Dip, double-dip, or triple-dip?

April 1, 2013

Co-authors of the Dictionary of Economics, Nigar Hashimzade and Gareth Myles take a look at the current economic climate through the eyes of the UK recession.

The forecast for UK economic growth in the recent budget speech of George Osborne was much less optimistic than in previous budgets. The downgraded forecast predicts growth of 0.6 per cent in 2013, 1.8 per cent in 2014, and 2.3 per cent in 2015. These rates of growth will take the UK out of recession but only just. If the outcome proves to be worse than forecast the UK runs the risk of returning to recession without having witnessed any significant period of positive growth. It is common practice to treat two quarters of negative growth as a recession. For past recessions it has worked well since they have been part of the business cycle: each period of recession followed by a boom, until the boom bursts and the cycle repeats.

What has been different about the recession beginning in 2008 is that the cyclical pattern has not emerged. Each period of recession has been followed by a short period of growth – but certainly no boom – and then further recession. This has brought about the coining of new terms and the redefinition of others. Traditionally, a double-dip recession has been understood as a recession followed by a short period of growth, followed by a further recession. The experience since 2008 of a period of recession followed by several quarters of slightly positive growth, and then a further recession does not quite fit this definition. This looks to all intents like a double-dip recession, so the definition has evolved to suit.

If the Chancellor’s policies do not achieve the desired effect, the UK is in danger of entering a third period of recession since 2008. This scenario has been given the name of the “triple-dip” recession and would be a unique occurrence. There is no guarantee that significant growth will follow a third recession, so terminology may need to evolve to add a “quadruple-dip” and even a “quintuple-dip”. Whether such a classification has any value to the economic analyst is doubtful. Indeed, the highly respected National Bureau of Economic Research chooses to take a more over-arching perspective on economic activity in its definition of a recession and looks for “a significant decline in economic activity spread across the economy, lasting more than a few months”.

There are broader issues facing the UK economy beyond its failure to return to sustained growth. The difficulties faced by the eurozone have received widespread media attention. This is justified; smaller EU economies such as Greece can be bailed out by the stronger members but the larger economies cannot. If the position of Italy or Spain becomes untenable then the current structure of the single currency will be seriously threatened. Any such disruption to major trading partners of the UK will make the return to growth more difficult. The combination of a high public debt, weak growth, and the potential for serious economic difficulties in the EU is a dangerous combination for the UK. We have so far avoided the economic catastrophe that has often been predicted but it is not yet an entirely remote possibility.

The source of our current economic difficulties is usually attributed to irresponsible behaviour in the banking sector. As a consequence, bankers have become objects of vilification and new banking regulation is planned. The perceived crime of the bankers was to provide too many loans too easily to people with no realistic chance of making scheduled repayments. In the past default on these loans would have been a burden only for the bank that had granted the loan. The financial innovation that changed the situation was the packaging of the loans into bundles (the mechanism of securitization) and the sale of the bundles as a new form of financial asset. This allowed the original lender to pass the risk onto many others in the financial system – and to transfer the eventual burden of default throughout the system.

The banks can appeal to two arguments for exoneration from guilt. First, it is clear that the banks were only responding to the loose financial environment set by lax government regulation. Gordon Brown was content to let the UK economy boom while proclaiming his unique success in eliminating boom and bust. Time has certainly proved the emptiness of this rhetoric. Second, the fact that the actions of the banking sector caused problems does not imply that bankers are individually culpable. What is involved here is the aggregation problem: a poor outcome at the aggregate level does not imply poor decisions at the individual level. In other words, each individual banker can make what seem reasonable decisions in isolation without foreseeing, or even being expected to foresee, what the overall consequence will be. It then becomes unreasonable to hold each individual to account.

The major initiative in the recent budget was the provision of £130 bn. of interest-free loans to assist house buyers. The logic of the policy is that this will ensure an increase in activity in the housing market which will have multiplier effect on the remainder of the economy. In some sense this is returning to one of the policies that created the economic difficulties in the first instance but with the role of irresponsible lender transferred from the banks to the government. There is also a good economic argument what the effect of the policy may be quite limited. As the Institute for Fiscal Studies observed, providing more money for borrowers does not necessarily make a house purchase any easier. The price of houses reflects the funds available for purchase, so increased funding will just mean higher prices. The actual success will be determined by how rapidly this process of capitalization occurs.

In all likelihood growth in the UK economy will remain weak for the foreseeable future with the possibility of further quarters of negative growth. While the problems in the UK, and outside, remain intractable we may need to continually update our descriptors of economics activity.

Nigar Hashimzade, Professor of Economics at the University of Reading, and Gareth Myles, Professor of Economics at the University of Exeter, are co-authors of the Dictionary of Economics.

The new, fourth edition of the Dictionary of Economics, which includes many new and updated definitions for terms mentioned above is coming soon to Oxford Reference.