Economic Outlook 1981–1985: The London Business School with Gower Publishing

The contrast between the "real" and the "financial" economy is acutely illustrated by the latest indicators. On the one hand industrial production fell I 'A per cent in June to the levels of a year ago and manufacturing industry recorded its worst month in 15 years. On the other hand developments on the financial side of the economy remain encouraging. Interest rates have fallen steadily since last October, public borrowing is under control, the money supply - on whatever measure - has been expanding within its target range and the exchange rate is firm against the average of all other currencies. Reflecting these developments, inflation is also improving rapidly. Retail prices were unchanged in July and 8.7 per cent higher than a year earlier - the best outturn since 1978. Ministers are now confident that their year-end forecast of 9 per cent will easily be beaten, and that an outturn of 7 1/2 per cent is possible.     

Economic Outlook 1990–1994: The London Business School with Gower Publishing: Forecast Release: THE 1991-92 WAGE ROUND

The current wage round begins under circumstances markedly different from the previous one. A year ago the Department of Employment measure of the underlying growth in average earnings was, at 10 per cent, higher than at any period since the 1979-80 pay explosion. Following the invasion of Kuwait there were considerable dangers that cost pressures would initiate a wage-price spiral. In the event the hike in oil prices had only a small and temporary effect on headline inflation rates, which was more than offset by deflationary pressures resulting from the worse-than-expected economic downturn. In addition, UK entry to the ERM in October meant a major shift in the conduct of economic policy. The need to maintain the pound at its high central parity introduced extra discipline into pay-bargaining by ruling out the accommodation of uncompetitive wage rises through depreciation.     

Economic Outlook 1991–1995: The London Business School with Gower Publishing: Forecast Release: THE CHANCELLOR'S ECONOMIC ADVICE

Within the last month the Chancellor has made two important speeches on macroeconomic policy. The first, to Surrey businessmen in June, pledged the UK to the French route to a ‘virtuous circle of low inflation, rising competitiveness and increasing market share’; the second, in July to the European Policy Forum, vigorously defended his present policy against the alternatives, which he dismissed as ‘illusory or destined to fail’, of devaluation or cutting interest rates. On both occasions Mr. Lamont placed the permanent conquest of inflation at the centre of his policy, arguing that holding sterling at its present central parity of DM 2.95 is the only way to achieve this objective. In his view the consequence of any of the alternative proposals would be ‘either higher interest rates, higher inflation, or most likely both’. In this Forecast Release we consider these claims and the economic advice on which it is based. On the latter we would surmise that the thrust of the advice which Mr. Lamont is receiving is that he has the opportunity to deliver a sustainably low inflation rate and that this requires a stable pound within the ERM. The alternatives involve a sterling devaluation which, no matter how obtained, would obstruct the goal of permanently low inflation in return for only transient benefits on output and unemployment. But the price of defeating inflation has been high and is not yet fully paid. Moreover the goalposts have been moved: to reach the French position on competitiveness, which underpins their gains in market share and which has taken the best part of a deeade to achieve, requires a still better inflation performance on the part of the UK and while this is being achieved, adjustment costs will persist. It is partly in defence of his own policies and partly in an attempt to moderate the already-high adjustment costs that Mr. Lamont has adopted a more combative stance. His advice is that to compete with Europe, we cannot award ourselves pay increases far in excess of European levels, indeed we need a period of below-average pay rises.     

The London Business School with Gower Publishing: Forecast Release: THE TIMING OF RECOVERY

In his Budget speech the Chancellor argued that "there are good reasons to expect that the recovery will begin around the middle of this year, although initially it may be slow. As we found ten years ago, confidence revives as inflation comes down… Just as falling consumer spending contributed to the onset of recession, so returning consumer confidence is likely to lead the recovery." Since then Mr. Lamont has detected 'faint stirrings' of a recovery in activity, while the Prime Minister is confident of a return to growth, arguing this month that "there are far too many indications for anyone to doubt that in the second half of this year there will be a great improvement and we will be coining out of recession." For all the official confidence that their relatively modest prognosis, which we shared in our June forecast, is proving correct, there are many who remain doubtful. The survey data, while improving, do not yet convincingly point to an upturn and there is a fear that while lower inflation and easier monetary policy would on their own produce higher spending, this effect could be outweighed by consumer caution in the face of rising unemployment. This Forecast Release examines these issues. It focuses particularly on the link between lower interest rates, falling inflation, rising unemployment and the savings ratio and finds that, on the basis of the experience in the recessions of 1975 and 1980 and the boom of 1988, it would be surprising if the savings ratio were not to head lower in the second half of the year. The latest figures on retail sales, which rose more than 1 per cent in June, suggest that this may already be happening, though this will only be confirmed by data showing a greater willingness on the part of consumers to step up their borrowing once again.     

