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The home economy.

Although the data for the recent past are still somewhat patchy at the time of writing, a limited turnaround in the non-oil economy can be expected in the third quarter of the year, accompanied by a recovery in North Sea output. We expect oil production in the latter half of the year to be some 10 per cent higher than in the first half, with the reopening of fields following installation of new equipment. Growth in the onshore economy is likely to prove hesitant, with the overall level of output in the second half of the year being little changed from that in the first.

As yet there remains little sign of any substantial growth in consumption, with retail sales in the third quarter only showing a rise of some 0*5 per cent on the second quarter level and remaining below the level of a year earlier. Personal sector borrowing remains depressed with the net new flow of consumer credit now lower in real terms than at any time since the mid-1970s. The housing market is still stagnant, with prices falling in the third quarter.

The recent developments in the company sector are dominated by the desire of firms to reduce their net borrowing requirement. Investment volumes in the first half of 1991 were some 13 per cent lower than a year earlier and destocking amounted to over [BRITISH POUNDS]3 billion. in terms of overall expenditure this fall in stock levels was as severe as experienced in the last two recessions. The reported cutbacks in expenditure helped the company sector financial deficit fall to some [BRITISH POUNDS]3.8 billion in the second quarter, a somewhat sharper improvement than we had previously anticipated. It is partly for this reason that we have revised down our projections for growth this year a little and increased our forecast growth in 1992.

The balance on visible trade has narrowed quite considerably this year and may turn out at around half the deficit reported in 1990. Export profit margins continue to decline with firms reacting to the disciplines imposed by membership of the ERM. Profit margins have also been under pressure at home, with the widespread price discounting reported in the manufacturing sector beginning to emerge in the latest inflation figures. Over the three months to October the annualised rate of wholesale price inflation (excluding food, drink and tobacco) was just over 3.5 per cent, while headline retail price inflation in the year to September was just over 4 per cent, some 7 percentage points lower than a year ago.

In addition to the fall in margins the decline in inflationary pressures has been helped by the moderation of both import prices and the growth in average earnings. Settlements in the third quarter averaged around 6.5 per cent suggesting that current annualised growth lies around 7.5 per cent. This has been accompanied by a continuing squeeze on employment, with the level of unemployment in the third quarter some 800,000 higher than in the first half of last year. The uncertainty engendered by this rise in redundancies is likely to have dampened expectations regarding future economic prospects.

The latest CBI Survey has been widely interpreted as heralding an upturn in the economy over the coming year. For the first time in three years confidence has improved, with a balance of 2 per cent of firms now having become more optimistic about business prospects, compared to a negative balance of 26 per cent in the previous survey. There were also marked improvements in the prospects for export orders and investment intentions, although the latter continue to show a balance of firms who expect to authorise less expenditure over the coming year.

Some caution should be exercised in the interpretation of the movements in business optimism. Information about the likely strength of any recovery is limited, particularly since fewer than 20 per cent of the respondents are more optimistic about prospects than they were four months ago at the trough of the recession. Our view is that the turnaround in the balance tells us more about activity over the third quarter of the year, since the jump in the balance is dominated by the number of firms who have moved from being less optimistic to being as optimistic as they were four months ago. This confirms the suggestion that the economy is likely to have bottomed out around the middle of this year.

Policy assumptions

The policy stance has changed since the latter part of the 1980s, with monetary policy, as measured by real interest rates, having been tightened and fiscal policy having become somewhat more relaxed. With inflation in the latter part of this year and the early part of next being around 4 per cent, expected real short term interest rates are currently around 6.5 per cent.

