Hamish McRae: Recession talk is over, now the recovery speculation begins...

Economic Life
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The Independent Online

The question has changed. It is no longer: "When will the recession end?" It is now: "What shape will the recovery take?" That applies to us here in the UK, to Continental Europe, to the US, to Japan, indeed to the entire developed world.

We know the answer to the first question. As we learned yesterday, the recession ended in France and Germany in the second quarter, though the eurozone economy as a whole continued to shrink slightly. The UK and US did continue to decline a little but look like showing growth in the present quarter. (The bottom here was probably in May or June.) Japan is probably growing, too. There are laggards, including Italy and Spain, but by the end of the year things should be clearly on the move again just about everywhere.

You can see these new second-quarter GDP numbers for France, Germany and Italy in the left-hand graph and there is no denying that two of the big three Continental economies have done better than expected and probably better than us. You can have an argument about which country got out of recession fastest, which had the deepest plunge and so on but that seems to me to be a bit childish. We don't know all the figures yet and, in any case, they will keep on being revised for months to come. So let's just heave a sigh of relief that growth at last seems to be returning, even if it came a little earlier over the Channel than it did here.

Unfortunately, the start of recovery says nothing about its probable strength and there is a host of reasons to be cautious about that. They include, most obviously, the fragility of the world banking system, the high personal debt carried by US consumers in particular, the pressure on consumption as rising unemployment continues to bite, the need to start unwinding the various support measures that governments around the world have taken and so on. The consensus is that this recovery will be slower and more protracted than previous ones, not only here in the UK but pretty much everywhere. Growth will return but it won't be great and it certainly will not generate much of a "feel-good" factor.

I think this widespread expectation of a muted recovery will probably turn out to be right. If you think about what will happen here in Britain next year, we know that there will have to be an austerity budget, the VAT cut will have been unwound, the car-scrapping scheme (which has clearly helped things on the Continent, too) will have come to an end and so on. What is worse, this is not just a one-year thing. Taxes will have to remain high and public spending will have to come down progressively for several years to bring the nation's finances back under control.

And yet there are some reasons to be a little more hopeful about the UK economy than the consensus currently believes. So let's explore these now. The starting point is the new Inflation Report from the Bank of England, out on Wednesday. To judge by the headlines, the Bank has become even more worried than it had been three months earlier. The recession had been deeper than expected, the Governor warned of risks on the downside and so on. I want central bankers to be cautious because that is what we pay them to be, but I found myself looking at the Bank's fan charts and thinking, er, actually this does not look too bad.

Have a look at the middle graph. The bottom line, the green one, shows the middle point of the Bank's growth forecast back in the May report. The white line shows a rough estimate of the centre point of its new forecast – it is an estimate because the full figures are not published yet and you have to try to work it out from the Bank's graphs. The economics team at Goldman Sachs has done a more precise job than I could and the results are shown on that white line. As you can see, not only is the Bank expecting growth to have begun some months earlier; it has also become radically more optimistic about growth next year than it was three months ago. Indeed, it seems to have gone from expecting less than 0.5 per cent growth next year to something close to 2 per cent.

Now this is only a deduction of what the Bank thinks and I have coarsened its forecast by focusing on the central number, while the Bank would stress that it is giving a range of probabilities, but this looks to me as a huge change in the Bank's perceptions. When the May report was published I thought the Bank was being too gloomy about the recovery. Now it seems to have cheered up.

So how will this recession compare with previous ones? In the right-hand chart I have tried to plot the Bank's projection against the National Institute's comparison of different recessions. It is a rough-and-ready job and I would have failed my statistics exams had I tried to do this when I was being taught the subject. But it looks to me as though, if the Bank's central projection turns out to be right, we will indeed have a less serious recession than we had in the early 1980s, though a much deeper one than in the early 1990s. Of course, it is also much less serious than the 1930s.

There is a further issue. What will be the upward slope of the recovery? Trend growth in the UK is around 2.5 per cent. But we have lost nearly 6 per cent of output. So if we merely get back to trend growth that output will be lost for ever. That would seem to be the Treasury's view, insofar as one can judge from the forecasts at the time of the Budget. Suppose, however, that growth reverts to a mean, as it has after previous recessions. In other words, instead of just getting back to 2.5 per cent, if we follow the path of previous recoveries, we should have a period of maybe several years above that.

To follow through this argument, if we get several years of growth at or above 3 per cent, suddenly all the really dreadful numbers about the fiscal deficit begin to look a little less daunting. I am not trying to play down the scale of the fiscal catastrophe that this Government has brought upon us. It is, as Alistair Darling would be the first to acknowledge, going to take two parliaments to get the nation's finances back under control. I am saying that the output that has been lost may not be lost forever and that, with appropriate policies, things could look a lot better in six or seven years' time.

All this is surmise. That projected growth line is inevitably smoother than the probable outcome: there will be bumps on the path to recovery. This is still a very serious recession, however you slice it. We still have a lot of disruption and, I am afraid, human misery still to come. But – and this is important – it does look now as though this recession will be within post-war experience and in that sense will be a "normal" one. Just that normal isn't nice.

h.mcrae@independent.co.uk

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