Economic Outlook 1991–1995: London Business School with Gower Publishing: Forecast Release: ECONOMIC POLICY AFTER THE STERLING DEBACLE

Now that sterling has withdrawn front the ERM and is once again in free float, the Government must decide on the next stage of policy. Should it seek to rejoin the ERM as quickly as possible or should it prolong the float? We argue that, whichever way the Government moves, devaluation has undone progress on inflation arid irreversibly damaged the credibility of the UK commitment to the ERM - the credibility of the ERM itself has also been damaged, perhaps irretrievably. In these circumstances, the Government should accept the verdict of the foreign exchanges arid switch the focus of its policy to ending the recession by setting interest rates in accordance with the needs of domestic recovery. The inflation costs of such a move should be small, at least initially, and the battle to reduce inflation can be rejoined in earnest arid the pound returned to the ERM when Germany has itself sorted out its unification problems. On the ERM we argue that it mist move either forwards to EMU or back to the crawling peg system of exchange rates that characterised the first half of the 1960s: it cannot remain in its current limbo.     

The London Business School with Gower Publishing: Forecast Release: THE GULF WAR: RECESSION AND RECOVERY

The Iraqi invasion of Kuwait occurred at a time when many economies were in or heading towards recession. These trends were exacerbated by the Gulf crisis which had adverse effects on consumer and producer confidence. Now that the Gulf war is over, confidence is recovering but against the background of a relatively severe recession. In this Forecast Release we make use of a simple statistical tool to throw some light on how much of the downturn was due to confidence factors and thus to draw implications for the recovery. In broad terms we find that a large part of the US recession, in particular the downturn in consumer spending, was attributable to the effects on confidence of the Gulf crisis. In both the US and the UK, however, the effects on producer confidence were less marked, though here too the analysis suggests that, at its low point, producer confidence was also adversely affected by the crisis in the Gulf. The latest data show that there has been a full recovery in US consumer confidence but that producer confidence on both sides of the Atlantic remains well below pre-Gulf trends. On this basis, therefore, we would expect a further recovery in industry's confidence over the coming months.     

The London Business School with Gower Publishing

Collapsing oil prices and a falling dollar set the background to a Budget in which the Chancellor, hamstrung by lower oil revenues, was seen as having little room for manoeuvre. In fact the sharp fall in the sterling price of oil has provided him with the perfect excuse for not making significant cuts in personal income tax that were largely irrelevant to the needs of the economy. Instead of a boost to household demand we have had, thanks to OPEC, a transfer to companies in the form of a reduction in costs. This should enable them to expand output against a background of falling inflation. Our post-Budget assessment of macroeconomic prospects (Section I), made on the Treasury's assumption of a $15 oil price, shows output growing by 2 1/2 per cent this year and inflation falling below 3 per cent in 1987. We are thus less optimistic than the Treasury about output but more optimistic about inflation. How was the Chancellor able, within the confines of the Medium-Term Financial Strategy, to give anything away having lost so much oil revenue? A detailed analysis of the PSBR forecast (Section II) reveals good reasons why non-oil tax revenues should be some £3 1/2n higher than forecast this time last year. But, because we still expect public spending to be above the official figures, our PSBR forecast is £1bn higher than the Treasury's. Although the macroeconomic impact of the Budget was small (especially in relation to that of the fall in oil prices which preceded it), it continued the process of tax reform. We focus, in Section III, on the new proposals to deal with the problem of the pension fund surpluses to which we drew attention in the November issue of Financial Outlook. We conclude that the proposed measures could have a larger effect on tax revenues in the longer term than is indicated by the Treasury's Budget estimates.     

The London Business School with Gower Publishing

In the last six months manufacturing output has risen at a rate in excess of 10 per cent while inflation has dropped to 1.2 per cent, its lowest level in a generation. Unemployment has fallen for five successive months. None of these developments was forecast - either by us or, so far as we are aware, by anyone else. How is that the British economy continues to surprise all the forecasters and will it continue to do so? We examine the shift in the forecast consensus over the last year and ask whether the revisions will have to continue. Our conclusion is that some of the most recent optimism is misplaced and that there remain setbacks ahead both in terms of output arid inflation. Nevertheless, it would appear that the risks are on the right side, that if anything output is likely to rise faster and prices more slowly than the current Consensus.     