Base rates are now some 4.5 per cent below their level in the middle of last year and the current three-month rate differential between the UK and Germany is little over 1 per cent. We assume that there is scope for a further half point cut in UK base rates before the annual reviews of mortgage payments by building societies in the early part of next year. Prospects thereafter depend heavily on movements in rates elsewhere in Europe. Current developments suggest that policy makers are becoming increasingly concerned about the outlook for growth. The world forecast elsewhere in the Review assumes that French and German rates do not rise any further from their present levels and begin to decline by the second quarter of next year. There seems little economic reason why the UK should not be able to follow, and we anticipate that base rates may be 9.5 per cent by the end of 1992. Movements in key interest rates are shown in Chart 1 and in Table 10 below. We continue to base our exchange rate projections on the uncovered interest parity condition and thus our forecast implies that the average sterling-dollar rate in 1992 may be some 4 per cent lower than in this year. The likely depreciation in the effective rate is much lower at around 2 per cent.

In the past year the commitment of the government to a fixed exchange rate within the EMS has become increasingly credible and the short-term interest differential has narrowed accordingly. Nonetheless doubts remain about the likelihood of the UK participating in a full monetary union, and the differential in UK-German long term bond yields has remained at about 1 per cent for some time. A successful conclusion to the Maastricht negotiations may well result in some further narrowing of this differential.

The outlook for the public sector

The Autumn Statement provided confirmation of the expectation of many commentators, including ourselves, that the borrowing targets announced in the Budget had become unrealistic. Our latest projections are for borrowing requirements of [BRITISH POUNDS]10.5 billion in the present fiscal year and around [BRITISH POUNDS]18.5 billion over 1992/3, or 2.9 per cent of nominal GDP at market prices. The deficit excluding privatisation proceeds and other financial adjustments is likely to be around [BRITISH POUNDS]23.4 billion, some 3.7 per cent of GDP. Our expenditure projections, in line with those in the Autumn Statement, imply that tight control will need to be kept over public sector pay since we assume that the current moderation in earnings in the private sector will be reflected in future public sector settlements. More details are given in Table 11 below.TABULAR DATA OMITTED

The stated medium-term objective of the government is to balance the budget over the cycle. If so, the cycle is likely to prove unusually protracted, as even with growth returning to its long-term trend in our projections, the borrowing requirement averages some [BRITISH POUNDS]15 billion per annum over 1993-95 ([BRITISH POUNDS]19 billion excluding financial adjustments). The forecast path for the borrowing requirement as a proportion of GDP is shown in Chart 2. As the economy picks up the financial deficit declines gradually in real terms and falls within the proposed Maastricht guidelines by 1994. The return to public sector borrowing implies that the net debt of the public sector may amount to around 30 per cent of GDP by the mid-1990s, equivalent to its average level at the end of the last decade.

Our projections for public sector borrowing are based on the absence of any income tax cuts, either in the basic rate or through over-indexation of allowances. If changes are made to income tax, they are likely to be part of either a wider change in the mix of taxation or to be accompanied by changes to the tax base.

Summary of the forecast

Growth in GDP next year is forecast to be just above 2 per cent, so that the average level of activity in 1992 will be close to that in 1990. This forecast is slightly higher than our previous one because the projected level of interest rates is some 0*5 per cent lower than before and because the company sector appears to have taken action to remedy its financial position more quickly than we had anticipated.

Much of the growth forecast for next year is associated with a turnaround in stockbuilding, typical of this stage of the cycle. Destocking next year may be around the level of 1990, with the turnaround of some [BRITISH POUNDS]4 billion from the level observed this year being equivalent to over 1 per cent of GDP. Whilst stocks of finished goods remain higher than currently desired, stocks of raw materials can be expected to pick up in the early part of next year.

We anticipate some growth in all the main categories of expenditure over the coming year, although recovery in investment, and therefore in industries heavily reliant upon investment demand, may well be postponed to the latter half of the year. Details can be found in Table 1 below. The growth in consumers' expenditure is forecast to be around 1.25 per cent, close to the likely growth in real disposable income of just over 1 per cent. This modest recovery is consistent with the turnaround in consumption in the initial stages of the recovery after the recessions of 1974/5 and 1980/1.

