Duncan’s Economic Blog

Time for some forecasting…

Posted in Uncategorized by duncanseconomicblog on July 10, 2010

So, first proper post in months, where to start?

The outlook for GDP and the question of how realistic the OBR forecasts are seems as good a place as any.

Much was made by Labour in the run up to the election of the notion of a double dip recession and accusations levelled at the Tories that they were putting the recovery at risk.  Now that the cuts have started, does this claim stack up? Are we heading for a double dip?

Now, I’m usually fairly reluctant to put precise forecasts now on paper – how else is an economist to maintain their credibility? I prefer to forecast trends rather than precise outcomes. But in this case I’m happy to make an exception.

As an important caveat, I do not expect the numbers below to be 100%, or even 70%, accurate. But I do think they might turn out to be more realistic than those the OBR seem to be using. Time will tell.

On the first question – will we double dip?

Well – it depends what you mean. If the question is will we get one or quarters of negative GDP growth? I’d say probably, yes. Q3 2010 may be negative, Q4 10 and Q1 11 though will be the real danger as policy changes bite and the inventory rebuilding that has propelled much of growth comes to an end.

To be honest I suspect we have a bigger problem than a quarter or two of relapsing – generally much slower growth.

The table below shows the OBR’s forecast of growth, and importantly the contributions of different parts of the economy to growth, over the next few years (table C3, page 85 of the budget).

2009 2010 2011 2012 2013 2014 2015
Private Consumption -2.1 0.2 0.8 1.1 1.3 1.4 1.4
Business Investment -2.1 0.1 0.8 1 1.1 1.1 1
Dwellings Investment -0.6 -0.2 0.2 0.2 0.3 0.2 0.2
Government 0.8 0.3 -0.7 -0.6 -0.6 -0.6 -0.4
Change in Inventories -1.2 1.2 0.4 0 0 0 0
Net Trade 0.7 -0.5 0.9 0.9 0.7 0.5 0.5
Total -4.5 1.1 2.4 2.6 2.8 2.6 2.7

A few things leap out – the turn in inventories as firms restock is the main, private sector driver of recovery in 2010 and that is a temporary phenomena. The OBR is predicting a boom in both business investment and net exports. They are also predicting fairly string consumption growth.

Over the couple of weeks I plan to discuss each of these components in more detail. But my immediate headlines would be along these lines –

Consumption – the OBR is forecasting consumption to grow at a much faster rate than disposable income, this is driven by a falling household savings rate. I suspect the savings rate will hold up higher as households repair stretched personal balance sheets and banks remain unwilling to lend to finance consumption on anything like the scale we saw pre-recession.

Business Investment – regular readers will now this is something of an unhealthy interest of mine. The OBR are predicting a boom and basing that prediction on a “fall in the cost of capital” because of a cut in corporation tax – if only it was that simple! A terrible example of neo-classical nonsense that ignores the cuts to capital allowances, the ending of the RDAs and the general shift in attitude from BIS. It also ignores the continuing reluctance of banks to finance investment and the state of “animal spirits in the business community.

Net trade – Lower consumption will lead to lower imports, but it’s hard to see the 40% growth in exports over 5 yeasrs the OBR is predicting, especially as 50% of our trade goes to the Euroarea (and here Sterling’s recent strength against the euro will be very unhelpful). Net trade will add to growth (mainly due to lower than expected imports rather than export growth) but not as much as the OBR hopes.

Dwellings investment – It seems reasonable to expect a pick up, but I doubt as fast as the OBR hopes for.

Inventory builds – I’ll give the OBR the benefit of the doubt here and assume that the build up of inventories does indeed continue into 2011 – although that appears to be based on the assumption that businesses will want inventories to be back at 2007 levels, they may settle for lower.

Government – If I’m right on all the above, government will subtract less from GDP. Unemployment will be higher and tax revenue lower, so overall tightening will not be as quick as the OBR expects. The government will still be slashing departmental spending and raising taxes but the automatic stabilisers will counteract some of this.

Putting it all together my best initial guess would be:

2009 2010 2011 2012 2013 2014 2015
Private Consumption -2.1 0.2 0.7 0.8 1 1.1 1.1
Business Investment -2.1 0.1 0.4 0.5 0.6 0.6 0.6
Dwellings Investment -0.6 -0.2 0.2 0.2 0.2 0.2 0.2
Government 0.8 0.3 -0.6 -0.4 -0.4 -0.4 -0.4
Change in Inventories -1.2 1.2 0.4 0 0 0 0
Net Trade 0.7 -0.5 0.7 0.7 0.6 0.4 0.4
Total -4.5 1.1 1.8 1.8 2 1.9 1.9

Not a forecast of perpetual recession but one of slow and sluggish growth.

The consequences of this would likely be unemployment 2-3% higher than forecast by the OBR throughout the period – so peaking around 11% in 2011 and still at 8/9% in 2015.

In terms of the deficit – rather than being cut to 1.1% of GDP by 2015/16 (from a current 10.1%) it would still likely be in the region of 3-5% of GDP and the net debt to GDP ratio would still be rising.

3 Responses

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  1. Mr. Mxyzptlk said, on July 10, 2010 at 5:31 pm

    Sorry Dunc but……

  2. […] I think we face 5 years of sluggish growth and high unemployment. […]

  3. […] downgrades have taken the OBR closer to my own (back of the envelope) forecasts made six months […]

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