used to be in the UK. In the present environment, a brief period of growth in the 0% to 1% range may not cause unemployment to rise, particularly if there is an element of labour hoarding. Nevertheless, the apparently disjointed nature of economic performance either side of a critical level of economic growth, which may now be close to zero, means it is vital that policymakers do all they can to lessen the impact of the Brexit vote on an economy that was already slowing. The danger zone for growth may have shifted a little to the left in our chart, but with the monetary policy tool cupboard bare, it is a particularly terrifying place. Fiscal policy must do the heavy lifting, and soon.