The Edge

Richard Northedge takes on corporate finance

King checks the maths and forecasts negative growth

You don’t have to be an economist to forecast that the UK economy will contract again in the final quarter of 2012 – just a mathematician. Well done Sir Mervyn King for doing the sums.

This blog has said before that, after emerging from recession in the third quarter, the economy will shrink again in the fourth unless the past figures are revised. Now the governor of the Bank of England has worked it out too and warned that the economy is going backwards again.

But King did not need his economic skills to come to that conclusion. He simply needs to remember what most economists have ignored – the way we present the gross domestic product statistics.

The quarterly GDP figures compare one level of output with the level three months earlier, reporting it as a per centage rise or fall. The underlying absolute number, nor even an index, is not reported. So in the third quarter, GDP was announced as rising 1 per cent after falling 0.4, 0.3 and 0.4 per cent in the three previous quarters. That surprisingly high jump ended the recession.

But because it was so high, the underlying level of GDP is unlikely to be maintained in the final quarter – which means there will be a fall. Another fall after that and Britain will be back in recession – a treble dip.

Imagine if the weather was reported not as absolute temperatures but as the movement from the previous day’s temperature. If there is an exceptionally hot day, say 30 degrees, followed by a day at 29, most of us would call that a two-day heatwave. But on the GDP method of measurement, it would be one hot day followed by a day when temperatures are getting colder – a reason for disappointment rather than celebration.

The contraction in the economy after that exceptional third quarter is a mathematical probability, as King has now worked out but which most other economists have failed to grasp. To avoid it would require the fourth quarter also to be at least 1 per cent better than the second quarter – which is unlikely.

However, if the third quarter’s announced 1 per cent growth is revised down, the chance of beating it increases, thus reducing the prospect of returning to recession. Having basked in the glow of good headlines from that growth, chancellor George Osborne – if not King – must be praying for a hefty downward amendment to that figure.



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