The London Business School with Gower Publishing

The current economic outlook is dominated by fears of continued industrial unrest and uncertainty regarding wage increases. The key issues for output and expenditure will be the outcome of the almost inevitable conflict between the monetary objectives and wage inflation. The most recent indicators provide some evidence of the type of problems the economy will face during 1979. The figures for industrial output and consumption suggest that, by end of 1978, the growth of output was slowing down and the figures for wholesale and retail prices suggest that inflation was picking up. Adherence to the monetary targets is already, on a short-term basis, requiring little or no growth in the real money supply and accompanying high interest rates. The latest official longer-term indicators also point to a slowdown in domestic demand.
Inflation would probably have increased by now had it not been for the recent tight monetary policy and the resulting stability of the exchange rate. We have earlier argued that earnings increases of about 12% will be consistent with the current financial background. But earnings increases of 15% or more will put extreme pressure on the company sector and would bring into sharp focus the choice between finanacing wage increases and letting the exchange rate fall with resulting higher inflation rates: or holding the monetary targets and accepting the short-term consequences for output and unemployment.     

The London Business School with Gower Publishing

Inflation is the aspect of our economic performance which is now changing most dramatically (with the possible exception of the balance of payments on current account). Yet price changes and their measurement are many-sided, with a range of indices measuring different stages and different parts of the inflationary process. In this Forecast Release we examine the most important indicators of CJK inflation, look briefly at the relationship between them, and trace the manner in which the rapid slowdown in inflation is now filtering through the economy, having its final impact on the consumer/retail price index.     

The London Business School with Gower Publishing

In the first of this Forecast Release we update our February forecast to take account of the Budget measures and the impact of lower oil price. In the second part we examine the latest (Mark III) version of the Medium Term Financial Strategy and compare it with the earlier versions announced in the 1980 and 1981 Budgets. We conclude that there has been some relaxation of policy though less than might at first appear when account is taken of at the possible shift in the velocity of circulation and by the changed level of output.     

The London Business School with Gower Publishing

A reasoned assessment of the impact of the Budget leads to the following implications:
Interest rates over the course of the year will be higher than they are today.
The possibility of an upturn in the inflation rate before the end of 1978 is more likely than before the Budget.
The combination of this higher inflation rate and the weaker currency is likely to keep the growth of consumer spending significantly below the official (and most other) forecasts, although the 1978 growth will still be substantial.
In February we argued that on the assumption of £l½b net tax reduction in the Budget 'a responsible financial policy would require that part at least should be reversed in 1979'. The scale of the Budget tax reductions and suggestions of further net reliefs in July increase the likelihood that we will be seeing forces at work to slacken demand later this year, or in the first part of 1979.     

The London Business School with Gower Publishing

In October we forecast 1 per cent output growth in 1993 accompanied by little change in retail price inflation, an increase in unemployment to 3.2 million by the end of the year and a £20bn deficit on the current account of the balance of payments. Since then we have revised our view of the international outlook and the Chancellor has made his Autumn Statement. There are also some hopeful signs in the latest data on retail sales, manufactured exports and the money supply that demand may be picking up both domestically and overseas. How do these developments affect our short-term forecast? The simple answer is very little: the outlook on output and inflation in 1993 is barely changed since October (Table I). We have lowered our forecasts for world inflation and for German interest rates which means that the pound can be held steady against the DM at lower UK interest rates and that the inflationary consequences of devaluation, though significant, are slightly less over the medium term than we made out in October. There is one revision of major significance, and that relates to the PSBR, which is now likely to reach f45bn in 1993-4, more than 7per cent of nominal GDP. The change is not on the spending side - the Autumn Statement confirmed existing expenditure plans - but on revenues, notably corporate taxes and tares 011 spending, which have fallen far more quickly than we envisaged. This, in combination with a projected near-2'per cent of GDP deficit on the balance of payments, poses a difficult medium-term policy dilemma. To escape from the twin deficits requires either deflation of demand, which conflicts with the Government's new-found commitment to growth, or a more buoyant economy to boost tax revenues and a competitive pound to underpin export-led growth. Of the two the latter is self-evidently more inflationary. This highlights the policy dilemma: at some stage the Government may have to choose between reducing the deficits and its 1–4 per cent inflation target or sacrifice its commitment to growth.     

