The home economy.
The decision to join the exchange-rate mechanism had been expected, with increasing confidence, for several years. Nevertheless the actual announcement on 5th October came as something of a surprise. Up to that point the authorities, both the bank of England and the Treasury, had been encouraging the view that interest rates should be kept high for the foreseeable future so as to cut back the growth of domestic demand and to curb inflation. Joining the ERM implies that interest rates must be set mainly with a view to the foreign exchange market and are no longer fully available as an instrument to control the domestic economy. The decision to join the ERM in October, and the associated 1 percentage point cut in interest rates were probably the result of a reassessment of the state of the economy-as well as being a move in the complex game of European and domestic politics.
Over the past three months it has become increasingly clear that the UK economy has moved into recession. The signal has been most clear from the CBI Industrial Trends Survey, but it is confirmed by data on bankruptcies, retail sales, new car registrations, industrial output, vacancies, unemployment and the volume of imports. The scale of the fall in output will not be clear for some months yet, but the early indications are that it will be substantial. This would suggest a pattern unlike most other post-war cycles with the downturn phase lasting longer than usual, and intensifying in the later stages. it is already more than two years since the cyclical peak, identified by the CSO as August 1988.
The onset of this recession was unexpected. The same was true of the recession in 1979-80. Indeed, the onset of a recession may generally be unpredictable, rather like jumps' in the exchange rate. Decisions to cut investment spending, to reduce employment, to run down stocks all reflect the expectations of firms about the future demand for their products. When expectations change, real variables as well as prices can sometimes move abruptly, and these changes of sentiment are inherently unforecastable. After the event it may nevertheless be possible to guess what the new information was which caused the change of perception and behaviour.
The 'bad news' which has come to light since the summer includes the rise in world oil prices and the prospect of war in the Middle East, but also the continued rise in underlying inflation in this country despite two years of tight monetary policy. This will have been reinforced by the more cautious interpretation put on events in recent Government statements. Since the Budget Statement the expectation of a continuing succession of cuts in income tax in future years has evaporated. The Government's continuing political difficulties over the poll tax and especially over European integration seem to have contributed to the sombre mood of business in recent months-to judge by statements made at the CBI Annual Conference.
An alternative view would be that the recession is the predictable result of a sustained period of high interest rates-perhaps even its intended result. One difficulty with this interpretation is that neither the Government, nor the independent forecasters, ourselves included, actually foresaw that it would happen. Typically our models show the output response to higher interest rates building up gradually over a period of years, not intensifying suddenly after a long delay.
A third interpretation would be more worrying. It could be that the effects of tight monetary policy were delayed, perhaps because households were reluctant to sell their houses at a loss, or because firms went ahead with their investment plans using borrowed money. The implication could be that the worst of the downturn is still to come, reinforced by a contraction of credit, and a fall in house prices. We do not take such a gloomy view in our forecast, partly because we assume that interest rates will be able to fall gradually over the next twelve months.
The National Accounts Data up to the second quarter of the year show output and expenditure still rising. They do however give an indication of imbalance which could have contributed to the origin of the recession. The financial deficit of the industrial and commercial company sector, which was already large in 1989, increased to [Br pound]10 billion (7 1/2 per cent of GDP) in the second quarter. The scale of this deficit is now considerably in excess of previous records. (Clearly the figure is subject to revision, especially as it reflects the' statistical adjustments' made to the raw data by the CSO.) Firms seem willing and able to finance fixed investment, and dividend distribution or even interest payments, by borrowing to a greater extent than ever before. This parallels the behaviour of the personal sector a few years ago, and is no doubt another consequence of the liberalisation of credit and competition amongst financial institutions. it is not, of course, a pattern of behaviour which can continue indefinitely.
For the forecast our policy assumptions are based on the Autumn Statement and the consequences, as we see them, of joining the ERM. The Government has accepted a substantial increase to its earlier plans for public spending in this financial year, although the share of spending in GDP has not risen. The plans for public spending next year, especially spending by local authorities, may reflect what the Treasury would like to see happen rather than a best guess at the outcome.
