PERSPECTIVES By Ruth Lea, Economic Adviser to the Arbuthnot Banking Group Ruth Lea The past four UK Economic Adviser Arbuthnot Banking Group [email protected] recessions compared, and 07800 608 674 no recession expected on Brexit 10th September 2018 Introduction As discussed in recent Perspectives, the economy is holding up remarkably well, given the political uncertainties relating to the Brexit negotiations.1 Perhaps unsurprisingly, there is increasing speculation that the economy may slip into recession if the there is a highly “disruptive” Brexit in March 2019. Suffice to say at this point, we do not know what form of Brexit will take, though, as indicated on previous occasions, there are grounds for some economic confidence, even if it is a so-called “no deal” hard Brexit.2-3 However, it is not unreasonable to anticipate some Brexit related disruption which could impact on GDP growth – even to the extent that GDP may slip back in one or two quarters. But this would probably be temporary, barely deserving of the word “recession”, with relatively little impact on unemployment. (This assumes no major political turmoil or other unforeseen event on Brexit.) Therefore, a recession in the sense of a prolonged hit on GDP, as in the mid-1970s, early-1980s, early-1990s and the Great Recession, remains unlikely. The first three of these recessions were broadly characterised by high interest rates intended to control inflationary pressures and the Great Recession was triggered by the financial crisis of 2007-08. We do not expect any replication of the former, inflation is moderate and there are no signs the Bank wishes to rapidly escalate interest rates. And we do not expect a replay of the latter, assuming the tighter regulation and closer supervision of the banks in recent years should prevent a repeat of the late 2000s financial cataclysm. It is worth noting there are problems with the term “recession”. The term “recession” is conventionally defined as when an economy experiences two or more consecutive quarterly falls in GDP. But this can be criticised for being, on the one hand, too pedantic or, on the hand, too inexact. Too pedantic because if an economy grows below trend (which is broadly 0.5% a quarter), or even stagnates, this can result in significantly higher unemployment. This state of affairs 1 undoubtedly feels like recession for the many adversely affected, even though GDP does not actually fall on a quarter-to-quarter basis. Too inexact because an economy that experiences two consecutive quarters of modestly falling GDP and then recovers quickly would, obviously, be in better shape than one that experiences sharper falls in output and/or falls in output over a more protracted period. Yet both scenarios could be termed “recessions”. The last four recessions: overview The UK’s recessions of the 1970s, 1980s and the 1990s and the Great Recession, were undoubtedly economically damaging. Taking table 1 and chart 1 together, they show the key GDP data for the recessions of the mid-1970s and the early-1980s, where GDP fell by over 5% from pre- recession peak to trough, and the less severe early-1990s recession. They also show the Great Recession where GDP fell over 6% from pre-recession peak (2008Q1) to trough (2009Q2) and it took over 5 years to attain the level of the pre-recession peak. Table 1 The last four recessions Pre- Trough Pre-recession peak attained GDP fall pre- recession recession peak to peak trough Quarter Quarters from start of recession Mid-1970s 1973Q2 1975Q3 1976Q4 (though 14 (3½ years) 193.5/204.4=fall of recession note 1977Q2 5.3% (Q16) “double dip”) Early-1980s 1979Q2 1981Q1 1983Q1 15 (3¾ years) 214.6/226.7=fall of recession 5.3% Early-1990s 1990Q2 1991Q3 1993Q1 11 (2 ¾ years) 287.1/292.9=fall of recession 2.0% Great 2008Q1 2009Q2 2013Q2 21 (5¼ years) 428.1/456.7=fall of Recession 6.3% Source of data: ONS, “First estimate of UK GDP: 2018Q2”, 10 August 2018, database, GDP data in 2016 prices (£bn). 2 Chart 1 The last four recessions; pre-recession quarterly peak GDP (Q0) =100 104 1979Q2-1983Q2 1973Q2-1977Q4 102 1990Q2-1993Q2 100 98 2008Q1-2013Q3 96 94 92 90 Q0 Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12 Q13 Q14 Q15 Q16 Q17 Q18 Q19 Q20 Q21 Q22 1973Q2-1977Q4 1979Q2-1983Q2 1990Q2-1993Q2 2008Q1-2013Q3 Source of data: ONS, “First estimate of UK GDP: 2018Q2”, 10 August 2018, database, indices calculated by the author. Chart 2 shows the impact on unemployment (annual data). Suffice to say, the unemployment rate rose significantly in all recessions, albeit with the customary lag. It plateaued at 5.6% in 1977-78 (LFS measure), peaked at 11.9% in 1984, peaked at 10.5% in 1993 and reached 8.3% in 2011. The increase in the Great Recession was less-than-expected, given the severity of the recession, which has been attributed to the flexibility of the labour market