According to the latest IMF projections output will fall this year in no fewer than 10 European economies. And the IMF recently lowered its forecast for growth in the advanced economies next year. Ours may be a sceptred isle, with its own currency and control of monetary policy, but we cannot insulate ourselves from these events. So this precious stone set in the silver sea seems more like a storm-tossed vessel. Despite the probable rise in output in the third quarter, the big picture is that GDP is barely higher than two years ago, and remains some 15% below where steady growth since 2007 would have taken us. Total exports have risen sharply in the wake of sterling’s depreciation, but manufactured exports to Europe are falling. Recovery and rebalancing of our economy remain the main challenges for economic policy. Here in Wales, despite impressive improvements to the infrastructure – not least the remarkable regeneration of Cardiff Bay and the magnificent monument to Welsh culture in this Millennium Centre – your economy too is suffering with total production well below its peak in 2007. In combating the downturn, monetary policy has played its part. Bank Rate has been cut to its lowest level ever and the Bank has purchased £ billion of assets in order to inject money into the economy. Although this unprecedented degree of monetary loosening has prevented a depression, it has caused pain to those dependent on interest income. And we have not been able to avoid a sharp rise in youth unemployment.
The United States also has substantial structural current account and budget deficits. Sweden has been exposed to a major demand shock with a collapse of exports and a loss of demand in the export sector. Exports are now recovering again. Sweden does not appear to have any structural problems in the finance sector, or in any other sector, and has no structural budget or current account deficits. This being the case, I think one could claim that the development of Sweden’s potential GDP should in fact be better than that of the United States, not worse. The difference in potential GDP underlines the difficulties and the element of arbitrariness in these calculations. Figure 6 compares the Riksbank’s estimates and forecasts for potential GDP from two different points in time, namely September 2008 shortly before the investment bank Lehman Brothers went bankrupt and February 2011. The September 2008 forecast for Sweden’s potential GDP is rather similar to the CBO’s latest forecast for potential GDP in the United States in Figure 5. We can see in Figure 6 that the February 2011 assessment of potential GDP in the longer term is approximately 4 per cent below the corresponding assessment in September 2008. Why should a pure demand shock in the absence of structural problems lead to such a significantly lower potential GDP in the longer term?