This is a longer version of an article which appeared in the print edition of the Financial Times on Friday, 12 July 2012.
The British economy, unlike its inspirational Olympic team, has been unable to match even the tepid performance which other developed economies have mustered since the Great Recession hit bottom in 2009. In the past two years, after allowing for the under-recording of growth in the official data, real GDP has been little better than flat, at a time when a strong recovery from recession would normally have been expected. So what has gone wrong, and what should be done about it?
The first issue is whether the growth shortfall has been due mainly to demand side or supply side factors. Sir Mervyn King has consistently pointed to the demand side, arguing that the crisis in the Eurozone, and the rise in commodity prices, has depressed private sector demand, while the reduction in public spending has actually occurred slightly faster than the Coalition originally planned in 2010.
Aggregate demand has certainly been far weaker than I expected this year, and that has been primarily responsible for the absence of growth. Essentially, an aggressively easy monetary stance has not been sufficient to offset the impact of the fiscal tightening, and the twin external shocks from oil and the euro crisis. Read more