As we discuss below in Part 2, the real flow of borrowing is likely to recover somewhat in 1992, but will remain well below the levels of the late-1980s, with the personal sector continuing to adjust the position of its financial balance sheet. However with banks and other financial service companies beginning to widen interest-rate spreads, the improvement in the income gearing of the personal sector may be slower than expected.

At this stage of the cycle projections of high rates of growth in consumption over the coming year remain more of a hope than an expectation. Whilst consumer confidence has recovered somewhat in the third quarter, there is little firm statistical evidence of either the speed or the extent to which it will be translated into additional expenditure.

Nonetheless, it would be right to recognise that a margin of error is attached to any forecast. The average absolute error in the Institute forecasts of consumption growth made over the last two decades is just over 1.5 per cent. Thus we present the results of a variant in Box A in Part 2 of this chapter, in which borrowing recovers sufficiently in the later half of this year and 1992, so that consumption grows in line with the Autumn Statement projections. The net effect is to boost overall growth in 1992 and 1993 by some 0.3 per cent per year. This boost to demand is sufficient to raise consumer price inflation by over 1.5 percentage points in each year, whilst the current account deteriorates by an average [BRITISH POUNDS]4 billion per annum. An expansion of this magnitude could hamper the necessary adjustments that need to be made to the UK economy in the transition towards a monetary union.

The outlook for exports continues to appear promising with the world economy forecast elsewhere in the Review implying growth of around 5 per cent in UK weighted world trade in 1992. The growth in net exports is much smaller, as import volumes, particularly non-oil non-manufactures, are likely to rise as the level of domestic activity begins to turn up. Overall we expect a current account deficit of around 99 billion in 1992, with the main difference with 1991 being a deterioration in the invisibles balance as Gulf War transfer payments from overseas begin to decline.

One widely held view is that UK exports may be depressed in 1992 by a downturn in world activity, particularly in the European economies. Although this is not a feature of our main forecast, we present a variant in Box B in Part 2 of the chapter in which the level of world trade growth is halved in 1992. The adverse consequences of this temporary shock to world trade are relatively small. Growth falls by around 0.3 per cent, with the downturn in net exports being partially offset by the fall in import prices as low world trade depresses world prices.

Our labour market forecasts suggest that unemployment is likely to rise for some time to come and may average around 2.7 million next year. The persistence of high levels of unemployment is likely to be accompanied by changes in the duration structure of the claimant count, with a sharp rise in the proportion of the total unemployed who have been out of work for over six months. This may mitigate the impact of high unemployment on the level of wage settlements.

With some pick up in cyclically related earnings such as overtime payments, average earnings growth may be around 6.5 per cent next year. Unit labour costs are likely to continue to behave counter-cyclically in the short-term, with productivity growth in manufacturing forecast to be around 6 per cent next year. The outlook for inflation remains promising and headline inflation may be 3.5 per cent or less by the end of next year, with wholesale price inflation under 3 per cent. Consumer price inflation may show a sharp fall in the second half of the year as VAT effects drop out of the series. Capacity utilisation in manufacturing remains some 15 per cent lower than the peak levels of 1988 and therefore the initial pick up in demand is unlikely to be accompanied by a noticeable strengthening in margins.

The prospects for the financial deficits of the private sector and the overall balance of payments are summarised in Chart 3. The personal sector continues its move into a surplus, which at around 4 per cent of GDP is close to the levels of the early-1980s. Some further improvement is apparent in the deficit of the company sector, both in nominal and real terms. Despite the rise in the current account deficit in 1992, it remains under 2 per cent of GDP. Personal income and expenditure (Table 2)TABULAR DATA OMITTED

Our forecast of consumers' expenditure is less optimistic than the most recent consensus forecasts, with growth currently expected to be about 1*25 per cent. In fact growth in the present forecast is higher than last time. This is for two main reasons. First, the forecast level of interest rates throughout next year has fallen, with base rates now projected to be 9.5 per cent in the fourth quarter. The second reason is statistical in that we now expect the level of expenditure in the latter half of this year to be somewhat lower.

