It’s Really Demand
Chris Dillow’s response to my call for an NGDP target raised the (persistent) suggestion that the UK supply-side is not able to keep up with demand growth. This puts Chris in the same position as that held by inflation hawks like Andrew Sentance, I suppose – an odd alliance.
Jason Rave’s analysis is probably my favourite, as he nails inflation targeting as the source of all this woe, advising that we should ignore the “inflationary illusions“. Here, here!
I don’t really have much to add to all this discussion, but I’d like to attempt a quick defence of the much-maligned UK supply-side.
If we take the liberty of ignoring the effect of the VAT changes as Whitehall takes a larger cut of nominal spending, a supply-side constraint on demand growth just does not look that obvious. This graph shows the annual rate of change of both nominal GDP at basic prices, and real GDP (note this is the change over four quarters, not the more volatile quarter-on-quarter rate of change):
In 2011 as a whole, NGDP at Basic Prices – the income actually available to produce new stuff – increased just 2%. And there was a 0.7% increase in output. Is that really such a terrible supply-side performance?
So I think the VAT change is perfectly sufficient to explain the size of the “wedge” between 2011 NGDP (a pathetic 3% even including VAT) and output growth, and the UK supply-side performance gives little evidence for pessimism about whether faster demand growth would only be inflationary.