Academic journal article National Institute Economic Review

The Home Economy

Academic journal article National Institute Economic Review

The Home Economy

Article excerpt


The forecasts were prepared by Bob Anderton, Andrew Britton and Soterios Soteri, but they draw on the work of the whole team engaged in macroeconomic analysis and modelbuilding at the Institute. Parts One and Two of the chapter are written by Andrew Britton, Part Three by Bob Anderton and Soterios Soteri.


Seldom has such close attention been paid to the indicators of economic activity and seldom have economic and political commentators been so preoccupied with short-term forecasting. It seems right on this occasion to reinforce our customary warning that the interpretation of recent statistics, and their projection even a few months into the future, is always an imprecise and hazardous exercise. This is true whether one attempts to follow a scientific methodology based on an econometric model or whether one prefers to rely on market sentiment, informed anecdotes or surveys of business confidence.

Recent developments and their interpretation

A somewhat clearer picture is now emerging of the state of the economy in the latter half of last year. The fall in output at the time is accounted for, in the latest national accounts, by lower consumption and fixed investment partly offset by an end to destocking. We would interpret the positive stockbuilding in the non-manufacturing sector in the third and fourth quarters as an involuntary consequence of an unexpected contraction of demand. As such it would point to a further fall in activity in the early part of this year.

The fall in consumer spending occurred despite a continuing rise in real personal disposable incomes. In the latter part of last year rpdi was up 3 per cent on a year earlier, but the whole of that increment was devoted to extra saving. Part of the explanation may lie in the sharp fall in the net wealth of the personal sector, although it would be unusual for this to have such a quick effect on household spending. An additional factor was the state of the housing market, where turnover was exceptionally low and prices falling in real terms. Credit conditions were also getting tighter, with the stock of consumer debt hardly keeping pace with inflation.

In the early months of the year retail sales have fallen further (although the preannouncement of a rise in VAT brought some purchases forward into March). It seems likely that consumer spending fell again in the first quarter. It may seem that the response of consumers to repeated and well-publicised cuts in interest rates is disappointingly slow, but the delay is not out of line with previous experience.

Fixed investment also fell in the latter part of last year. The housing market had been depressed for some time, and even now when turnover is beginning to improve builders are in no hurry to increase new construction. There has also been a very general fall in industrial investment, both in manufacturing and elsewhere.

Our model equation for manufacturing investment now fits the downturn remarkably well. The explanation is based on the fall in capacity utilisation, and on the decline in profits which would already have been evident to businesses by last summer, coupled with excessive borrowing in the late 1980s which left balance sheet positions very fragile - picked up in our model by a measure of |disequilibrium net liquidity'. The negative effects of these variables on investment are likely to intensify this year. The CBI Industrial Trends Survey throughout last year was pointing to a fall in investment, in both buildings and new machinery. There was a further sharp deterioration in the surveys conducted in January and April of this year.

The fall in investment has not been confined to manufacturing industry. Separate figures are no longer available for distribution and other services, but the suggestion is that the strong upward trend in investment by these sectors may now be in reverse, and there is no reason to be confident that it will revive the same pace even when the present recession is at an end. …

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