Although there was a slight recovery in the level of retail sales in the third quarter, demand for durable goods, particularly vehicles remains depressed. The latest CBI Distributive Trades Survey suggested that retailers only expected a marginal upturn in sales at the start of the fourth quarter. The housing market is still slack, with house prices falling in the third quarter of the year. Preliminary figures for October suggest that real prices are now around 8 per cent lower than a year ago. It is likely that the uncertainty caused by the rise in unemployment has offset any beneficial effect that may have resulted from a decline in borrowing costs. Nominal house prices in 1992 are forecast to grow by less than 1 per cent, implying a further fall of some 3-4 per cent in real prices.

The projected growth in consumption in 1992 is in line with an expected growth in real disposable income of around 1*1 per cent. Thus there is little substantive decline in the savings ratio. The factors behind the forecast are largely as explained in the August Review, with the slow growth in expenditure being a counterpart to a desired slowdown in borrowing as consumers adjust their debt-income ratios towards more sustainable levels. The real flow of borrowing by the personal sector is shown in Chart 4.

The slowdown over 1989-91 is reversed next year, but borrowing remains relatively weak. This is consistent with the latest figures for consumer credit and the subdued level of mortgage lending reported by the Council of Mortgage Lenders in the third quarter of this year.

Our forecast implies that the financial surplus of the personal sector may amount to around 4 per cent of GDP this year and 3.6 per cent in 1992. This move into surplus helps to lower both the net debt of the personal sector and net interest payments. However the extent of the decline in such payments may be limited as evidence suggests that lenders have widened their interest spreads. A balance of 12 per cent of respondents in the September CBI/Coopers Deloitte Financial Services Survey reported a rise in average spreads over the past quarter and the coming one. Thus any improvement in the net property income of the personal sector is likely to be dispersed over the whole of the coming year.

Fixed investment and stockbuilding (Table 3 and Table 4)TABULAR DATA OMITTED The latest data for investment largely reflect the process of adjustment that the company sector has undertaken in an attempt to improve its financial position. In the second quarter of this year the total volume of investment was some 14 per cent lower than a year before, with manufacturing investment having fallen by some 19 per cent. The profile of investment growth over the last few years is shown in Chart 5, along with the outlook for the coming 12 months. We anticipate that overall the level of total investment will remain flat next year, although there may be a gradual pick-up in the latter half of the year. In contrast manufacturing investment may fall by a further 6 per cent or so in 1992. Total investment is likely to be held up by a higher level of investment in the service sectors where there is a prospect of further productivity-enhancing investments in information technology.

The profile of capacity utilisation in the manufacturing sector is shown in Chart 6. Utilisation is currently some 15 per cent below the peak levels of 1988 and we anticipate only a limited recovery over the course of next year, giving year-on-year growth of around 1.5 per cent. As we explained in the August Review, investment decisions in the late 1980s were based on over-optimistic output expectations and therefore many firms currently have a considerable degree of spare capacity. With around 70 per cent of firms in the latest CBI Survey working below capacity, we anticipate that the recovery in investment will lag behind that of output, with the initial demand stimulus being met by a rise in utilisation rates.

The housing market has also been particularly depressed this year, with personal sector investment in dwellings having declined by 25 per cent in the year to the second quarter. More recent data reveal little sign of any substantive pick-up in new orders. Our forecast suggests that with further declines in mortgage rates, year-on-year investment in dwellings may grow by around 2 per cent next year, although the level of investment in the last quarter of 1992 remains slightly below the level of investment in the first quarter of this year.

The first half of this year has seen widespread destocking throughout all sectors of the economy amounting to some [BRITISH POUNDS]3*1 billion in constant prices. Chart 7 shows that in terms of GDP destocking of this magnitude is as severe as experienced in the 1974/5 and 1980/1 recessions. Our forecast implies that the downturn in stock levels will continue in the latter part of this year and the early part of next, albeit at a moderating pace.

