A downturn is as good as a rest to a slow recovery

The body politic has not yet awakened to the fact that there could be a downturn in UK economic activity before the next election. This may seem unthinkable, but at a National Institute seminar on Wednesday, Andrew Britton reminded the audience that the average length of an economic cycle in the UK is only four and a half years, and that the last peak was in 1988. On this basis, he warned that a downturn could start "any time now". In fact, it would seem clearly overdue.

Chris Riley of the Treasury pointed out that the prolonged recovery of the 1980s, which lasted virtually the whole decade, was the longest upswing since the last century. So just when the Conservative Party was hoping that the recovery would become noticeable to the electorate, macro- economists are beginning to say that the UK is overdue for a downward correction.

But things surely cannot be that dismal. To make sense of forecasts of an impending "recession", we need to know how the statisticians define cyclical peaks and troughs, and what they mean by a "downswing" in activity. Economists define the peak to be the point where the gap between GDP and its trend level is at its maximum. Since the GDP trendline obviously increases over time at the UK's average rate of growth, the gap between GDP and its trend rises when the actual rate of growth in the economy is above average.

This is the upswing phase of the cycle. At the point where GDP is growing exactly at its average rate, the cycle peaks, and the downswing phase occurs when growth drops below normal. Note that output need not fall during the downswing phase - it may simply grow by less than its trend rate, which in the UK is about 2.5 per cent per annum.

The 1980s era seems to have been one of continuing boom, with the "feel-good" factor rising without interruption. However, that is not how the statisticians see it. They have split the period into two cycles, the first upswing hitting a peak in early 1984, and the first downswing hitting a trough at the start of 1986.

Surprisingly, therefore, 1984-86 is now classified as a recession. This was a time when GDP temporarily grew by less than its trend rate, partly because the coal strike damaged industrial production for several quarters. Output in the rest of the economy barely fell in this period, and few people now remember it as a recession. And even if it was a recession, it was certainly not severe enough to prevent a Tory victory in the 1987 election.

What does all this imply for the likelihood of recession in the next couple of years? If by recession we mean a substantial period - say six months to a year - of declining GDP, then the chances look pretty remote. But this does not rule out a downswing in which GDP grows less rapidly than its long-term trend rate. In fact, we may have already entered such a period. Based on the indicators for the first quarter of this year, the level of GDP may have risen by less than 0.5 per cent on the previous quarter, which is comfortably less than the trend growth rate. So when the statisticians look back at 1995, it is quite conceivable (though far from certain) that they will describe it as the start of the downswing,with the peak in the latter half of 1994. It would be a very good thing if this happened. The pause in the boom in 1984-85 definitely refreshed.The slowdown in the growth of demand allowed the supply side of the economy to catch up via a surge in investment spending - partly generated by the corporation tax changes in the 1984 Budget. As a result of this gain in capacity, the early inflationary strains which were building in 1983/84 were nipped in the bud.

It would be no bad thing if the same thing happens in 1995-96. The tightening in fiscal and monetary policy since early 1994 has been quite carefully designed to ensure that this will be the case. But it would not be such a good thing if a much needed pause in the recovery turned into a fully- fledged recession. Whether this will happen depends largely on two factors - the sustainability of the European economic upswing, which lies behind our export growth, and the prospects for inflation. The upswing in Europe started around the middle of 1993, and by the first half of last year European GDP was growing at an annualised rate of 3.8 per cent.

More than two-thirds of this growth was due to a sharp turnaround in inventories, which is quite a common in the first year of a recovery. In the second half of last year, the level of inventories stabilised, and European GDP growth slowed from 3.6 per cent in the third quarter to 2.4 per cent in the fourth. From now on, the main driving force behind the European recovery will be a sharp pick-up in investment spending. Leading indicators for capital spending are rising, and we are finally seeing a response from investment,which is up by 4.5 per cent in the latest 12 months. With overall European investment likely to rise by some 5-10 per cent this year, we can be confident that the European upswing - and with it the demand for UK exports - will remain robust.

