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Now that sterling has withdrawn front the ERM and is once again in free float, the Government must decide on the next stage of policy.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.     

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 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 1991–1995: London Business School with Gower Publishing: Forecast Release: A NEW ERA FOR UK EARNINGS?

Wage growth has been one of the few economic indicators moving in the right direction for the government in recent months. Critics would point to the influence of an extra 1 million jobless in bidding down pay awards but it is clear that the present deflation has been more effective than in the early 1980s. Nevertheless, it is too early to celebrate the transition to European inflation rates. The present situation is not irreversible and to a large extent has been the product of unusual circumstances. Full adjustment could be a longer and more difficult process.     

Economic Outlook 1991 – 1995: The London Business School with Gower Publishing: THE HOUSING MAFUCJIT IN RECESSION : A PAINFUL ADJUSTMENT TO ERM DISCIPLINE

We, together with almost every other commentator on the UK housing market, forecast a recovery of house prices and turnover during 1991. These hopes have been disappointed. This Forecast Release addresses some of the questions raised by this prolonged weakness in the housing market. Why did we, and so many others mis-judge the outlook for house prices and housing investment? Are there structural problems, especially those associated with the adjustment to the inflationary discipline of the E M, which are preventing a revival? When will recoverly take place and can there ever be a house-price boom similar to 1984–1988 again? One reason for the unanticipated weakness of the housing market is the growing problem of mortgage arrears and possessions. This can be expected to produce at least some temporary weakening of house prices as a reaction to the current volume of empty properties being put onto the market. There is a more fundamental reason for the current weakness of house prices. Unlike previous house price booms and busts, the present recession offers no relief to the hard-pressed borrower in the form of a rapid inflation of average earnings. Difficulties with mortgage repayments, for highly indebted households, are set to continue for some time. These lessons are not being lost, either on prospective purchasers who are’ being discouraged from taking out substantial mortgages in relation to their incomes, or on mortgage lenders who are being much more prudent in the setting of mortgage to- income and mortgage-to-price limits. The result is a long overdue adjustment of British attitudes towards own er-occupation.     

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 1985- 1989: The London Business School with Gower Publishing: Forecast Release: THE AUTUMN STATEMENT: IF YOU CAN'T BEAT 'EM

In announcing significant increases in public spending in the Autumn Statement, the government has recognised that the scope for further interest rate reductions ahead of the election is virtually nil. It has therefore sought to boost demand, and its own popularity, by a fiscal relaxation. It so doing, it is prepared to risk a PSBR. (excluding privatization) of £27bn, exactly in line with the estimates which we made in June of Labour Party policy. In terms of macroeconomic policy, therefore, the gap between the two parties is virtually closed, while that between Mr. Major's government and that of Mrs. Thatcher is evident. Front this starting point, we argue that honouring Mr. Laniont's pledge on income tax could be at the expense of removing tax relief on mortgage interest payments and that a Labour government which still cherishes higher public spending may be forced into continuing the privatization programme. Under either Party there is a strong political case for tax increases, or for rescinding some of the planned increase in spending, early in the life of the next Parliament in order to bring the economic and political cycles back into synchronisation from which they were disturbed by Mr. Lawson's tax-cutting Budget of 1988.     

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

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

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

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

Last year earnings growth fell below the lowest rates of increase experienced in the 1980s. At the time this was seen as primarily the result of the deflationary squeeze produced by ERM membership. It was too early to proclaim a new era of responsible wage bargaining until the recovery had occurred. Since then not only has sterling lost its E m anchor, and suffered a sharp depreciation, but an upswing in activity has also been established. However, in spite of the revival in potential inflationary forces, earnings growth has continued to decelerate in 1993. It is clear that the last recession has had a more pronounced effect on nominal wages than its predecessor. In terms of real wages, however, there appears to have been little change, implying that the fall in nominal wages is due solely to lower price inflation. The important question for the present pay round is how will the labour market respond to the recovery? Have the supply-side policies pursued in the 1980s had a decisive effect, allowing the UK to make the transition to low, stable inflation rates in the 1990s? Or will there be a reversion to traditional inflationary practices?     

The London Business School with Gower Publishing

In the last month there have been three major items of economic news. First there was Mr Healey's package of 26 October; then there was the announcement on 31 October that the Government's exchange rate policy would change; finally on 1 November there was the news that the miners had rejected the National Coal Board's pay offer. In terms of our view of the outlook for the longer-term development of the economy, the most significant change is the move to free the pound. The effects of Mr Healey's package upon total output are to leave 1977–78 much where it would have been had the Treasury's original public expenditure plans been realised; the shortfall in spending has been made up by tax reductions and, in turn, consumer spending increases.     

The London Business School with Gower Publishing

Last year the Chancellor followed "the path of prudence and caution", cutting taxes by £4bn and budgeting for a public sector surplus of £3bn. This year - rather more compellingly - he is travelling the same route. Against the background of a record current account deficit and rising inflation, Mr. Lawson has tightened fiscal policy, cutting taxes in 1989–90 by nearly £2bn - less than is needed to offset real fiscal drag. His main priority, reaffirmed in the Budget speech, is to tackle inflation and, to this end, he chose not to revalorize excise duties. This was reinforced by a reduction in national insurance contributions, which not only benefits the low paid in relative terms, but also sharpens the incentive to supply labour at the bottom end of the wage spectrum. But this reform of national insurance is not cheap. Even though it is not practicable to implement the changes until October, the cost in 1989–90 is estimated at £1bn, rising to £2.8bn in 1990–1. This is equivalent, in PSDR terms, to a 2 per cent cut in the basic rate of income tax arid, in our post-Budget forecast, precludes further tax cuts in 1990. Unless there is an unexpectedly large rebound in personal savings, the Chancellor is likely to find himself in his present position in a year's time: presiding over a large budget surplus but unable to reduce it significantly for fear of rekindling inflation or aggravating the current account deficit. Simply writing declining numbers for the PSDR into the MTFS offers no genuine guidance on medium-term fiscal policy and may even be positively misleading to financial markets.     

The London Business School with Gower Publishing

The world economy is just starting to emerge from the second trough of a "W-shaped" recession. Compared with the experience after the first oil shock, when industrial production fell by 12 per cent, bringing inflation quickly down from 14 per cent into single figures. the 1980 world recession was mild. Between the first and third quarters industrial output fell 5 per cent; it recovered in the fourth quarter and inflation stopped falling. As a result governments - and this is especially true of the United States - look "another bite at the cherry": monetary policy was tightened and interest rates rose. The effect over the last six months has been to produce a second dip in output. The renewed attack on inflation has, however, been successful and inflation is now well in single figures and falling. Consequently a general easing of policy is evident and a recovery of output in the second half of 1982 and into 1983 remains our forecast.     

The London Business School with Gower Publishing

This forecast release examines the latest monthly indicators. In general they are in line with the detailed forecast published in February; retail sales have recovered from the fall in 1977 and price inflation is firmly in single figures, whilst output is showing only slight signs of recovery. The most disturbing indications are for money supply and the exchange rate. Monetary growth has been above the limit and the exchange rate has drifted in a manner that we did not expect until later this year. These indicators are related and give a clear warning for the Budget strategy. Unless the rate of monetary growth is brought back below 12 per cent it will not be possible to maintain a stable exchange rate. The target of maintaining single-figure inflation would then be virtually impossible.