One technical problem with the stockbuilding figures in the national accounts is that they include a quarterly alignment adjustment in order to bring the growth rates of output and expenditure more closely into line. The adjustments made in the first half of the year account for some [BRITISH POUNDS]1*4 billion of the reported destocking. Recorded destocking in the national accounts can be expected to moderate in the second half of 1991 if the present adjustments are not revised since the quarterly adjustments are intended to sum to zero for the year as a whole. The sectoral stockbuilding categories in our model are for manufacturing, distribution and the rest of industry. We have followed the CSO in treating the alignment adjustments as if they were part of stockbuilding in the latter category of output. Thus over the forecast period the alignment adjustment is subsumed within the level of stockbuilding predicted by our behavioural equation for stock levels in the rest of industry.

In spite of the statistical adjustments we believe that the data in the accounts provide a fair picture of the recent trends in stock levels. The figures accord with survey evidence and our own econometric research which suggests that destocking is an important route through which firms adjust to any difficulties in their short-term cash flow. An additional factor depressing stock levels in production industries in the first half of this year was the temporary suspension of oil output from the North Sea.

The most recently available survey evidence for both the manufacturing and retail sectors suggests that the initial recovery in activity will be accompanied by some further rundown of stocks as respondents report that their stock levels are still more than adequate to meet expected demand.

The balance of payments (Tables 5 and 6)TABULAR DATA OMITTED

Our central forecast is for the deficit on the current account to widen from some [BRITISH POUNDS]6.3 billion this year to around [BRITISH POUNDS]9 billion in 1992. We expect the balance on invisible trade to deteriorate more sharply than the visible balance over the course of next year. A large part of this is due to a rise in net transfers abroad by the public sector as the contributions by foreign governments towards the costs of the Gulf War decline. This year such contributions may amount to around [BRITISH POUNDS]2 billion. Our forecast allows the level of transfers in the second half of next year to return to their level in the second half of 1990.

With the continuing decline in trade barriers in the European market, particularly in the service sector, we expect both export and import volumes to grow by over 5 per cent. Although export volumes are projected to rise slightly faster than import volumes, there may be a slight worsening of the overall balance on visible trade due to a fall in the terms of trade. We anticipate continued downward pressure on export profit margins as firms strive to retain newly-won markets. Some 61 per cent of firms in the latest CBI Survey cite prices as a factor likely to limit export orders. The need to retain competitiveness may be expected to become more pressing as trade barriers are lowered and market demands become more price sensitive.

With the level of activity forseen next year now somewhat higher than in our previous forecast, the projected growth in the volume of imported goods has also risen to just under 6 per cent. Much of this rise is accounted for by non-manufactures due to the anticipated recovery in raw material stocks that traditionally takes place in the early stages of an upturn. The relatively low level of capacity utilisation in the domestic manufacturing sector helps to limit the growth in imports of finished manufactures.

The forecast for exports of goods is shaped by two key assumptions. First, our measure of UK weighed world trade is expected to grow by 5 per cent next year. Further details are given in the World Economy forecast elsewhere in the Review. The downside risks associated with this projection are discussed in detail in Box B. The second factor is that the work described in Anderton (1991) has been updated to include data up to the end of 1990. This work uses a stochastic time trend to capture movements in the UK share of world trade. The profile of the trend obtained from the latest data is shown in Chart 8 and is consistent with an upturn in the share of world trade since 1986.

In this forecast we have adopted the statistically neutral assumption of allowing the trend to continue upwards at the rate experienced in 1990. This implies that the trend rises by around 0*25 per cent per annum. By construction it is not clear what lies behind the trend as it captures the impact of all variables omitted from an otherwise conventionally specified exports equation. However we feel that the two most likely explanations are either the change in the composition and quality of UK exports due to foreign direct investment in this country or, more prosaically, mismeasurement due to an index number problem. This may arise since the world trade measure is a base weighted index. Thus the trade share may turn around if UK firms have entered new markets, especially in Europe, that have grown more rapidly than the traditional export markets.