The prospective surplus on the public sector financial balance this year has been eliminated by the extra spending, which is not fully offset by extra taxation. If any debt is repaid it will be matched by receipts from privatisation. The recession is likely to reduce the growth of revenue further, suggesting that there may well be a borrowing requirement in prospect again for 1991/2. In his Statement the Chancellor reiterated his commitment to the medium term objective of a balanced Budget. In March this objective seemed consistent with small tax cuts each year. The new figuring suggests that any future cuts in taxation would probably involve extra borrowing. We are therefore assuming a neutral Budget next spring and no easing of fiscal policy even in the medium term. If the Government wished to keep to its aim of reducing the rate of income tax, it would have to make room for that concession by reducing expenditure below our projections.
Since interest rates were cut by 1 per cent last month market expectations have, on more than one occasion, anticipated a further reduction. The authorities have made clear on each occasion that they will not make a further move until they are confident that it is 'safe' to do so. After its initial appreciation within the ERM band, sterling has fallen back to its midpoint or a little below. Interest-rate cuts are more likely to occur when sterling is under upward pressure.
The market expectation for interest rates in the latter half of next year is implied by the difference between the interbank rates on 6 and 12 month deposits. In early November the implied rate was 12 1/8 per cent. This is consistent with our assumption that base rates will be down to 12 per cent at the end of next year. Thereafter we expect a gradual further reduction towards the interest rates on other EMS currencies. By the middle of the decade sterling interest rates might be about 7 1/2per cent.
Our projection for the exchange rate is consistent with this path for interest rates, on the assumption of equal expected returns in sterling and foreign exchange, subject to a declining risk premium. Between the fourth quarter of this year and next we expect sterling to fall by 3 1/2 per cent, followed by a further 2 per cent during 1992. This pattern may be consistent with depreciation within the 6 per cent margin followed by a realignment and a narrowing of the band about a year from now. Looking further ahead, we assume that an economic and monetary union is formed in 1997 with the UK as a member. By then the risk premium attached to sterling should be almost eliminated. The effective exchange-rate index on this assumption would be rising slightly in the late 1990s, because the EMS currency block would be a little stronger than the Dollar.
The general election must be held before the summer of 1992, the most likely date being the fourth quarter of next year. In this chapter we assume no change in economic policy after the election, thus assuming implicitly that the present Government is returned to office. In Chapter III below we look at some of the policy commitments of the Labour Party and consider the options open to them if they come to power at the end of next year.
Summary of forecast
The world economy background to our domestic forecast, set out in Chapter 11, is especially important on this occasion. We are assuming that oil prices fall from $34.5 per barrel in the current quarter to $28.5 in a year's time. This is an important factor behind our forecast of reduced inflation in the UK, as elsewhere. We are assuming that world inflation (in terms of consumer prices) speeds up a little in the early part of next year, but then slows down to about 3 per cent a year. The forecast of world trade growth is also important to the outlook for UK exports. We foresee some acceleration in the course of next year.
Our forecast for the UK are summarised in table A.
The slow growth of the economy in 1990 and 1991 is mainly associated with reduced spending by companies. Stockbuilding is negative and fixed investment reduced. Consumer spending, on the other hand, continues to rise by about 2 per cent a year, helped by the resilience of real earnings. Unemployment is expected to rise through next year, peaking at a little over 2 million in 1992.
The underlying rate of inflation (the CPI adjusted to remove the effects on its definition of the change from rates to the poll tax) over the past twelve months is about 7 1/2 per cent. Wage costs are likely to go on rising quite rapidly over the next 12 months. Our assumptions however imply a fall in oil prices, and import prices should be restrained by the effects of the higher exchange rate in the latter half of this year. By the fourth quarter of 1991 the underlying rate of inflation (as defined above) should be around 5 per cent. The 'headline' figure for the retail prices index is sensitive both to the size of the poll tax rise next Spring and to the timing of mortgage rate reductions. Our forecast for the fourth quarter of next year is also 5 per cent.
Consistent with this pattern of growth and inflation we would expect the financial deficit of the company sector to be somewhat reduced next year, with the personal sector and the public sector together close to balance. The counterpart would be a small reduction in the current account deficit on the balance of payments.