The London Business School with Gower Publishing

Suddenly the recovery is with us. After two months in which manufacturing output rose 2.5 per cent, there are few who doubt that a sustainable recovery is under way. While it is unlikely in the extreme that manufacturing will continue to grow at the rate of January-February, an annual rate of 15 per cent, and equally likely that there will still be some bad months, almost no one is dismissing the recent experience as another 'false dawn'. With retail sales rising steadily, and industrial surveys registering a marked upturn in business confidence, it would appear that the Chancellor's green shoots' are finally with us. Indeed, when the CSO conies to date the trough of the present cycle, it is likely to put it in the second quarter of last year. If this is the case, the first year of recovery will have been particularly weak, reminiscent of the experience in 1981-2 when the trough of the cycle was in February 1981 but it was not until late 1982 that a convincing recovery was under way. Given the apparent similarity between these two episodes, we draw comfort from the fact that (non-oil) GDP rose 1.3 per cent in 1982 and 2.8 per cent in 1983, in line with our February forecast of 1.3 per cent growth this year followed by 3.2 per cent in 1994.     

The London Business School with Gower Publishing

The theory of employment is reasonably well understood. Producers are confronted with a given level of aggregate demand. They decide how much they can profitably produce, and decide on the mix of capital and labour in response to a given set of relative prices. Over most of the post-war period variations in employment were accounted for mainly by variations in aggregate demand, but that situation changed dramatically during the 1970s. As unemployment has mounted, so has the interest in so-called supply-side explanations of the problem, since it has become obvious that an increase in employment on the scale required can hardly come from a demand stimulus alone. In our account of the 1980 recession, we tended to focus on profitability as a key element in the decision to supply. If the price of goods is too low relative to the price of the factors of production needed to produce them, then the supply of output will fall. In the 1980 recession the price of all the factors of production rose dramatically: real wages shot up following the Clegg awards; real interest rates were at record levels; and the price of energy had recently soared following the OPEC II oil shock. At the same time goods prices were being constrained by the government's counter-inflationary strategy, and most notably by a strong exchange rate. Under these circumstances a substantial proportion of firms, especially in the traded goods sector, found it unprofitable to continue producing. When unprofitable production lines were abandoned, the associated capital equipment was scrapped. These decisions, once taken, were for the most part irreversible even if, as must have happened in some cases, subsequent movements in factor prices would have made production profitable once again. We discussed this phenomenon in the April Forecast Release and showed that, on the assumption that capital-labour ratios had remained at their trend levels, some £25bn of capital equipment (at I980 prices) had been scrapped. The fact that manufacturing output and employment have remained far below their 1979 levels, even though total output at home and abroad is at or well above that level is, we believe, mainly due to this capital scrapping. The jobs in manufacturing will not be re-created - even though UK competitiveness has been restored to pre-1980 levels - until the capital stock is re-built. The scrapping phenomenon is important because it creates a link between employment and too-high real wages (or other factor costs) that is often ignored. In standard production theory a rise in real wages leads to the substitution of capital for labour and employment may fall (if the rive in real wages does not create a more than offsetting increase in aggregate demand). However, production theory is complicated by the fact that capital and labour are complements as well as substitutes. Since a large part of the nation's productive-capacity, once built, uses capital and labour in fixed proportions, a rise in real wages may render part of the existing capital stock uneconomic. High real wages thus destroy capital as well as jobs. In our April Forecast Release, in order to estimate the scale of the scrapping problem, we made the simplifying assumption that capital-labour ratios remained on trend. In practice they vary in line with movements in relative factor prices. In the present Forecast Release we look more closely at the role of factor prices. We find some evidence that changes in relative factor prices affect the capital-labour mix. However, the substitution elasticities are small. The conclusion of this analysis is that the job losses which resulted from too-high factor prices (mainly wages) during the recession cannot be quickly reversed.     

The London Business School with Gower Publishing

Over the lastfive years events in the United States have been repeated throughout the OECD area, with a lag of 6–12 months. A repeat of this pattern in I982 would mean that the recovery in Europe and Japan, which has been progressing slowly since the middle of last year. would not last into 1983. The present forecast excludes this possibility. The argument, which we have put previously, is that the US recovety of 1980 was premature and that the current recession Jollows a renewed attempt by US policy-makers to reduce inflation. There are already signs that they will be succes & Consequently we do not expect the US recession to be prolonged In the second haIfof the year we expect an expansion of output to be in progress, both in the US and elsewhere; in the next few months, however, world activity is likely to remain subdued.