The level of net overseas assets fell sharply last year from [BRITISH POUNDS]84 billion at the end of 1989 to [BRITISH POUNDS]30 billion at end of 1990. Some [BRITISH POUNDS]12 billion of the fall was due to net foreign investment in the UK, with remainder accounted for by the divergent movements of world stock markets and an appreciation in sterling, particularly against the dollar. Our estimates suggest that some of the fall in 1990 was recouped in the early part of this year and we expect the end-year level of net assets to be around [BRITISH POUNDS]45-50 billion.

The labour market & sectoral output (Tables 7 and 8)TABULAR DATA OMITTED

The decline in the level of unemployment that began in the second half of 1986 came to an end in the first half of 1990. Since then unemployment has risen by some 800,000 to the third quarter of this year. As we have argued in earlier forecasts the annualised rate of increase is likely to slow over the coming months. Despite this unemployment is likely to go on rising for some time to come and may not peak until early 1993 at a level just under 2.8 million, implying an unemployment rate of just under 10 per cent.

This continuing rise in the claimant count is likely to be accompanied by changes in the duration structure of unemployment, with a marked growth in the numbers out of work for more than 6 months. Our present forecast implies that the proportion of long-term unemployed in the total will rise from some 44 per cent at the start of this year to around 60 per cent by 1993. This change in the composition of unemployment may limit the extent to which rising unemployment helps to moderate earnings growth. The note by Paul Gregg elsewhere in the Review suggests that Special Employment Measures may help to ameliorate the adverse labour market effects arising from these projected changes in unemployment.

At the sectoral level prospects for employment are closely related to the likely growth in output. We expect that output in the onshore economy will grow by about 2 per cent in 1992 with slightly faster growth in the North Sea. Growth will be focused in the public sector, reflecting the additional expenditure announced in the Autumn Statement, manufacturing and business services. Developments in manufacturing reflect the forecast improvement in exports and the end of destocking. Industries that rely heavily on consumer demand and investment, such as distribution and construction, are likely to remain depressed for some time to come, with any recovery delayed until the second half of 1992 at the earliest.

Average earnings (Table 2)TABULAR DATA OMITTED

Earnings growth has continued to moderate in the second half of this year, with the mean level of settlements in the third quarter being 6.4 per cent, some 2 per cent below the level of settlements in the first three months of the year. The moderation in the level of settlements has been apparent in all sectors of the economy, reflecting the widespread nature of the recession. Our forecast suggests that average earnings growth over the year to the third quarter will be about 7*5 per cent and we anticipate a further fall to around 6*5 per cent by the third quarter of 1992.

Some further decline in the level of settlements may be offset by a pick-up in wage drift as overtime earnings begin to recover as output strengthens. Department of Employment figures show that the average hours worked over the three months to August were some 0*5 per cent above the level in the preceding three months. The decline in overall earnings growth has also been aided by a number of well-publicised pay freezes. Such deals are likely to be reviewed as activity begins to pick up once more.

With the projected year-on-year growth in earnings of 6.7 per cent, real earnings are likely to rise by some 3 per cent. This largely reflects the procyclical behaviour of productivity. The recent growth in earnings, productivity and retail prices is shown in Chart 9.

Costs and prices (Table 9)TABULAR DATA OMITTED

Inflation has continued to moderate in the second half of this year, with the September RPI rate of 4*1 per cent nearly 7 percentage points lower than in September 1990. This fall has been helped by an annual fall of 8*8 per cent in the housing component that accounts for around one-fifth of the index reflecting, the lower level of community charge payments and successive reductions in mortgage rates. The rate of change in the RPI excluding housing has shown a smaller decline and stood at 7.2 per cent in the year to September, reflecting the rise in the VAT rate and the relative stickiness of prices in many labour intensive service industries.