In the medium term we expect the growth rate to recover, with quite a sharp upturn in 1992 as a result of the cut in interest rates. The sustainable growth rate of the economy is probably about 2 1/2 per cent a year. Unemployment in the medium term should average between 1 1/2 million and 2 million. This would be consistent with a nearly constant exchange rate and inflation of around 2 1/2 per cent. The current account of the balance of payments may remain in small deficit even in the medium term, provided confidence is maintained and financial inflows can be generated.
Our medium-term forecasts indicate the outcome necessary for the UK to join an economic and monetary union. The process of convergence is rather slow, with underlying inflation coming down by only 4 percentage points in 4 years (1 990-4). Partly for that reason the cost in terms of unemployment is less than that paid by France or italy (see the note on page 64 below). Our forecast assumes that wage and price setting reflects forecasts (similar to our own) as well as the past behaviour of inflation. The outcome could be very different if the commitment to ERM membership were ignored altogether, or not believed.
As the Autumn Statement was published unusually early this year we are able to compare our forecast with those of the Treasury (see table B). The differences on this occasion are small except that we expect both exports and imports to rise a good deal faster than shown in the official forecasts.
PART TWO. THE FORECAST IN DETAIL
Forecasts of expenditure and output (table 1) We are now forecasting a recession-Aefined as falling output for two consecutive quarters-in the second half of this year followed by total real GDP growth of approximately of a per cent next year. This is a much more pessimistic forecast compared to our August Review and reflects both new data and other recessionary signals from the economy.
Latest indicators show falling output in the production industries, rapid deceleration in retail sales and a dwindling public sector debt repayment reflecting slower activity (as well as higher spending). The CBI survey of industrial trends has signalled the onset of a recession through reports of rapidly declining capacity utilisation, expected declines in stockbuilding, investment and output combined with deteriorating export optimism. In general there seems to be a substantial turnaround between the first and second halves of this year.
In our forecast the major factors creating a recession and subsequent slower GDP growth are: first, the continued financial imbalance of the company sector which should encourage considerable de-stocking and slower employment growth both this year and next. Second, total investment is forecast to f al I i n both 1 990 and 1 991 as spare capacity arises due to the slower output growth. Third, oil production should fall next year due to the installation of new safety equipment (non-oil GDP growth for 1991 should be over 1 per cent). Fourth, the high level of sterling harms competitiveness and will reduce exports particularly in the second half of this year.
The slower domestic demand this year and next will subdue imports and there will be some improvement in the current balance deficit next year. However, the longer-term improvement in the trade balance is a more protracted process as our forecast of UK interest-rate falls should contribute to a sharp recovery in output in 1992.
Personal income and expenditure (table 2)
The volume of retail sales between the second and the third quarter of this year fell by % per cent and showed only a 1 per cent increase on a year earlier. Therefore there seems little doubt that real consumers' expenditure has finally begun to slow down rapidly. Slower growth of real personal disposable income is partly responsible for this and the poll tax has had a stronger impact upon general consumption than rates as it affects the lower income groups the most and they have the highest marginal propensity to consume. However, in addition to the direct impact of recent high interest rates upon consumers' expenditure, it seems that consumers have realised that the boom is over and in consequence confidence has suddenly hit the floor; no tax cuts are expected in the near future and consumers have revised downwards their expected future permanent income, housing wealth has fallen and the expectation of a recession in the near future encourages saving now.
For the second half of 1990 we therefore expect a substantial deceleration in the growth of real consumers' expenditure s unemployment rises, but real disposable income will remain flat rather than fall through the latter part of 1990 as wage inflation will still be strong and the reform of National insurance contributions and independent taxation will provide a boost to income. This depressed real consumption should continue into the first half of 1991 (as unemployment continues to rise) but then further interestrate falls will begin to increase non-housing wealth (equities and gilts) and the housing market will begin to recover with the rest of the economy in the second half of next year. The recovery occurs fairly rapidly in our model due to its forward-looking nature; employment falls only for a couple of quarters as firms see the future recovery in output in 1991. Therefore, given such a short period of recession, firms treat labour as a quasi-fixed factor of production and terminate employment for as few workers as possible in order to minimise labour turnover costs and retain their skilled workforce for the expected future increase in demand.
