George Osborne must weigh supply against demand
There has been much talk in Westminster over the past few weeks about the government's room for manoeuvre in responding to the disappointing state of the economy.
Apparently, George Osborne had lots of it. And if he chose to make use of it - as we might expect him to in the Autumn Statement at the end of November - such a mid-course "correction" was not, under any circumstances, to be confused with Plan B.
But Monday's Financial Times brought some bad news for the chancellor, that the slow growth of the economy has opened a "black hole" of £12bn (it always seems to be £12bn) which his own targets may require him to fill.
The FT used the Office for Budget Responsibility's (OBR) own model to reach this conclusion.
So, assuming no big change in their approach between now and November, we have to expect the director, Robert Chote, to be delivering some bad news to Mr Osborne in the coming weeks.
But there is another, less gloomy, way of looking at the past few months, which Mr Chote will also surely be considering.
Bad news first. The £12bn overshoot in borrowing that the FT is talking about relates to the structural - ie "permanent" - part of the deficit, not the cyclical part that will supposedly disappear by itself as the economy recovers.
That matters enormously to Mr Osborne, because his first fiscal rule dictates that he balances the structural current deficit over five years. He does not have to balance the cyclical piece of the budget, or at least not under that rule.
That, in fact, is a key part of his celebrated room for manoeuvre, in the face of this very weak recovery.
In the jargon, he can "let the automatic stabilisers operate in full". Or to put it another way, if borrowing overshoots purely due to slow growth, he doesn't have to find any new spending cuts or tax rises to compensate. He is allowed to borrow more and support the economy.
But there is another reason why borrowing might overshoot. It might be because the OBR has overestimated the amount of spare capacity in the economy.
The current forecasts, drawn up in March, assumed that the economy would have nearly 4% of GDP in spare capacity in 2011-12. That was the room it reckoned that the UK had to grow, before encountering supply constraints and causing extra inflation.
I've talked before - and at length - about the vexed question of Britain's slow productivity growth during this recovery. It is a key part of this discussion.
Productivity has been low because growth has been weak but employment growth relatively strong, at least until recently. At the same time, tax revenues and profits have held up well, even though the overall growth forecast for 2011 will need to be sharply revised down.
This combination of outcomes - according to the FT - will force the OBR to revise down the amount of economic slack available, to 2.6% of GDP. And this, in turn will force them to revise up their estimate of the structural deficit. On that reading, a good chunk of the extra borrowing this year will be labelled structural, not cyclical.
So Mr Osborne can't be relaxed about it. To meet his targets he might actually have to tighten further, to cut spending even more, in the middle of this oh-so-fragile recovery.
I said it was bad news. But two pieces of good news for you, before you go off to cry in a darkened room.
Firstly, the chancellor is meeting his structural deficit target a year early, on his previous forecasts. So even if the structural deficit has risen by £12bn, he doesn't need to tighten by the full amount.
He might not need to tighten at all, although he would not be leaving any room for further errors.
He was due to run a structural current surplus of 0.8% of GDP in 2015-16. By my reckoning, that gives him more than £12bn to play with, if he chooses to meet his target more slowly.
It's also worth noting that he has to balance the budget over a five-year "rolling" period.
In other words, he always has to balance the budget in five years' time. The target doesn't say anything about what you do if you missed the target for the five years before. (Put like that, it sounds "flexible" enough to be one of Gordon Brown's golden rules. But I digress.)
The second, and much more important piece of good news is that the FT and the OBR, and everyone else who thinks that Britain's growth potential has been permanently and significantly damaged by the crisis, could be wrong.
If they are wrong, if what Britain - and other advanced economies like the US - are suffering from is not a shortage of supply, but a prolonged and self-perpetuating shortage of demand, the whole story looks very different.
Bill Martin, professor of the Centre for Business Research at Cambridge, has made this argument very forcefully, in a paper published in the summer. Briefly, he thinks the slowdown is being misinterpreted in the UK, with potentially costly implications for all of us.
There is no space here to do justice to his arguments. The paper is well worth a read if you want to feel more cheerful about the state of the UK economy.
His bottom line is that, on past history, the UK would now have not 2-3% of GDP spare capacity, but more than 10% of GDP.
He says the crisis might have robbed us of some of that economic slack, but there is nothing in the recent data, including the productivity numbers, to suggest that it has permanently destroyed as much of our potential as the OBR and others suggest.
In his view, which has some prominent supporters, it is not a lack of supply, but a fall in real wages which has helped maintain employment and profits in an environment of slow demand.
So the problem is in the low real wages and low level of demand, not a lack of available supply.
This is not a universally supported view. Far from it. But nor is it crazy. Reading the FT this morning, Mr Osborne might be hoping that the OBR has read Professor Martin's paper as well. Otherwise his Autumn Statement will be grim reading indeed.