Growth improves, but one swallow does not make a summer

The UK economy grew 0.5% in the third quarter (July to September) which was a welcome relief after the second quarter growth of just 0.1%.

While 0.5% may not seem like a lot it is actually a huge improvement and a welcome sign in an economy that needs growth badly. Unfortunately part of the improvement is a 'rebound' from the poor second quarter - a 'catch - up' rather than a clear upward trend.

The figures hide differences between sectors. Services and finances showed their strongest growth since 2007, but manufacturing continues to struggle.

There is talk of recession. Let's be clear on what that means - falling GDP, not slower growth. A rule of thumb is that a recession is two consecutive quarters of falling GDP. This remains a possibility, especially if the Euro collapses.

It may be useful to talk about the stages of a recession and policy responses. This can be illustrated in the excellent BBC graphic on the linked article showing the path of previous recessions.

Stage 1 - Falling GDP. Here there is falling output and the immediate policy response to slow the fall in GDP. At this stage fiscal and monetary policy are set to expansionary settings and the challenge is to stop the recession being as deep as it otherwise would be.

Stage 2 - Levelling out. Here the crisis is not over but the economy has stopped shrinking. Fiscal and monetary policy continue to try to boost Aggregate Demand to help use up spare capacity. Unemployment will continue to rise, probably faster than in Stage 1 as firms let worker go and adjust to the new level of demand. Workers entering the workforce find it difficult to find jobs as firms are not hiring.

Stage 3 - Recovery. In this stage the economy begins to grow. Unemployment remains a problem, continuing to rise, especially among young workers. They have no experience and are expensive to employ. Firms are cautious and confidence is low among consumers as well.

This is the most challenging phase in terms of policy. The challenge in this phase is coping with unemployment and preventing a large group of long-term unemployed. Expanding AD may not work and supply side measures, that will target the structural and youth unemployment, take a long time to work. Productivity increases alone may mean few extra workers are needed for the modest rises in GDP.

Stage 4 - Return to growth. This stage is elusive. Productive capacity begins to increase as well as demand. It is not clear when normality will return and as the BBC graphic shows it is taking longer to get there than in previous recessions. This is mainly due to the greater extent of the recession and the fact it originated in the financial and not the goods market which makes fiscal stimulus largely ineffective in stages 2 and 3.

None of these stages has a fixed time-frame of course, adding to uncertainty.

Apologies for a long post, this has been on my mind for a while!

The BBC article is here