Conversely, our consumption equations are not forward-looking; for this reason we dampen the response of our consumer equations to the reductions in the interest rate next year and beyond as much of the implied wealth effects must have already been discounted by many people who saw the period of high interest rates as temporary. Nevertheless even with growing negative residuals on the consumption equation our model predicts a further fall in the savings ratio in the medium term.
Fixed investment and stockbuilding (tables 3 and 4 and chart 1)
We are forecasting small falls in total investment for both this year and next. Deteriorating real company sector profitability will subdue investment and the slowdown in output growth will reduce capacity utilisation thereby reducing the necessity for new investment. However, in many respects this is an optimistic investment forecast for the following reasons:
(1) Our manufacturing investment equation is particularly forward-looking in terms of future output and capacity utilisation and in consequence the predicted downturn in investment is short-lived as activity begins to recover later next year.
(2) Our measure of capacity utilisation in manufacturing currently indicates far less excess capacity than the measure reported by the CBI. If we adopted the latter measure then investment would be more severely negative over this year and next.
(3) The cost of capital is reduced in our forecast over the next year but this is dependent upon our assumption that interest rates are 12 per cent by the end of 1991.
(4) The large financial deficit of the company sector, in particular our measure of company sector net liquidity disequilibrium, does not enter our investment equations.
Although the investment falls are not enormous the dip below trend investment growth will exacerbate capacity constraints in the future and also reduce average labour productivity at a time when relative unit labour costs are important for competition with other European countries within the ERM.
Our measure of disequilibrium net liquidity is the major reason for our forecast of substantial de-stocking. This measure reflects the very large financial deficits recorded for the company sector. Unfortunately, the situation is difficult to interpret as the data are extremely inaccurate (and frequently revised) and the company sector balancing item accounts for [Br pound]15 billion of our measure of company liquidity disequilibrium in the second quarter of this year. However, the extent of our predicted de-stocking is tempered by the forward-looking nature of our stockbuilding equations which produce a recovery that is more rapid than would be suggested by backward-looking models.
Due to the allocation of part of the statistical discrepancy the data for stockbuilding are far less accurate than many other categories and a forecast basing a recession purely upon de-stocking is a risky business. Chart 1 shows stockbuilding with and without the statistical discrepancy. As one can see, the divergence between recorded stockbuilding adjusted for the inclusion of the statistical discrepancy (ADJ) and unadjusted stockbuilding (UNADJ) has increased in an erratic fashion in the recent past. In terms of macro-modelling it becomes unclear whether our stockbuilding equations are actually under-predicting or over-predicting during the previous two years. But it should be noted that the scale of our de-stocking this year and next is of only a similar magnitude to the statistical discrepancy itself.
Balance of payments (tables 5 and 6)
The considerable improvement in the underlying performance of UK visible trade since mid 1989 has been masked by the total figures for the UK current balance. This is because the UK's invisible surplus has deteriorated quite sharply and in spite of the fact that North Sea Oil production problems have severely reduced the oil trade surplus. The reasons for this improvement are quite important for explaining the past and predicting the future. Demand has obviously decelerated which largely explains the slowdown in import growth. But the main success seems to be the strong growth in export volumes. In our exports of manufactures equation we proxy non-price competitiveness by a stochastic trend which indicates that underlying manufacturing exports have improved in the 1980s relative to the 1970s. This stochastic trend may be a substitute for some measure of profitability (i.e. an increase in relative profitability results in an increase in UK exports). Profitability of exporting relative to sales in the home market will probably improve in the near future. On the other hand the profitability of exporting from Britain relative to the rest of the world (which influences the location of production decisions of multinational corporations) will probably deteriorate in the future relative to the recent past. Therefore, as these effects will largely offset each other, we only add residuals roughly in line with the past to our exports of manufactures equation and incorporate a neutral view of movements in UK non-price competitiveness in the future.