The outlook for inflation remains promising and we expect the RPI inflation rate to be no more than 3.5 per cent by the end of 1992. The decline in producer price inflation may be even more marked, with the possibility of year-on-year growth being as low as 2.5 per cent. This is consistent with the CBI Survey, which for some time has shown little upward pressure on margins. Indeed in the year to October the annualised rate of increase in manufacturing prices (excluding food, drink and tobacco) was only 4.2 per cent. With some 94 per cent of firms in the latest CBI Survey reporting that their present capacity was at least adequate to meet expected demand over the coming year, any rise in capacity utilisation as demand picks up is unlikely to lead to a quick restoration of profit margins.

Pressures on margins may be eased by developments in the labour market. Growth in manufacturing productivity is projected to be around 6 per cent next year and therefore it is possible that unit labour costs in the manufacturing sector may be little changed from their level over the course of this year. Upward pressures on costs have also been eased by the relative weakness of import prices. Overall the total imports deflator may fall by over 1 per cent in 1991, helped by a sharp fall in oil prices in the early part of the year. Prospects next year are for a rise of about 2 per cent, although commodity prices may rise by 3-4 per cent in sterling terms, reflecting the likely depreciation of sterling against the dollar.

As we argued in the August Review, the medium term prospects for inflation are shaped by the realisation of wage bargainers and price setters that relative prices in the UK and Germany need to be adjusted towards a more sustainable level prior to a monetary union. The consequent moderation in wage increases and the relative stability of the sterling exchange rate help to ensure that the outlook for the UK is similar to that for France, with inflation remaining below 3 per cent in the mid-1990s.

The public sector (Table 11)TABULAR DATA OMITTED

Our latest projections imply that the public sector borrowing requirement will be around [BRITISH POUNDS]10*5 billion in 1991/2 and [BRITISH POUNDS]18*5 billion in 1992/3. These are little changed from our previous projections, with most of the extra cyclically-related expenditure announced in the Autumn Statement having been anticipated. However, there also appears to be some slippage in the previously announced plans for discretionary items such as procurement expenditure. The volume of public authority consumption in the first half of this year was some 2*7 per cent higher than in 1990, with nominal expenditure being pushed up further by adverse price effects. In the first half of the year the procurement deflator was some 9 per cent higher than in 1990. In our forecast we assume that the rate of public sector wage increases will moderate in line with those in the private sector.

The widening in the deficit in the coming fiscal year reflects the fact that the PSBR typically lags behind the economic cycle, with further falls expected in corporate tax receipts and further growth in transfer payments, with unemployment forecast to average over 2.7 million in 1992. However, overall growth in expenditure may be moderated by the likelihood that inflation will turn out somewhat lower than in the Autumn Statement projections. Next year will also see a rise in net transfer payments overseas.

We assume that income tax allowances rise in line with inflation over the course of the forecast. Community charge payments and business rates are both projected to rise by around 4 per cent in the coming year.

Medium-term projections (Table 12)TABULAR DATA OMITTED The medium term projections associated with this forecast are summarised in Table 12. We continue with our assumption, first made in May 1990, that the UK joins a monetary union in 1997. The projections show the rate of inflation remaining under 3 per cent in the mid-1990s with the disciplines of the EMS affecting the expectations of wage bargainers and price setters. This level of inflation is close to that in our projections for France and around 0*5 per cent below that in Germany, bringing some welcome adjustment in relative price levels.

The longer-term outlook for unemployment is slightly better than in our previous forecasts as new research at the Institute indicates that search effects remain important even at the high levels of unemployment observed in 1991/3. Our old equation relied upon the impact of Restart interviews which we believed had a once-for-all effect on exits from long-term unemployment. Even with this new equation and growth at or around its long-term trend, unemployment remains over 2 million throughout the decade.


Anderton, R. (1991), Underlying trends in manufacturing export shares for six major industrialised countries', Bulletin of Economic Research, vol. 43, no. 2.
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Title Annotation:Chapter 1; Great Britain
Author:Pain, Nigel
Publication:National Institute Economic Review
Date:Nov 1, 1991
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