compared with earlier recessions. Chart 2 UK unemployment rates (%): Labour Force Survey (LFS) and claimant count 14 12 10 LFS 8 6 4 2 Claimant count 0 % rate (LFS) % rate (claimant count) Source: ONS, “UK labour market, August 2018”, 14 August 2018, database. There were definitional changes to the claimant count during the 1980s, which reduced the numbers on the count Associated with the first three recessions was a rapid build-up of inflationary pressures in the economy, as already noted (chart 3). RPI inflation in 1974, the first year of falling output in the 1970s, was 16%. Despite an economy in recession, with rapidly rising unemployment, RPI inflation was over 24% in 1975. Even though the term “stagflation” was much used at the time, it was more 3 a period of recession and inflation. Moving on to the early-1980s recession, RPI inflation of 18% was recorded for 1980, when GDP was already falling quite steeply. RPI inflation was around 9½% in 1990, the second half of which saw the start of the early-1990s recession. The economic disruption caused by high inflation and the costs involved in rectifying entrenched inflationary pressures were substantial in all cases and serve as a timely reminder of the economic costs of losing control of inflation. And after the UK’s withdrawal from the Exchange Rate Mechanism (ERM) in September 1992, the Treasury introduced inflation targeting in October 1992. The Government’s commitment to controlling inflation was reinforced when the Bank of England was given responsibility for monetary policy in May 1997. Targeting CPI inflation at 2% was adopted in 2003, when the CPI replaced the RPI as the targeted measure. Since the mid-1990s, inflationary pressures have been kept relatively contained – though CPI inflation did pick up to 4.5% in 2011, reflecting sharply higher oil prices, as the economy was recovering from the worst of the Great Recession. But the pick-up was temporary, not entrenched, and did not lead to any overall increase in long-term inflationary pressures. The Great Recession was not triggered by worrying inflationary pressures. It was, therefore, quite different in origin from its three predecessors. As already noted, the trigger was the financial crisis. Chart 3 CPI and RPI annual inflation (%), 1970-2017 30 25 20 RPI annual inflation 15 10 CPI annual inflation 5 0 -5 Sources: (i) ONS, “UK consumer price inflation: July 2018”, 15 August 2018, database; (ii) www.swanlowpark.co.uk for the RPI. CPI data began in 1989. The mid-1970s recession The 1970s was an economically turbulent decade. Britain was known as the “sick man of Europe” and sought salvation in membership of the European Economic Community (EEC), joining on 1 January 1973. Wildcat strikes, “working to rule” and other manifestations of quasi-anarchic industrial relations were known as the “English disease”. Chancellor Anthony Barber’s tax-cutting 1972 Budget added to macroeconomic instability by triggering the inflationary “Barber Boom” (1972-73) and inflationary wage demands from public sector employees. The pound was “temporarily” floated in June 1972, and has floated since. 4 Britain’s economic problems intensified when the Heath Government sought to control rising inflationary pressures by capping pay rises (in 1972-73). Powerful unions reacted with industrial action, culminating in the NUM’s “work to rule”. Coal stocks dwindled and at the beginning of 1974 the “three-day week” was introduced to conserve electricity. GDP fell over 2½% (QOQ) in 1974Q1. But it was not just powerful unions and problematic industrial relations that troubled the British economy at this time. The 1973 oil crisis, triggered off by OPEC’s oil embargo (starting October 1973) on shipments to Israel’s allies in the Yom Kippur War, led to a quadrupling of oil prices (see chart 4).4 This gave a significant kick on UK prices inflation (chart 3, above) which provided further impetus to higher wage settlements. The “wage-price spiral” intensified through 1974 and 1975, but began easing in 1976 as higher unemployment curbed inflationary pressures. Monetary policy was tightened significantly in 1973-74 despite the onset of recession in 1973H2, in order to curb demand. The official interest rate (then the minimum lending rate) was hiked dramatically in 1973H2 (from 7.5% mid-year to 13% in November), remaining high (around 12%) throughout 1974. The economy picked up in the second half of the 1970s and unemployment fell. But industrial relations deteriorated towards the end of the 1970s when the Government sought to contain inflationary pay awards, culminating in the “winter of discontent” of 1978-79. One consequence of the 1980s retrenchment of organised labour and the trade union reforms of the Thatcher Government is that trade unions are very unlikely to hold the British economy “to ransom” as they did in the 1970s.