What does the growth data tell us about the impact of cuts?

I suggested in a previous post that the FT's Chris Giles might be saying something of economic and political importance when he wrote recently that the main driver of the unexpected slowdown in the economy was inflation and not cuts. Yesterday's GDP data adds some evidence to back his view although slightly ambiguously.

In their very useful further analysis of the main GDP release, the ONS give a more rounded account of growth.  In typical ONS fashion, their conclusions are guarded but it seems to me there are two main inferences to be drawn from their analysis.

Firstly, the decline in household disposable income continues to be very constrained and the main driver of this is inflation.  Real wage growth has been negative for much of the last three years and inflation has been running at nearly twice the rate of earnings growth for over two years. With such a gloomy picture, this data seems to uphold Giles's point that prices are likely to be the major driver of weakened demand.  

Secondly, government spending is still making a contribution to growth.  Indeed, during the first half of 2011, government spending contributed 0.5% to overall service sector growth year on year.  And interestingly, while government spending contributed nothing to growth for the whole economy in the second quarter of 2011, it has contributed 0.1% in the third quarter. Again that seems to uphold Giles's argument.

However, the ONS is clear that the contribution to growth being made by government spending is beginning to slow quite severely. Average year on year growth in the output of government and other services in the first half of 2011 was 1.6%.  In the third quarter, this fell to 0.2%.  So although, the cuts have yet to positively shrink the economy, they seem to be doing less and less to help it grow.

The data suggests therefore that inflation is still taking a terrible long-term toll on household incomes and must be suppressing demand very significantly.  Meanwhile, the cuts have yet to actively shrink the economy but growth is becoming less likely to come from the public coffers. A more nuanced position than the one Giles presents in his original article but still one some distance from those keen to claim that the current crisis is all the fault of austerity.