We have added positive residuals to our imports and exports equations (both manufactures and services) as UK ERM entry and the 1992 programme should encourage trade in both directions. (This will make the UK deficit a little worse as increasing imports and exports by the same proportion means increasing the deficit by the same percentage.)
Our expected substantial downturn in UK economic activity in the latter part of this year and early part of next year will reduce UK imports. The lower demand growth will be especially potent in reducing imports of manufactures due to the high import intensity of stockbuilding and investment as well as consumers' expenditure. However, one factor limiting the recovery of the current balance in 1991 is the lower output of North Sea Oil due to the installation of new safety equipment. The UK oil trade surplus is further eroded by our assumption of falling oil prices through 1991.
As the current balance deficit is also the difference between aggregate savings and investment it is worth explaining the improvement in the current account next year in terms of its counterparts. The improved net saving position of the personal and company sectors next year (via, for example, slower consumption growth and destocking respectively) is partially offset by the movement into deficit of the public sector. Therefore, the scale of the reduction in the current balance deficit in 1991 is not as great as the rise in savings of the private sector because the implied slower output growth reduces taxation revenue and causes dissaving in the public sector.
Lower interest rates reduce the returns on short-term capital flowing into the UK and improve the IPD balance. This also contributes to our predicted reduction in the current balance deficit to below [Br pound] 14 billion in 1991. However, the strong rise in demand in 1992 as interest rates continue to come down tends to keep the current balance deficit around the 912 billion level and this persists into the medium term.
We are forecasting a similar basic balance (current account plus structural flows) to the last Review suggesting that the UK needs financial inflows which more than offset the current balance deficit. We have made no adjustment to our capital flows equations now that the UK is an ERM member as it is difficult to judge the effects of reduced exchange-rate volatility upon these flows. For example, foreign inward direct investment may have been encouraged in the past by exchange-rate volatility as exporters to the UK may have preferred to move production directly to the UK rather than face export price uncertainty. In this case ERM entry may reduce foreign inward investment. Conversely, a quasi-fixed exchange rate may induce more inward foreign direct investment as both non-European and European firms locate production in the UK for export to Europe encouraged by the reduced uncertainty of a more stable future exchange rate.
Output and the labour market (tables 7 and 8)
Total unemployment has been rising for the past few months with the South East region particularly affected. Vacancies, which are usually a leading indicator of future unemployment, are also failing and recent data suggest that vacancies fell by approximately 20 per cent between the beginning of the second quarter and the end of the third quarter of this year. Conversely, total employment has continued to rise although manufacturing employment has been falling for several quarters. The sharp slowdown in activity expected in our forecast will be associated with a substantial rise in unemployment with more than 2 million jobless by the end of next year. The current financial deficit of the company sector also puts upward pressure on unemployment as, in a similar fashion to de-stocking, reducing expenditure on employment is a rapid means of restoring financial balance. Consequently, we will probably see employment falls in manufacturing, distribution and self employment next year.
The extent of the expected recession in the second half of this year is highlighted by the latest output figures: output of the production industries fell by 3 per cent between the second and third quarters of 1990 with manufacturing output declining by 2 per cent (these data have not been incorporated into our forecast). Within manufacturing, the chemicals industry has suffered a substantial decline which is particularly worrying as this is one of the UK's strongest exporting sectors. We are expecting non-oil GDP to grow by around 1 per cent for both this year and next. This implies that total GDP growth will fall next year to around 3/4 per cent as oil output will actually decline in 1991 (after a period of recovery last year) as shutdowns of oilfields to install safety equipment occur. The output of the manufacturing and distribution sectors will be particularly restrained by the slowdown in demand this year and next. However, the effect of the slowdown upon employment growth should ensure both a rise in productivity in 1991 and, combined with lower wage inflation, a deceleration in the growth of unit labour costs.
Wage and price inflation (tables 2, 9 and 1 ) Recent data indicate that whole economy average earnings are growing at an annual rate of per cent with settlements at around 9 per cent. Settlements may not begin to fall until the first quarter of next year following influential high settlements at Vauxhall and Ford etc. Wage drift, originating from overtime worked and productivity linked pay deals, explains the difference between average earnings and settlements. Given our expected sharp decline in output in the second half of this year we expect average earnings growth to decline slightly in the fourth quarter of this year. We are also optimistic concerning the slowdown in average earnings for next year. This partly arises from our assumption of forward-looking behaviour by wage bargainers but is mostly the result of the recession and slow growth in import prices (due to a higher level of sterling) rather than any extra wage discipline imposed by UK ERM membership. Our forecast of a considerable increase in unemployment next year will also reduce wage pressure and slower output growth implies substantially lower wage drift via a large decline in overtime hours worked (although productivity related pay deals will have an opposite, but much smaller, effect on wage drift as output per head recovers).
We expect annual retail price inflation of approximately 1 1/4per cent during the fourth quarter of this year falling to around 5 per cent by the end of next year. This arises partly from slower underlying inflation originating from a recessionary environment (i.e. less demand pressure, earnings growth declining etc) but also from special factors such as the interest rate falling to 12 per cent (hence lowering the mortgage rate), oil prices falling through 1991 and the introduction of the poll tax in 1990 failing out of the year-on-year calculation.
The consumers' expenditure deflator is subject to a discontinuity from the second quarter of this year due to the treatment of the poll tax in the National Accounts (see previous Reviews for an explanation of this) and hence does not reveal the true underlying rate of inflation. The CPI calculated on the old basis is given in the forecast summary table A and does represent underlying price increases. Our assumption for the poll tax next year is that it rises roughly in line with non-domestic rates at around 11 per cent. Our forecast for the GDP deflator reveals less of a year-on-year slowdown in inflation next year compared to the RPI although the fourth quarter growth rate shows more of a deceleration as the GDP deflator includes a high weight for oil prices.
Latest data reveal that manufacturing producer output prices are still increasing in October but at a decelerating annual rate. This implies producers were somewhat reluctant to reduce profit margins even though demand has fallen substantially.
Public sector finance (table 11)
The recent Autumn statement set planned public expenditure for the current fiscal year at [Br pound]180.6 billion. Although this is approximately 1 per cent higher than the nominal target set last year (due to extra expenditure on the Gulf crisis and agricultural market support) in real terms it is 2 per cent lower than the announced planned expenditure in the previous Autumn Statement. Given this [Br pound]1.6 billion rise in planned expenditure the Government's forecast of a public sector debt repayment of [Br pound]3 billion this year (compared to [Br pound]7 billion in the Budget) implies that a deceleration in underlying revenue growth (due to slower than expected GDP growth) in the second half of this fiscal year is mainly responsible for the downward revision in the expected PSDR. Given the actual [Br pound]5 billion deficit to September of this year (in a period of fairly buoyant GDP growth) this PSDR forecast could prove optimistic. However, there are several factors which should deliver a larger PSDR in the latter part of this fiscal year; both poll tax and non-domestic rates payments should improve as the year progresses as the current non-payers face prosecution, and the imposition of cash limits on spending should slow down public expenditure in the latter half of this fiscal year. Conversely, during the same period these effects will be partly offset by falls in GDP which cause lower employment growth, deceleration in the growth of earnings, reduced wage drift and lower profits growth. Given all of these effects we are expecting a PSBR of approximately [Br pound]1.7 billion (excluding privatisation receipts) for this fiscal year.
The 91/92 fiscal year sees planned spending increasing from its previous target of 9-1 92.3 to 9-200 billion but this is not expected to compensate departments fully for the higher price level. Receipts will be more subdued in the early part of the 91/2 fiscal year (but partly recover in the latter part as GDP growth improves) because of slow growth combined with lower oil tax revenue. These factors and the extra [Br pound]3 billion support for local authority spending (largely in the form of poll tax transitional relief) may well deliver a small public sector borrowing requirement for the next fiscal year even after allowing for privatisation receipts of [Br pound]5.5 billion. Despite the expected depressed state of the economy by the time of the 1991 Budget we assume no tax cuts as the extent of the current balance deficit makes such action unwise.
In the medium term the new expected future spending levels, combined with the expected fall in the inflation rate, imply the PSDR may be a phenomenon of the past even though revenues will be boosted by the GDP growth encouraged by interestrate reductions.
Medium term (table 12)
We assume that the UK is a partner in economic and monetary union circa 1997. This implies a convergence of monetary policy between the participating states which suggests that the UK interest rate will decline to around 7 per cent over the next six years. Given this path for UK interest rates, real GDP growth in 1992 should recover strongly and the average medium to long-term output growth should be slightly below the UK's sustainable level at just below 2/2 per cent. Real consumers' expenditure accounts for much of this growth as cheaper credit encourages more consumer borrowing and revaluations of wealth occur as the interest rate declines. Consequently, after recovering to around 7 1/2 per cent by 1991, the savings ratio begins to fall again through the decade.
The strong recovery in demand in 1992 sustains wage inflation at around 8 per cent but the continuation of strong wage pressure into the medium term is partly countered by unemployment remaining above 2 million until the mid-1990s. Given that our wage equation is forward-looking the non-validation of excessive wage increases (by not allowing downward exchange-rate realignments within the ERM) is partly expected by wage negotiators and this will tend to predict a more rapid reduction in wage inflation compared to a more backward-looking model of earnings. Nevertheless the combination of a high level of the nominal exchange rate and price inflation initially above that of our competitors will deliver a slower growth rate of exports compared to recent years. Given our predicted recovery in demand, the current balance deficit remains above [Br pound]10 billion throughout the mid-1990s although it steadily declines as a percentage of GDP. Our forecast is constructed on the basis that the current balance will tend toward equilibrium by the end of the decade. Therefore, unemployment remains above the non-accelerating inflationary rate of unemployment (NAIRU) for most of the medium to long-term in order for price inflation to fall steadily over this period and hence move the UK's real exchange rate towards the UK's fundamental equilibrium exchange rate (FEER). in addition, in order to partly counter the loosening of monetary policy and its detrimental effect upon the current balance we assume a very tight fiscal policy which incorporates no further tax cuts and a growth rate of public expenditure below real GDP growth throughout the medium term.
The counterparts to the current balance deficit change through the medium and long-term; at first the company sector is in deficit but corrects itself by the mid-1990s whereas the personal sector once again moves increasingly into deficit as interest rates are reduced. The public sector through higher nominal expenditure on current grants (via increased unemployment) and lower taxation revenue (as output grows below its sustainable level) remains slightly in deficit in the medium term even after allowing for substantial privatisation receipts.
A PC VERSION OF THE NATIONAL INSTITUTE'S DOMESTIC MACROMODEL The institute's domestic econometric macromodel is now available for use on a IBM PS2 with a 386 chip and 4 megabytes of memory (or on a close clone). The machine must have an EGA or VGA graphics card and if it is part of a network it must be possible for it to be isolated. The model comes with a user friendly menu driven front end' in the same style as that available with the institute's world economy model GEM. This allows the user to do either forecasts or simulations using the model, using as a starting point the Institute's own forecast which is updated every quarter.
The package requires a 80386 based PC, such as the IBM P/S2 Model 70 or 80, with a minimum of 4 megabytes of memory. A maths co-processor (80387) is also recommended. The computer should also have at least 10 megabytes of hard disk.
The Institute's domestic macromodel can claim to be the most advanced large econometric model of the UK economy. It incorporates rational expectations in a number of areas including the foreign exchange markets. The model has a well developed supply side including a vintage technology in each of the manufacturing, distribution and business service sectors. The model is firmly data based, in the sense of incorporating very few imposed behavioural parameters.
The annual subscription from January 1991 will be [Br pound]4000 plus VAT, or [Br pound]3000 plus VAT for those already subscribing to the world model GEM. There is a reduced rate of [Br pound]500 for academic users. For details of GEM see page 43.
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|Title Annotation:||economic forecasts of Great Britain by the National Institute of Economic and Social Research; chapter 1|
|Publication:||National Institute Economic Review|
|Date:||Nov 1, 1990|
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