But a more serious problem is developing on the inflation front. The recent decline in sterling has been sufficient to threaten the inflation target in the first half of 1996. Case B in the graph shows what might happen to inflation if sterling remains at the level (84.5 on the trade weighted index) it reached on Friday, while case C shows what might happen if the turbulence of the exchange markets takes sterling down by another 5 per cent.

If the Government wants to maintain the credibility of its inflation target, it would need to raise interest rates to combat any prolonged further fall in the pound. But that might be enough to tip the domestic economy into something worse than a "pause that refreshes". It has always been certain that, one day, the Government would have to choose between sticking to its inflation target, and allowing the economic upswing to continue. With a bit of luck, sterling will bounce back as soon as general market turbulence declines. But if the sterling bounce does not come within, say, 3 months, then interest rates will need to rise. Last week's row over the "feel-good" factor would look like a tea party compared with the political upheaval that would follow such action. But necessary it would be.

Start your day with The Independent, sign up for daily news emails
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Graduate Recruitment Resourcer

£20000 per annum + commission: SThree: Sthree have an exciting opportunity for...

Recruitment Genius: Telesales Executive - OTE £32,000+

£18000 - £32000 per annum: Recruitment Genius: A Telesales Executive is requir...

Ashdown Group: Marketing Manager - B2B, Corporate - City, London

£45000 - £50000 per annum + benefits : Ashdown Group: A highly successful, glo...

Neil Pavier: Commercial Analyst

£50,000 - £55,000: Neil Pavier: Are you a professionally qualified commercial ...

Day In a Page

General Election 2015: The masterminds behind the scenes

The masterminds behind the election

How do you get your party leader to embrace a message and then stick to it? By employing these people
Machine Gun America: The amusement park where teenagers go to shoot a huge range of automatic weapons

Machine Gun America

The amusement park where teenagers go to shoot a huge range of automatic weapons
The ethics of pet food: Why are we are so selective in how we show animals our love?

The ethics of pet food

Why are we are so selective in how we show animals our love?
How Tansy Davies turned 9/11 into her opera 'Between Worlds'

How a composer turned 9/11 into her opera 'Between Worlds'

Tansy Davies makes her operatic debut with a work about the attack on the Twin Towers. Despite the topic, she says it is a life-affirming piece
11 best bedside tables

11 best bedside tables

It could be the first thing you see in the morning, so make it work for you. We find night stands, tables and cabinets to wake up to
Italy vs England player ratings: Did Andros Townsend's goal see him beat Harry Kane and Wayne Rooney to top marks?

Italy vs England player ratings

Did Townsend's goal see him beat Kane and Rooney to top marks?
Danny Higginbotham: An underdog's tale of making the most of it

An underdog's tale of making the most of it

Danny Higginbotham on being let go by Manchester United, annoying Gordon Strachan, utilising his talents to the full at Stoke and plunging into the world of analysis
Audley Harrison's abusers forget the debt he's due, but Errol Christie will always remember what he owes the police

Steve Bunce: Inside Boxing

Audley Harrison's abusers forget the debt he's due, but Errol Christie will always remember what he owes the police
No postcode? No vote

Floating voters

How living on a houseboat meant I didn't officially 'exist'
Louis Theroux's affable Englishman routine begins to wear thin

By Reason of Insanity

Louis Theroux's affable Englishman routine begins to wear thin
Power dressing is back – but no shoulderpads!

Power dressing is back

But banish all thoughts of Eighties shoulderpads
Spanish stone-age cave paintings 'under threat' after being re-opened to the public

Spanish stone-age cave paintings in Altamira 'under threat'

Caves were re-opened to the public
'I was the bookies’ favourite to be first to leave the Cabinet'

Vince Cable interview

'I was the bookies’ favourite to be first to leave the Cabinet'
Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat