Prospects for the UK economy.

Kirby, Simon ; Whitworth, Rachel

The production of this forecast is supported by the Institute's Corporate Members: Bank of England, HM Treasury, the Office for National Statistics, Santander (UK) plc and by the members of the NiGEM users group.

Introduction

The economic news flow since the publication of our July Review has been predominately negative, focusing on the deteriorating Euro Area sovereign debt crisis. (1) This has added to further disappointing data on UK domestic activity. Quarterly economic growth has averaged just 0.3 per cent in the first three quarters of 2011 (see figure 1). (2) Anaemic GDP growth is due to both the public and private sectors simultaneously consolidating their balance sheets. Looking ahead, the crisis in the Euro Area will play a central role. We expect the UK economy to expand by 0.9 per cent this year and 0.8 per cent in 2012, before increasing by 2.6 per cent in 2013. This will be the most protracted recovery since the end of the First World War (see figure 2).

The forecasts we present here include significant revisions to those published in the July Review. Our forecast for this year has been lowered from 1.3 to 0.9 per cent. Half this revision is due to in-year revisions to data by the Office for National Statistics (ONS). The remaining half is due to weaker economic growth in the second half of this year than we had expected. We have revised down our forecast for 2012 by 1.2 percentage points. Of this downward revision, 1/2 percentage point is due to the downward revision of the second half of 2011 in comparison to our July forecast. A large part of the slowdown is due to weak domestic demand, which in turn is due to developments in international financial markets. UK equity prices have fallen by 11 per cent since July, with bank stocks in particular down around 19 per cent. The spread of corporate bonds over 10-year gilts in the UK has widened significantly over the past few months to levels last seen in 2009. We view this shadow price of borrowing as an indicator of general lending conditions for the corporate sector. As figure 10 in the World chapter in this Review shows, this tightening of lending conditions would imply a reduction in UK GDP growth of over 1 percentage point next year. There are of course offsetting factors; oil prices have fallen $13 per barrel since their April peak, while the Monetary Policy Committee (MPC) has announced a further round of quantitative easing (QE).

As figure 1 shows, we expect the UK economy to stagnate at the end of this year and in the first quarter of next year. The sharp slowdown does not persist for long due to the key assumption that the Troika (the International Monetary Fund, the European Central Bank and the European Commission is able to contain the crisis engulfing the Euro Area. This core assumption is discussed in more detail in the World chapter in this Review but, as it makes clear, a successful resolution of the crisis is far from certain. Policy failure in the Euro Area would have severe implications for the world and UK economies.

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Even with this base scenario, a best case, the probability of the UK re-entering a period of contraction has increased significantly. At the current juncture we give just under an even chance of the UK experiencing a 'technical recession' in the short term. (3) The current approach to the Euro Area sovereign debt crisis appears to be closer to the 'muddling through' scenario reported in Holland and Kirby in this Review. Under this scenario the probability of recession in the UK is around 70 per cent. These probabilities are conditional on our baseline forecast and do not factor in policy responses beyond allowing the automatic stabilisers to operate and a conventional monetary policy response. (4) The baseline discussed here does, however, incorporate the effect of an additional 75 billion [pounds sterling] of QE announced by the Monetary Policy Committee (MPC) in October.

We assume that policymakers are able to resolve the Euro Area sovereign debt crisis. This would help to ease lending conditions as well as reduce firms' uncertainty about future demand leading both to the inventory and investment cycles turning. Robust growth in business investment and the rebuilding of inventories are expected to contribute to above trend growth in 2013. Consequently we have revised up our forecast of GDP growth for 2013 by 0.3 percentage point to 2.6 per cent. The contribution to GDP growth from the replenishing of inventories is only a temporary phenomenon; we do not expect a contribution from the change in inventories after 2013. As such, the rate of economic growth is expected to dip slightly, but still to remain above our estimate of the trend rate of around 2 per cent per annum.

Estimates suggest that we are currently around 4 per cent below this peak (see figure 2). While the peak-to-trough fall in output in this Great Recession was not as severe as in the Great Depression, or the 1920s recession in the UK, the progress towards recovery to the pre-recession peak has been slower. We expect this to be the most protracted recovery since the end of the First World War. The level of output is forecast to return to its pre-recession peak at the end of 2013.

The stance of monetary policy in the UK has been loosened further with the introduction of another round of asset purchases, funded by the creation of central bank reserves. The MPC voted unanimously at their October 2011 meeting to purchase an additional 75 billion [pounds sterling] of assets over a four month period. (8) In addition the deterioration of the economic outlook has led financial markets to delay their expectation of when the MPC might first raise Bank Rate from its historical low of 0.5 per cent (see figure 3).

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These market expectations for interest rates have shifted even as the rate of inflation has risen further. CPI inflation reached 5.2 per cent per annum in September 2011. However, we do expect the rate of inflation to begin to fall back next year as the increase in the standard rate of VAT and rapid import and commodity price rises drop out of the calculation (see figure 4). The rate of inflation is expected to decelerate over the course of 2012, moving below target by the end of the year. As the effects of the temporary factors disappear, spare capacity in the economy will put downward pressure on the rate of inflation. However, as figure 4 clearly shows, there are large uncertainties around the outlook for inflation. The effect of QE on the economy poses an unquantifiable inflationary risk for the UK. However, the weakness of aggregate demand at the current juncture does warrant the use of an additional stimulus.

The Chancellor has stressed that the Bank should consider expanding its balance sheet through the acquisition of corporate bonds and commercial paper rather than focusing on the purchases of gilts on the secondary market. If the Bank behaves as in previous asset purchases then most, if not all, asset purchases will be gilts. But the government is looking at alternative measures. One such measure is credit easing. On the face of it credit easing differs little from QE, aside from the fact that it is gilts which are issued to fund asset purchases rather than the issuance of central bank reserves. (6) Indeed, this would be the case if the government were to expand its balance sheet through the purchase of corporate bonds and commercial paper.

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Posen (2011) argues for two quite different approaches. One is the creation of a public sector bank to lend to small and medium sized enterprises (SMEs). The other is a structured investment vehicle to purchase and securitise the debt of small businesses. While we fully support such proposals, the analogy to US government agencies is misplaced. (7) This investment vehicle is likely to be an official government body which, by definition, indicates that the markets in which it will purchase assets are illiquid. (8) The credit risk ought to be considered a contingent fiscal liability and therefore equivalent to fiscal policy.

The government can take this opportunity to address remaining concerns in the financial sector. New financial regulations do not come into force until 2019 so new institutions to deliver credit easing ought to have permanency and be consistent with wider structural changes to the financial systems. The UK financial system is likely to end up quite different from its form in 2007. Funding costs of banks remain high and the problems facing the Euro Area will inevitably affect UK banks. The funding costs for some large banks are high enough that non-financial corporations can raise money and lend to banks rather than the other way around. Although holdings of sovereign debt in periphery countries is low, exposures to the private sector in these countries is significant. The rise in market risk of UK banks suggests a tightening of credit conditions ahead.

While there is evidence that SMEs face borrowing constraints, credit easing will not address the fundamental drag on business investment; uncertainty with regards to future aggregate demand. Businesses understand well the adjustments the household sector and now major trading partners must go through. This is a classic coordination failure. Having chosen an immovable fiscal course, the ability to reduce uncertainty surrounding demand does not seem to be in the hands of UK policymakers. But the government has fiscal policy options if it chooses to provide some limited support.

The consolidation of the public finances is a medium-to-longer-term issue that the government must address. The overall plan that the government has introduced since the Emergency Budget of June 2010 has credibility in addressing this issue. It is unfortunate that the consolidation has started so early on such a scale. In the presence of deficient demand, the government should look to boost spending temporarily through fiscal policy, especially when deficient demand is largely a consequence of the deleveraging of the private sector, and monetary policy is limited to QE in its policy response. This is not the time for the government sector to exacerbate this adjustment.

If the Chancellor will not adjust overall consolidation plans, options still remain. A short-term fiscal expansion would not put at risk the credibility of the government's fiscal consolidation plan. Fiscal multipliers vary by instrument and by time. The largest multiplier is typically from government expenditure and where output is depressed. The government has capital expenditure plans for the next five-year period. Bringing

some of the plans forward would help to boost economic growth without additional spending within the life of the government's consolidation plan. Capital expenditure would also provide a short-term boost to the construction sector. Output of the construction sector is currently 10.7 per cent below the level seen in the first quarter of 2008.

Alternatively, the Chancellor could use the tax system in order to introduce a timely temporary fiscal expansion. Table 2 reports the effect on GDP from a temporary tax cut to household's direct taxes or indirect taxes derived from simulations using our global econometric model, NiGEM. In the base case indirect tax cuts have a larger effect on GDP than a direct tax cut. In a scenario where households are more borrowing constrained, the effect of a direct tax cut over the course of a year is similar. In the case of a targeted tax rebate the effect is even greater, increasing GDP by 0.44 per cent. If this tax rebate were targeted towards the middle and lower end of the income distribution the effect could be even greater.

We expect the deficit on the current budget to be greater than previously forecast in the short term. But much of this can be viewed as cyclical, due, in part, to the operation of the automatic stabilisers. This suggests that overall the position of the public finances remains unchanged. As in our July forecast, we still expect a cyclically adjusted current budget deficit in 2015-16. But the evaluation of the primary target of a balanced cyclically-adjusted current budget has moved on an additional fiscal year to 2016-17. In this year we do expect the primary target to be achieved, but with odds that are only slightly better than even. However, we do not currently expect the government to hit its secondary debt target. This should not be interpreted as a need for additional fiscal consolidation. There are large uncertainties around the forecasts for fiscal aggregates. A more robust economic recovery in future years or even asset sales could ensure the secondary target is also met.

Prices and earnings

The rate of consumer price inflation in the UK has remained considerably above target into the third quarter of this year, continuing the trend seen throughout 2010 and 2011 that was prompted by the rate of increase in crude oil and other commodity prices. The annual rate of CPI inflation reached 5.2 per cent in September 2011, up from 4.5 per cent in August, and aside from September 2008 which recorded the same figure, the rate of CPI inflation has not been higher since the measure was introduced in 1997. The rate of RPI inflation recorded 5.6 per cent in September, the highest rate since June 1991.

These recent figures mostly reflect the significant rate of energy price inflation faced by domestic consumers. The annual rate of energy price inflation reached 18.1 per cent in September 2011. Energy price inflation has been running well ahead of goods and services price inflation since the end of 2010 (see figure 5). Housing and household services, which include the impact of gas and electricity charges, contributed 1.1 percentage points to CPI inflation in the twelve months to September. Average gas and electricity bills have increased by 22.3 and 12.9 per cent in the twelve months to September 2011, respectively. These high rates of utility bill inflation are one of the manifestations from the rapid increase in oil prices over the past year. In the third quarter of this year oil prices were growing at a rate of 40.9 per cent per annum when priced in sterling. Upward pressure on the price of oil reflects long-run forces such as increasing global demand exerted by economies such as China, as well as the short-run supply concerns prompted by the 'Arab Spring'. Oil prices were the driver behind the high inflation figures seen in September 2008, and the more recent oil price rises are continuing to exert upward pressure on inflation in the UK through input prices, but also because oil prices are a key driver of prices in energy markets.

British energy prices are mainly driven by gas prices. Reliance on imports of gas means that the price of gas in the UK is increasingly susceptible to global influences such as the price of oil, with which European gas prices are strongly linked. Around 35-50 per cent of electricity is produced through burning gas according to the Office for Gas and Electricity Markets, which means that electricity prices are also influenced by these same events. Around 50 per cent of fuel costs feed through into wholesale electricity prices. Thus the upward pressure in inflation exerted by energy prices very much depends on the future path of oil prices. Oil prices are expected to increase at a much more muted pace in 2012, contributing to a deceleration in the rate of consumer price inflation. We expect CPI inflation to fall below target next year, remaining close to target over the next few years. The evolution of oil prices has both upside as well as downside risks to the outlook for inflation. There are concerns with regard to the upward effect that quantitative easing might have on inflation. Figure 4 reminds us that there are also downside risks to inflation stemming from deficient demand, especially deficient domestic demand.

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The magnitude of September's inflation figures is of particular significance given that the rate of CPI inflation recorded for this month is expected to be used in the calculation of April's rise in the basic state pension and benefits claimed by those of working age. The rate of RPI inflation is the measure typically used in pay setting; with a weakening labour market it is unlikely that we will see wage growth pick up sharply in response to this. There has certainly been no evidence of accelerating wage inflation. As figure A2 shows, both public and private sector wages have been growing at around 2 per cent per annum throughout this year. We expect real consumer wages to continue to fall through the rest of this year as the labour market weakens further. The response of wages has enabled unit labour costs to be relatively well contained, despite the weakness in demand and the extent of labour hoarding that has occurred to date. Growth in unit labour costs is expected to accelerate from 0.9 per cent per annum in 2011 to between 1 1/2 and 2 per cent per annum over the period 2012-16. Underpinning this are real product wages increasing at a rate of around 1 per cent per annum. Any stronger real product wage growth would pose a downside risk to our labour demand projections, given the low rate of productivity growth we expect over the next few years.

Components of demand

Following the pattern of weak domestic demand but robust external demand seen in the early part of the year, the second and third quarters suggest a reversal as domestic demand components have tentatively started to strengthen and in contrast net exports have slumped. The latest Quarterly National Accounts have incorporated a number of methodological changes as well as a number of additional data sources (see Everett, 2011). Consequently, the profile of economic growth throughout the recent crisis, recession and recovery has been altered. Specifically, annual real GDP growth in 2007 has been revised upward from 2.7 per cent to 3.5 per cent, mainly due to changes in household consumption and net trade which saw their respective contributions rise by 0.4 percentage points. Secondly, revisions to GDP estimates for 2008 mean that the extent of the contraction in the economy is significantly larger than previously estimated. The contraction in 2008 is now estimated to have been 1.1 per cent rather than 0.1 per cent per annum. The ONS notes that this is chiefly attributable to new information on company profits from HM Revenue and Customs (HMRC), which adversely affects the income measure of GDP.

As a result of these changes, the economy now appears to have fared worse through the recession and subsequent return to growth than estimated in the previous vintage of data. The higher starting point in 2007 and stronger contraction in 2008 mean that the downturn was much sharper than initially thought. The peak-to-trough fall in GDP throughout is now estimated to have been 7.1 per cent rather than 6.4 per cent (see figure 2). Throughout 2009, growth is now estimated to have returned slightly earlier than previously estimated, and is now around 0.3 percentage points higher since the second quarter of that year. Nevertheless, the profile of growth since the third quarter of 2010 has been weak.

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Domestic demand, which has posed a significant drag on growth through the first half of the year, showed signs of improvement through the second and third quarters. Decomposing demand into its various components shows that private investment and consumption posed a drag on domestic demand in the first quarter of 2011, and the negative contribution from changes in inventories over that quarter suggested that, due to pessimistic demand conditions in the economy, firms were depleting stocks rather than continuing production. But since the second quarter of this year, it appears that private investment and production may have begun to pick up again. However the contribution from inventories figures reported in figure 6 is misleading as it includes the quarterly alignment adjustments; after accounting for these (see figure A3), the contribution of inventories to domestic demand was -0.1 percentage point.

The data for changes in inventories were substantially changed in the latest vintage of data. Figure A3 illustrates the contribution changes in inventories have made to GDP according to both the June 2011 and October 2011 vintages of Quarterly National Accounts. Excluding the alignment adjustments, changes in inventories have been less volatile through 2007 and early 2008, contributing less to swings in output over this period than initially estimated. However, the vast declines seen in 2008, and in particular the depletion of inventories in the fourth quarter of that year, were much stronger than previous data suggested, contributing to the more severe contraction in output than previous estimates suggested.

The coalition's plans for fiscal consolidation are also a factor weighing down on consumer sentiment and dampening domestic demand. Throughout the first half of this year, government consumption continued to make a small but positive contribution to demand growth of around 0.2 percentage point. Given the government's plans for real-term spending cuts these positive contributions are not assumed to persist. We assume real government expenditure contracts as set out in the Office for Budget Responsibility's most recent Economic and Fiscal Outlook. General government consumption is expected to contribute 0.4 percentage point to GDP growth in 2011, before subtracting 0.2 percentage point in 2012 and around 1/2 percentage point in the subsequent three years.

Gross fixed investment is expected to subtract from GDP growth this year and next. The government's plans are for real general government investment to contract in each year through to 2015. As discussed above, we also expect private sector investment to contract next year due to the effect of the sharp rise in the corporate bond spread and the uncertainty about future demand. Overall gross fixed investment is expected to fall by almost 5 per cent next year, subtracting almost 3/4 percentage point from GDP growth. Weakening demand is also expected to result in firms reducing their inventories over the next two quarters, depressing GDP growth further. A recovery in gross fixed capital formation will support more robust growth in subsequent years. We expect gross fixed investment to expand by 5 3/4 per cent in 2013, rising to over 7 per cent in 2014, contributing 0.8 and 1.1 percentage points to GDP growth, respectively. The rebuilding of inventories is expected to contribute 0.3 percentage point to GDP growth in 2013. Overall the domestic demand is expected to contract by 3/4 per cent this year and 1/2 per cent in 2012, before expanding by 2 per cent per annum, on average, over the period 2013-15.

The volume of export growth bounced back strongly in 2010 by 6.2 per cent. Export volumes are expected to grow by almost 5 per cent this year. Weaker demand for UK exports next year is expected to lead to a sharp slowdown in the rate of export volume growth. In addition, UK exporters' price competitiveness fell by around 4 per cent this year despite the fact that the sterling effective exchange rate has proved to be relatively stable, further reducing the rate of growth in export volumes. It would appear that UK exporters have continued to boost their export margins through price increases rather than gain market share. We forecast export volume growth of just 1 3/4 per cent next year, weighed down by the weakness of demand in the Euro Area. Export volume growth is forecast to accelerate into 2013 as global growth recovers. We assume exporters do not continue to use a lower exchange rate to boost margins and that UK exports gradually gain price competitiveness over the period 2013 to 2016.

Despite weakening export volume growth, net trade is forecast to contribute 1 1/2 percentage points to GDP growth this year and 1.3 percentage points in 2012. This is due to the evolution of import volumes over the next couple of years. With firms reducing their inventories and a fall in capital expenditure we expect import volumes to fall by 0.2 per cent this year and by 2 1/2 per cent in 2012. As the UK economy recovers to a period of more robust growth, import volume growth is expected to accelerate to around 5 1/2 per cent per annum in 2013 and 2014. With export volumes continuing to outstrip import volume growth the contributions from net trade are expected to remain positive, but of a diminishing magnitude.

These positive contributions from net trade are expected to underlie a more balanced economy. In the second half of 2010 the deficit on the trade account was equivalent to 3.1 per cent of GDP. It has narrowed significantly in the first half of 2011, to an average of 1.7 per cent of GDP. The improvement in the trade balance is due to an increase in the surplus on the services trade account (see figure A4) rather than a narrowing of the deficit on the goods account. We expect the current account to improve from 1.2 per cent of GDP in 2011 to around 1/2 per cent of GDP in 2012. By 2012 our forecast shows a current account close to balance. As long as the UK enjoys a surplus on its services trade account and its income account a rebalancing of the economy is not dependent on the goods account moving into surplus. Rather, we expect the deficit simply to narrow.

Household sector

Most of 2011 has witnessed high rates of inflation, low wage growth and tight credit conditions which have all combined to erode consumer purchasing power. On a quarterly basis real disposable income has been falling, or at best growing very weakly, since the second quarter of 2010, due to inflation outpacing nominal wage growth. Previously ONS estimates suggested real disposable income declined for the first time in thirty years in 2010. The ONS has changed its deflator methodologies, with the household sector deflated by the CPI rather than the RPI. With this methodological change, and revisions to net property income, the ONS no longer estimates that real disposable incomes fell in 2010 (se figure A6). Even so the current vintage of data estimates that real disposable incomes grew by 0.1 per cent in 2010, which is the weakest annual growth rate since 1982, and is well below the average annual growth rate of 0.6 for the 2007-10 period.

Myers (2011) notes that, throughout 2008 and 2009, real disposable incomes were boosted by automatic fiscal stabilisers in the form of increased government transfers and lower taxes. A further boost in 2009 was increased net property income resulting from lower mortgage payments as the economy responded to stimulatory monetary policy. In 2010 employee compensation picked up from the weak growth rates it experienced in 2008 and 2009. This compensation boost came through expanding employment rather than wage growth, but clearly this was not enough to offset the detrimental effect of high inflation in eroding personal incomes.

As inflation has continued to be sustained well above the 2 per cent target throughout 2011, we forecast a decline in real personal disposable incomes of around 1 3/4 per cent. This reflects the poor growth of employee compensation over this year; over the period from June to August 2011, regular pay only rose by 1.8 per cent on a year earlier, well below the 4-5 per cent annual rates of inflation of goods and services we have seen over the past year. However this is only a temporary setback, as we forecast real incomes to begin to grow again from 2012 as inflation begins to fall back towards the 2 per cent target rate and employee compensation rises. Over the period 2013-16 we expect real disposable incomes to grow by 2.4 per cent per annum. In per capita terms we expect growth of 1.7 per cent, 1/2 percentage point below the rate of growth in the decade prior to 2008.

Consumer spending has contracted by 0.6 per cent per quarter in the first two quarters of this year and is likely to be subdued in the third quarter of this year as well. Retail sales volumes, which are equivalent to approximately a third of consumer spending, declined at a quarterly rate of 0.2 per cent in the three months to September 2011. Policy uncertainty is likely to weigh down on consumer confidence. Overall we expect consumer spending to decline by 1 per cent this year. Weak real income growth, falling real house prices and a higher average propensity to save in response to the heightened uncertainty are expected to limit the rate of increase in consumer spending to 1 per cent per annum next year. But as real incomes rise at a faster pace, consumer spending will grow by 2 to 2 1/2 per cent per annum over the period 2013-15.

The current vintage of data suggests households increase their rate of saving far more than previously thought over the course of the Great Recession. The household saving ratio peaked at 9.4 per cent in the second quarter of 2009 before dropping back somewhat. The household saving ratio reached 7.4 per cent in the second quarter of this year, up from 5.9 per cent in the first quarter. This is noticeably higher than the average saving ratio of 4.5 per cent in the decade prior to the onset of recession in the second quarter of 2008. That the household sector has addressed the balance sheet weakness more fundamentally than previously thought is to be welcomed. We expect the average saving ratio to remain at around 7.1 to 7.4 per cent over the forecast horizon as households continue to strengthen their balance sheets. Despite this upward revision to household saving, deleveraging by the household sector has been broadly unrevised. The household debt to income ratio has still only fallen from a peak of 1.7 in the first quarter of 2008 to 1.5 in the second quarter of 2011. We expect the debt to income ratio to fall further over the medium term, partly due to a persistent weak housing market. But even by the end of 2016 the debt to income ratio is still expected to be around 1.3.

The latest Housing Market Survey from the Royal Institute of Chartered Surveyors (RICS) paints a very subdued picture of the UK housing market. Over the three months to September 2011 the balance of surveyors reporting on house price changes was unchanged from the August figure, with 23 per cent more surveyors reporting falls in house prices (although most reported small falls of around 0-2 per cent). The Halifax and Nationwide house price indices both illustrate that house prices have remained broadly flat since early 2010, and this is further supported by our preferred measure, a seasonally adjusted version of the Department for Communities and Local Government mix-adjusted house price index.

The RICS reported that the ratio of the average number of sales per surveyor to the average stock on surveyors' books, which provides a measure of slack in the market, was unchanged between August and September at 21.1 per cent. However, the Bank of England reported in its latest Credit Conditions Survey that demand for secured credit for house purchases increased in the third quarter of this year, and that demand for buy-to-let lending rose substantially--tentative indicators that demand for house purchases may start to increase in coming months, posing an upside risk to our house price forecast.

Due to the sluggish behaviour of the market over the past year, as well as reduced household real income and borrowing constraints, we forecast nominal house prices to fall by around 1 per cent in 2011 as a whole. We expect them to decrease further in 2012 and 2013, but this will turn around in 2014, picking up to growth rates of around 3 per cent per annum by 2016.

Supply conditions

The labour market has fared unexpectedly well over the course of the recession, but data for the three months to August suggest it has been sluggish more recently. Following no change in the three month period from March to May 2011 on the previous three months to February, the latest three month period from June to August saw a fall in the employment rate of 0.3 percentage points to 70.4 per cent. The unemployment rate rose 0.4 percentage point to 8.1 per cent over the same period, the highest rate of unemployment seen in the UK since the three months to July 1996. We have revised our forecast for the ILO unemployment rate in 2011 upward by around 0.1 percentage point since July, and now expect the unemployment rate to reach 8 per cent this year. We expect this to peak at 8.9 per cent at the end of 2012, before beginning to recede from 2013 onwards as the economy starts to re-gather momentum.

In particular, youth unemployment is a growing problem in the UK. Unemployment for 16-24 year olds was 21.3 per cent in the three months to August 2011. This figure includes those in full-time education but who are seeking and available for employment. The ONS estimates that excluding those 16-24 year olds that are in full-time education, youth unemployment is around 721,000 (an increase of 78,000 from the previous three month period), or 20.2 per cent of the economically active population. A situation where one in five youths is unable to find employment, is adequate reason to be concerned about the scarring effect this will have on that cohort of the labour market, affecting both individual employability in the long run and the productivity of the labour market in aggregate (see Bell and Blanchflower, 2010, for discussion of the scarring effects of unemployment).

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In Holland et al. (2010a and b) we have analysed the remarkable performance of the labour market given the poor economic growth experienced since the crisis in 2007. Labour hoarding by firms, facilitated by flexible real wages, has buoyed up employment but at the expense of productivity. Between the first and second quarters of 2011, output per worker was unchanged but output per hour increased by 1.3 per cent. Output growth was broadly flat between those two quarters, and this increase in output per hour is thus attributable to an unusually large drop in hours worked over those two quarters. It was also focused in the manufacturing sector, for which output per hour increased by 3.7 per cent over this period. Much of this fall in hours worked is attributable to the additional holiday associated with the Royal Wedding. Initial estimates of hours worked across the whole economy in the third quarter of the year suggest that average hours worked have recovered. We expect labour hoarding to result in weak productivity growth this year and next at just under 1 per cent and 1/2 per cent, respectively. As the economy rebounds in 2013 we expect productivity growth to rise to just over 1 per cent, but it is only over the medium term when productivity growth returns to 2 per cent per annum. There is a risk that firms will try to boost productivity growth more quickly at the expense of employment growth. Under this scenario unemployment would not moderate as quickly as reported in figure 7 and table A7.

ONS methodological changes following new information on profits from HMRC have led to a downward revision of the data on corporate profits in the years 2008 and 2009. Despite these downward data revisions, firms are still relatively profitable. Furthermore, the corporate sector is a net lender to the rest of the economy, indicating balance sheets that have a significant amount of cash. However, clearly this is not being translated into investment. One of the main factors depressing investment is uncertainty regarding demand. In addition, net lending to SMEs is falling. In the latest Trends in Lending, the Bank of England notes that the stock of lending to business and SMEs declined in the three months between June and August this year, and has in fact been declining over the past two or three years since 2009. We expect business investment to fall by 3 1/2 per cent next year due mainly to the tighter lending conditions as indicated by the rise in the spread of BAA corporate bonds over gilt yields (figure 9 in the World chapter of this Review). This upward pressure on the user cost of capital is assumed to be temporary. As the user cost of capital is lowered again, and the uncertainty about demand is reduced, we expect business investment to grow by around 7 per cent per annum in 2013 and 2014.

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Housing investment has similarly suffered from an inability to raise adequate finance to fund investment opportunities, and therefore its recovery has been faltering. Housing investment remains a long way off its pre-recession peak. A significant proportion of housing investment was actually the transfer costs of non-produced assets. These are such things as estate agents' and surveyors' activity. The housing market remains subdued, depressing the level of activity that these costs measure. Figure 8 plots the number of housing transactions over 40,000 [pounds sterling] in value in the UK. It is clear that at the end of 2007 transactions plummeted and remain at around half the level seen prior to this. Housing investment is expected to fail by 2 1/4 per cent next year, before rising at 9 per cent and 12 3/4 per cent, in 2013 and 2014 respectively. Despite robust rates of growth the level of housing investment in the UK is not expected to reach the level seen in 2007 until after 2016. It is possible that the planning reform at the centre of the government's Plan for Growth could support a robust increase in housebuilding. Under such a scenario we should expect to see housing and possibly business investment grow at a more rapid pace than presented in table A6, increasing the rate of GDP growth and possibly potential growth.

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Public finances

The position of the public finances continues to improve. For the period over April to September 2011 the current budget deficit stands at 54.1 billion [pounds sterling], a 3.4 billion [pounds sterling] reduction on the deficit for the same period in 2010. Public sector net borrowing fell by 7.5 billion [pounds sterling] over the same period due to a 4.1 billion [pounds sterling] fall in public sector net investment. But the deterioration in the economic outlook in the near term is expected to result in a larger deficit on the current budget than previously expected. In money terms we expect the deficit on the current budget to be relatively flat, at around 105 billion [pounds sterling] in each of the fiscal years 2010-11 to 2012-13. Since we expect nominal GDP to continue to expand, even as the real economy stagnates, the deficit, as a share of money GDP, is forecast to shrink from 7.2 per cent in 2010-11 to 6.7 per cent in 2012-13. This 1/2 percentage point improvement is noticeably less than the 1.6 percentage point improvement expected in our July Review. Over the same period the OBR's forecast, published in March 2011, is for the current budget deficit to shrink from 7.1 per cent of GDP in 2010-11 to 4.5 per cent of GDP in 2012-13 (see figure 9).

It is likely that the near term deterioration in the UK's fiscal position is due to a weakness in economic growth, attributable to cyclical rather than structural factors. That is, much of the deterioration in the fiscal position can be related to the automatic stabilisers. The Chancellor has indicated that he will allow the automatic stabilisers to operate. This underpins our forecast, cushioning the weakening of the economic outlook in the near term. A softening economy is expected to translate into weaker tax buoyancy over the short term. Our forecast for tax receipts depends on our projection for money GDP and its components together with announced policy changes to tax rates. We expect the tax take to increase only modestly, from 37.4 per cent of GDP in 2010-11 to 37.7 per cent in 2011-12 and 2012-13. The tax take will continue to rise as the economy moves into a period of more robust growth from 2013. In addition we assume fiscal drag, which increases the income tax to GDP ratio by 0.1 percentage point per annum.

Despite the assumption that spending on goods and services evolves in line with the government's plans for Resource Departmental Expenditure Limits, total government expenditure is not expected to fall as a per cent of money GDP. Partly, this is due to a weaker projection for the denominator, money GDP, but also an increase in benefit payments due to a rise in unemployment. We expect benefit payments to increase by 7 billion [pounds sterling] this fiscal year, in comparison to our July forecast. (9) Total managed expenditure is forecast to shrink, as a share of money GDP, from 47.1 per cent of GDP in 2011-12 to 41.9 per cent of GDP in 2016-17.

Public sector net borrowing is expected to shrink from 9.4 per cent of GDP this fiscal year to 3.3 per cent of GDP in 2016-17. Even by 2016-17 general government borrowing is still expected to breach the Maastricht criteria. The same applies to government debt. Gross general government debt is projected to rise from 76 per cent of GDP at the end of 2010 to a peak of almost 95 per cent of GDP at the end of 2015.

But the confidence intervals around any forecast of fiscal aggregates are large. Fiscal policy decisions should not be based on point forecasts alone. Rather, the uncertainty inherent around any projections should be acknowledged and incorporated into the Budget process. The government does just this: the Fiscal Mandate tasking the Office for Budget Responsibility with judging whether the government's plans for fiscal consolidation have a greater than even chance of pushing the cyclically adjusted budget balance into surplus over a five year window. (10) We have previously stated that the government would miss its primary fiscal target when evaluated to 2015-16. We continue to expect this to be the case. With the rolling window moving one year onwards to 2016-17 we expect the current budget to move into surplus with a greater than even chance.

[FIGURE 10 OMITTED]

The second target of the Fiscal Mandate is for public sector net debt, as a per cent of GDP, to fall in 2015-16. Our central forecast is for this target to be missed. We expect public sector net debt to increase by 1 per cent of GDP to 83.5 per cent between 2014-15 and 2015-16. Despite this we do not advocate any additional fiscal tightening at this juncture. As noted, confidence intervals around the forecasts for public sector finance aggregates are large, with the public sector net debt forecast no exception (see figure 10). The Chancellor has ample time to respond if outturns actually mirror our forecast. Future asset sales pose significant positive risks to our debt forecasts.

Accumulation

The current account is a measure of whether domestic saving is at a sufficient level to fund domestic investment. Running a persistent deficit indicates that domestic saving is not high enough to finance investment, requiring financing from abroad. The UK has been a persistent borrower since 1983, as indicated by a current account deficit. (11) The latest vintage of balance of payments statistics estimates that the current account has narrowed significantly, to just 0.5 per cent of GDP in the second quarter of 2011. We expect the UK current account deficit to narrow further, moving into balance over the period 2014-16. This is not due to a surplus on the trade in goods balance, which we expect to continue to remain in deficit. A narrowing of the trade in goods deficit is part of the story, but it is also a continued surplus on the UK's income account and trade in services balance. With the UK current account moving into balance we expect the negative net asset position of the UK to shrink as the need for the UK to sell net assets to fund current expenditure disappears.

The sectoral saving and investment projections in table A9 are presented gross of depreciation. It declined from 18.3 per cent of GDP in 2007 to 14.2 per cent in 2009. Gross fixed capital formation as a share of GDP increased to 15.4 per cent in 2010. Given the recent heightening of uncertainty about future demand, we expect fixed investment as a share of GDP to fall back next year to 13 1/2 per cent of GDP. General government investment is forecast to contribute to this fall, but this is consistent with the government's fiscal consolidation plan and has been a feature of our forecast since the publication of the Emergency Budget in June 2010. The change, in comparison to the forecast published in July's Review, is the fall in corporate sector investment. We expect gross fixed investment in the corporate sector to drop to around 7 3/4 per cent of GDP in 2012. As UK economic activity thaws in the second half of next year, business investment is expected to pick up, rising by around 1 per cent of GDP to 8 3/4 per cent, on average, over the period 2014-16. Investment by the household sector is also expected to increase, but at a more modest pace, rising to around 5 per cent of GDP in 2016. This still leaves housing investment below the level seen in 2007, by around 1 per cent of GDP.

The balance of a country's current account gives no indication as to the optimal level of gross fixed investment. We can determine this from our view about the shape of the economy. We assume the UK has a depreciation rate of 5 per cent, while the potential rate of growth is 2.1 per cent per annum. We expect gross fixed investment to rise to around 14 1/2 to 15 per cent of GDP over the medium term, up from 13 3/4 per cent in 2012. This investment over the medium term is enough to sustain a capital-output ratio of 2.1, a slight reduction from the ratio of just under 2.3 enjoyed in 2009.

The expectation of the current account returning to balance over the next few years implies that we expect the saving ratio to continue to rise. We forecast national saving to increase from 12.7 per cent of GDP in 2009 to 15 per cent in 2015 and 2016. This increase in saving is essential if the economy is to rebalance and move onto a sustainable path. An ageing population presents the country with liabilities for future pension and adult care commitments. These future commitments can either be funded out of future incomes, through further increases in national saving beyond what we are currently projecting, or through changes to pension ages reducing the implied liabilities from the retirement of cohorts currently below state pension age. As we have noted previously, the government is aware of these issues, as evidenced by plans to bring forward the increase in the state pension age in the Pensions Bill 2011, and the requirement that the Office for Budget Responsibility evaluates fiscal sustainability.

The medium term

Our projections for the medium term are presented in table A10. The medium-term outlook normally provides an indication of the trend rate of growth of the UK. Our projection for the trend rate of growth is derived from a production function approach. The factor inputs that determine trend growth are capital, labour and energy together with the growth in total factor productivity. Our estimate of the trend rate of growth over the medium term is about 2.1 per cent per annum.

Table A10 reports average GDP growth of 2.6 per cent over the period 2017-21, a figure in excess of our estimate of the trend rate. This is due to the continued response of the economy to the current disequilibria, whereby a significant output gap is closed over the next decade. We would normally expect the output gap to be closed more rapidly than is currently projected, but GDP growth is constrained each year by fiscal consolidation.

The medium term will also be shaped by shocks. But these are, by definition, unpredictable. Demographic changes can be included with some degree of predictability. In their 2010-based population projections, the ONS has revised up the projections for the working age population. In comparison to the 2008-based projections, these suggest that the working age population will be around 60,000 larger in 2017 with the difference rising to 100,000 by 2021. With the naive assumption that increases in the working age population enter average productivity jobs, simulations suggest these increases would raise trend output by almost 0.2 per cent by 2021. The size of the working age population will also be affected by the government's plans to bring forward the increase in the state pension age from the period 2024-6. (12)

We expect public sector net borrowing to average around 2 per cent over the period 2017-21. After steadily rising to 83.5 per cent of GDP at the end of 2016, public sector net debt is expected to fall back over the medium term due to a combination of reduced borrowing and robust economic growth. With the adjustment of the UK economy well under way over the medium term, the government in the next parliamentary term will need to consider additional fiscal consolidation to address two long-term issues: the speed with which the debt stock should be reduced, which is in part intertwined with the long-term sustainability of the public finances. The government is currently discussing the automatic uprating of the state pension age, which will be a significant step forward with regard to both these issues. (13) It is over the longer term that the sustainability of the UK's public finances will need to be addressed, as the Office for Budget Responsibility (2011) highlight.

The medium term will be affected by the introduction of banking legislation designed to implement the Basel III regulatory standards and the recommendations of the Independent Commission on Banking. The government is committed to introducing legislation in this parliamentary term, with the implementation date for banking reform expected to be 2019. A key component of banking reform is the raising of risk-weighted capital adequacy ratios, with greater increases for larger banks. Given the concentration of UK domestic banks, the increase on the basis of current proposals is likely to be close to 5 1/2 per cent of risk-weighted assets. (14) Using our global econometric model, NiGEM, we are able to illustrate the impacts from a gradual increase in risk-weighted capital ratios over the period 2015-19. (15) We assume that capital ratios are raised gradually and at a uniform rate over this period. This gradual increase in bank risk-weighted capital ratios reduces output by around 0.2 per cent over the medium term. (16)

Appendix--Forecast details

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Table A1. Exchange rates and interest rates

 UK exchange rates
 FTSE
 Effective All-share
 2005 = 100 Dollar Euro index

2006 100.76 1.84 1.47 3022.6
2007 102.90 2.00 1.46 3306.3
2008 90.76 1.85 1.26 2728.0
2009 81.19 1.57 1.12 2326.0
2010 81.00 1.55 1.17 2818.3
2011 80.73 1.60 1.15 2937.2
2012 80.61 1.56 1.15 2679.0
2013 81.28 1.56 1.16 2917.7
2014 82.23 1.57 1.18 2928.8
2015 83.13 1.57 1.19 2955.9
2016 84.02 1.57 1.20 3005.2

2010 Q1 79.92 1.56 1.13 2778.8
2010 Q2 80.43 1.49 1.17 2765.9
2010 Q3 82.52 1.55 1.20 2744.2
2010 Q4 81.12 1.58 1.16 2984.1

2011 Q1 81.80 1.60 1.17 3085.1
2011 Q2 80.30 1.63 1.13 3078.9
2011 Q3 80.26 1.61 1.14 2836.0
2011 Q4 80.55 1.56 1.15 2748.8

2012 Q1 80.52 1.56 1.15 2423.0
2012 Q2 80.50 1.56 1.15 2623.3
2012 Q3 80.63 1.56 1.15 2811.4
2012 Q4 80.78 1.56 1.15 2858.5

Percentage changes

2006/2005 0.8 1.3 0.4 16.8
2007/2006 2.1 8.6 -0.4 9.4
2008/2007 -11.8 -7.4 -13.9 -17.5
2009/2008 -10.6 -15.6 -10.7 -14.7
2010/2009 -0.2 -1.3 3.7 21.2
2011/2010 -0.3 3.6 -1.5 4.2
2012/2011 -0.1 -2.4 0.2 -8.8
2013/2012 0.8 0.0 0.8 8.9
2014/2013 1.2 0.1 1.3 0.4
2015/2014 1.1 0.1 1.2 0.9
2016/2015 1.1 0.1 1.2 1.7

2010Q4/09Q4 0.4 -3.3 5.2 11.3
2011Q4/10Q4 -0.7 -1.1 -1.2 -7.9
2012Q4/11Q4 0.3 -0.1 0.3 4.0

 Interest rates

 3-month Mortgage 10-year World Bank
 rates interest gilts (a) Rate (b)

2006 4.8 6.5 4.5 4.0 5.00
2007 6.0 7.4 5.0 4.6 5.50
2008 5.5 6.9 4.5 3.4 2.00
2009 1.2 4.0 3.7 1.1 0.50
2010 0.7 4.0 3.6 1.0 0.50
2011 0.9 4.1 3.1 1.2 0.50
2012 1.0 4.2 2.4 1.4 0.50
2013 0.7 4.1 2.5 1.8 0.75
2014 1.1 4.3 2.7 2.1 1.25
2015 1.6 4.5 2.9 2.5 1.75
2016 2.1 4.8 3.1 3.0 2.00

2010 Q1 0.6 4.1 4.1 0.9 0.50
2010 Q2 0.7 4.0 3.7 1.0 0.50
2010 Q3 0.8 3.9 3.2 1.0 0.50
2010 Q4 0.8 3.9 3.3 1.0 0.50

2011 Q1 0.8 4.0 3.7 1.0 0.50
2011 Q2 0.8 4.0 3.4 1.1 0.50
2011 Q3 0.9 4.1 2.8 1.2 0.50
2011 Q4 1.0 4.2 2.3 1.2 0.50

2012 Q1 1.0 4.2 2.4 1.4 0.50
2012 Q2 1.0 4.2 2.4 1.4 0.50
2012 Q3 1.0 4.2 2.4 1.5 0.50
2012 Q4 0.9 4.2 2.4 1.6 0.50

Percentage changes

2006/2005
2007/2006
2008/2007
2009/2008
2010/2009
2011/2010
2012/2011
2013/2012
2014/2013
2015/2014
2016/2015

2010Q4/09Q4
2011Q4/10Q4
2012Q4/11Q4

Notes: We assume that bilateral exchange rates for the fourth
quarter of this year are the average of the first three weeks of
October. We then assume that bilateral rates remain constant for
the first and second quarter of 2012 before moving in-line with
the path implied by the backward-looking uncovered interest rate
parity condition based on interest rate differentials relative to
the US. (a) Weighted average of central bank intervention rates
in OECD economies. (b) End of period.

Table A2. Price indices

2008= 100

 Unit Imports Exports Whole- World
 labour deflator deflator sale price oil price
 costs index(-) ($)(b)

2006 94.7 88.9 89.5 95.1 63.4
2007 96.4 89.1 89.6 96.5 70.5
2008 100.0 100.0 100.0 100.0 95.7
2009 105.4 103.8 103.3 102.5 61.8
2010 106.6 108.2 107.4 105.6 78.8
2011 107.6 117.1 112.9 109.4 108.7
2012 109.8 119.0 115.7 112.9 113.1
2013 111.4 118.6 116.0 115.2 116.2
2014 113.6 119.4 117.2 116.7 120.5
2015 115.6 120.9 118.7 118.4 124.2
2016 117.4 123.1 120.6 120.2 128.1

Percentage changes

2006/2005 2.6 2.0 2.5 1.5 22.4
2007/2006 1.8 0.2 0.0 1.4 11.2
2008/2007 3.7 12.3 11.7 3.7 35.7
2009/2008 5.3 3.8 3.3 2.5 -35.4
2010/2009 1.2 4.2 4.0 3.0 27.6
2011/2010 0.9 8.3 5.1 3.6 37.9
2012/2011 21 1.6 2.5 3.2 4.0
2013/2012 1.4 -0.3 0.3 2.0 2.8
2014/2013 2.0 0.7 1.0 1.3 3.6
2015/2014 1.8 1.3 1.3 1.4 3.1
2016/2015 1.5 1.8 1.6 1.6 3.1

2010Q4/09Q4 -0.2 5.0 3.3 3.0 13.8
2010Q4/10Q4 2.4 8.9 6.9 4.0 26.7
2012Q4/11Q4 Q4 1.3 -1.5 -0.1 2.8 4.3

 Retail price index
 GDP
 Consump- deflator All Excluding Consumer
 tion (market items mortgage prices
 deflator prices) interest index

2006 94.2 94.8 92.2 92.9 94.3
2007 96.7 97.0 96.1 95.9 96.5
2008 100.0 100.0 100.0 100.0 100.0
2009 101.4 101.7 99.5 102.0 102.2
2010 105.3 104.5 104.1 106.8 105.5
2011 110.0 106.5 109.6 112.4 110.2
2012 112.5 109.2 113.7 115.5 112.8
2013 114.4 111.2 115.8 118.0 114.7
2014 116.4 113.3 118.4 120.7 116.7
2015 118.5 115.3 121.9 123.5 118.8
2016 120.8 117.4 125.8 126.6 121.1

Percentage changes

2006/2005 2.7 3.2 3.2 2.9 2.3
2007/2006 2.6 2.3 4.3 3.2 2.3
2008/2007 3.5 3.2 4.0 4.3 3.6
2009/2008 1.4 1.6 -0.5 2.0 2.2
2010/2009 3.8 2.8 4.6 4.8 3.3
2011/2010 4.5 1.9 5.3 5.2 4.4
2012/2011 2.3 2.5 3.7 2.7 2.3
2013/2012 1.7 1.9 1.8 2.2 1.7
2014/2013 1.7 1.8 2.3 2.3 1.8
2015/2014 1.8 1.8 2.9 2.4 1.8
2016/2015 1.9 1.9 3.2 2.5 1.9

2010Q4/09Q4 4.2 3.2 4.7 4.7 3.4
2010Q4/10Q4 4.3 1.9 5.7 5.1 4.5
2012Q4/11Q4 1.7 2.1 2.5 2.1 1.7

Notes: (a) Excluding food, beverages, tobacco and petroleum
products. (b) Per barrel, average of Dubai and Brent spot prices.

Table A3. Gross domestic product and components of expenditure

[pounds sterling] billion, 2008 prices

 Final
 consumption Gross capital
 expenditure formation

 Gross Changes in
 Households General fixed inventories
 & NPISH(a) gov't investment (b)

2006 903.5 308.7 234.6 4.5
2007 927.5 310.6 253.6 8.3
2008 913.8 315.6 241.4 2.3
2009 881.4 315.4 209.1 -12.1
2010 891.1 320.2 214.5 5.5
2011 882.5 325.5 210.6 1.6
2012 888.8 322.6 200.2 1.8
2013 907.4 316.7 211.9 6.2
2014 927.8 309.1 227.4 6.2
2015 950.3 303.3 240.7 6.2
2016 975.4 302.7 251.7 6.2

Percentage changes

2006/2005 1.8 1.5 6.4
2007/2006 2.7 0.6 8.1
2008/2007 -1.5 1.6 -4.8
2009/2008 -3.5 -0.1 -13.4
2010/2009 1.1 1.5 2.6
2011/2010 -1.0 1.7 -1.8
2012/2011 0.7 -0.9 -4.9
2013/2012 2.1 -1.8 5.8
2014/2013 2.2 -2.4 7.3
2015/2014 2.4 -1.9 5.8
2016/2015 2.6 -0.2 4.6

Decomposition of growth
in GDP(d)

2006 1.2 0.3 1.0 0.0
2007 1.7 0.1 1.4 0.3
2008 -0.9 0.3 -0.8 -0.4
2009 -2.3 0.0 -2.3 -1.0
2010 0.7 0.4 0.4 1.3
2011 -0.6 0.4 -0.3 -0.3
2012 0.4 -0.2 -0.7 0.0
2013 1.3 -0.4 0.8 0.3
2014 1.4 -0.5 1.1 0.0
2015 1.5 -0.4 0.9 0.0
2016 1.6 0.0 0.7 0.0

 Total Total Total
 Domestic imports final imports Net
 demand (c) expenditure (c) trade

2006 1449.0 423.2 1872.1 471.8 -48.6
2007 1499.1 417.5 1917.4 467.6 -50.0
2008 1473.0 422.9 1895.9 462.0 -39.1
2009 1393.8 382.9 1776.7 405.5 -22.7
2010 1431.3 406.5 1837.8 440.2 -33.7
2011 1420.3 426.2 1846.5 439.1 -12.9
2012 1413.4 433.5 1846.9 428.7 4.8
2013 1442.2 465.2 1907.3 452.8 12.4
2014 1470.6 497.7 1968.2 477.2 20.5
2015 1500.5 524.3 2024.8 499.0 25.3
2016 1536.0 547.2 2083.1 520.3 26.9

Percentage changes

2006/2005 2.5 11.7 4.3 10.2
2007/2006 3.5 -1.3 2.4 -0.9
2008/2007 -1.7 1.3 -1.1 -1.2
2009/2008 -5.4 -9.5 -6.3 -12.2
2010/2009 2.7 6.2 3.4 8.5
2011/2010 -0.8 4.9 0.5 -0.2
2012/2011 -0.5 1.7 0.0 -2.4
2013/2012 2.0 7.3 3.3 5.6
2014/2013 2.0 700 3.2 5.4
2015/2014 2.0 5.3 2.9 4.6
2016/2015 2.4 4.4 2.9 4.3

Decomposition of growth
in GDP(d)

2006 2.6 3.2 5.7 -3.2 0.1
2007 3.6 -0.4 3.2 0.3 -0.1
2008 -1.8 0.4 -1.5 0.4 0.8
2009 -5.5 -2.8 -8.3 3.9 1.1
2010 2.7 1.7 4.5 -2.5 -0.8
2011 -0.8 1.4 0.6 0.1 1.5
2012 -0.5 0.5 0.0 0.7 1.3
2013 2.0 2.2 4.3 -1.7 0.5
2014 2.0 2.2 4.2 -1.7 0.6
2015 2.0 1.8 3.8 -1.5 0.3
2016 2.3 1.5 3.8 -1.4 0.1

 GDP
 at
 market
 prices

2006 1401.3
2007 1449.9
2008 1433.9
2009 1371.2
2010 1395.3
2011 1407.9
2012 1419.0
2013 1455.3
2014 1491.8
2015 1526.6
2016 1563.6

Percentage changes

2006/2005 2.6
2007/2006 3.5
2008/2007 -1.1
2009/2008 -4.4
2010/2009 1.8
2011/2010 0.9
2012/2011 0.8
2013/2012 2.6
2014/2013 2.5
2015/2014 2.3
2016/2015 2.4

Decomposition of growth
in GDP(d)

2006 2.6
2007 3.5
2008 -1.1
2009 -4.4
2010 1.8
2011 0.9
2012 0.8
2013 2.6
2014 2.5
2015 2.3
2016 2.4

Notes: (a) Non-profit institutions serving households. (b)
Including acquisitions less disposals of valuables and quarterly
alignment adjustment. (c) Includes Missing Trader Intra-
Community Fraud. (d) Components may not add up to total GDP
growth due to rounding and the statistical discrepancy included
in GDP.

Table A4. External sector

 Exports Imports Net Exports Imports
 of goods of goods trade in of of
 (a) (a) goods(a) services services

 [pounds sterling] billion, 2008 prices (b)

2006 270.4 361.6 -91.2 152.5 110.4
2007 247.2 350.8 -103.7 170.4 116.8
2008 252.0 346.2 -94.2 170.9 115.8
2009 221.7 302.6 -80.9 161.2 103.0
2010 244.5 337.5 -92.9 161.9 102.7
2011 258.7 339.2 -80.5 167.5 99.9
2012 263.4 329.4 -65.9 170.1 99.4
2013 283.7 347.5 -63.7 181.4 105.3
2014 303.7 366.0 -62.4 194.0 111.2
2015 319.2 382.6 -63.3 205.1 116.4
2016 332.4 398.8 -66.4 214.8 121.5

Percentage changes

2006/2005 13.0 11.8 9.3 5.2
2007/2006 -8.6 -3.0 11.7 5.8
2008/2007 1.9 -1.3 0.3 -0.8
2009/2008 -12.0 -12.6 -5.7 -11.1
2010/2009 10.3 11.5 0.4 -0.3
2011/2010 5.8 0.5 3.4 -2.7
2012/2011 1.8 -2.9 1.6 -0.5
2013/2012 7.7 5.5 6.7 6.0
2014/2013 7.0 5.3 6.9 5.6
2015/2014 5.1 4.5 5.7 4.7
2016/2015 4.1 4.2 4.8 4.4

 Export
 Net price World Terms
 trade in competitiveness trade of trade
 services (c) (d) (e)

 [pounds
 sterling]
 billion, 2008=100
 2008
 prices (b)

2006 42.1 100.4 90.8 100.7
2007 53.6 102.8 97.5 100.6
2008 55.1 100.0 100.0 100.0
2009 58.2 94.2 89.1 99.5
2010 59.2 96.1 98.2 99.3
2011 67.6 100.1 104.3 96.4
2012 70.8 99.2 108.7 97.3
2013 76.1 98.3 116.3 97.8
2014 82.9 98.0 123.4 98.1
2015 88.6 97.7 129.3 98.2
2016 93.3 97.3 134.7 98.0

Percentage changes

2006/2005 1.7 8.2 0.5
2007/2006 2.4 7.3 -0.2
2008/2007 -2.8 2.5 -0.6
2009/2008 -5.8 -10.9 -0.5
2010/2009 2.0 10.2 -0.2
2011/2010 4.2 6.3 -3.0
2012/2011 -0.9 4.2 0.9
2013/2012 -0.9 6.9 0.6
2014/2013 -0.3 6.1 0.3
2015/2014 -0.3 4.8 0.0
2016/2015 -0.3 4.2 -0.2

 Current
 balance

 % of GDP

2006 -3.2
2007 -2.5
2008 -1.4
2009 -1.5
2010 -2.5
2011 -1.2
2012 -0.5
2013 -0.3
2014 0.0
2015 0.0
2016 -0.1

Percentage changes

2006/2005
2007/2006
2008/2007
2009/2008
2010/2009
2011/2010
2012/2011
2013/2012
2014/2013
2015/2014
2016/2015

Notes: (a) Includes Missing Trader Intra-Community Fraud. (b)
Balance of payments basis. (c) A rise denotes a loss in UK
competitiveness. (d) Weighted by import shares in UK export
markets. (e) Ratio of average value of exports to imports.

Table A5. Household income and expenditure

 Compen- Total Gross
 Average (a) sation of personal disposable
 earnings employees income income

 [pounds sterling] billion,
 2008=100 current prices

2006 93.7 713.5 1130.0 849.8
2007 98.3 751.9 1181.1 882.4
2008 100.0 771.0 1224.7 915.1
2009 102.7 776.9 1242.2 943.1
2010 106.1 800.0 1283.3 979.2
2011 107.3 814.3 1319.3 1004.4
2012 110.9 837.8 1364.9 1038.2
2013 114.0 871.6 1421.6 1078.3
2014 116.9 911.7 1486.8 1123.5
2015 120.1 949.2 1554.4 1171.1
2016 123.7 986.9 1626.1 1224.6

Percentage changes

2006/2005 4.6 5.3 4.7 4.2
2007/2006 4.9 5.4 4.5 3.8
2008/2007 1.8 2.5 3.7 3.7
2009/2008 2.7 0.8 1.4 3.1
2010/2009 3.3 3.0 3.3 3.8
2011/2010 1.1 1.8 2.8 2.6
2012/2011 3.3 2.9 3.5 3.4
2013/2012 2.9 4.0 4.2 3.9
2014/2013 2.5 4.6 4.6 4.2
2015/2014 2.7 4.1 4.5 4.2
2016/2015 3.0 4.0 4.6 4.6

 Final
 consumption Saving House
 Real expenditure ratio prices
 disposable (c) (d)
 income (b) Total Durable

 [pounds sterling] 2008
 prices per cent 2008=100

2006 901.6 903.5 84.3 3.1 91.0
2007 912.8 927.5 90.5 2.7 101.0
2008 914.9 913.8 91.4 3.1 100.0
2009 929.8 881.4 90.6 7.7 92.2
2010 930.4 891.1 91.4 7.5 98.9
2011 913.3 882.5 86.9 6.8 97.9
2012 922.8 888.8 85.9 7.1 96.1
2013 942.3 907.4 87.7 7.3 95.3
2014 964.9 927.8 89.9 7.4 96.2
2015 988.1 950.3 91.9 7.4 98.2
2016 1013.8 975.4 94.1 7.4 101.1

Percentage changes

2006/2005 1.5 1.8 6.5 6.3
2007/2006 1.2 2.7 7.3 10.9
2008/2007 0.2 -1.5 1.0 -0.9
2009/2008 1.6 -3.5 -0.9 -7.8
2010/2009 0.1 1.1 0.8 7.2
2011/2010 -1.8 -1.0 -4.9 -1.0
2012/2011 1.0 0.7 -1.2 -1.8
2013/2012 2.1 2.1 2.2 -0.9
2014/2013 2.4 2.2 2.5 0.9
2015/2014 2.4 2.4 2.2 2.1
2016/2015 2.6 2.6 2.4 3.0

 Net
 worth to
 income
 ratio
 (e)

2006 7.0
2007 7.1
2008 6.1
2009 6.5
2010 6.7
2011 6.4
2012 6.4
2013 6.3
2014 6.2
2015 6.1
2016 6.1

Percentage changes

2006/2005
2007/2006
2008/2007
2009/2008
2010/2009
2011/2010
2012/2011
2013/2012
2014/2013
2015/2014
2016/2015

Notes: (a) Average earnings equals total labour compensation
divided by the number of employees. (b) Deflated by consumers'
expenditure deflator. (c) Includes adjustment for change in net
equity of households in pension funds. (d) Department for
Communities and Local Government, mix-adjusted. (e) Net worth is
defined as housing wealth plus net financial assets.

Table A6. Fixed investment and capital billion

[pounds sterling], 2008 prices

 Gross fixed investment User
 cost
 Business Private General Total of
 investment housing (a) government capital (%)

2006 121.7 79.8 27.4 234.6 16.7
2007 135.8 82.5 28.9 253.6 16.6
2008 135.9 65.1 34.1 241.4 15.9
2009 118.6 51.2 39.3 209.1 17.3
2010 119.5 54.5 40.5 214.5 14.7
2011 120.2 54.0 36.5 210.6 14.4
2012 116.0 52.8 31.4 200.2 15.4
2013 124.4 57.5 30.0 211.9 14.4
2014 133.0 64.8 29.6 227.4 14.3
2015 137.8 72.6 30.3 240.7 14.4
2016 141.8 78.9 31.1 251.7 14.5

Percentage changes

2006/2005 9.0 16.1 -11.3 6.4
2007/2006 11.5 3.3 5.6 8.1
2008/2007 0.0 -21.1 17.8 -4.8
2009/2008 -12.7 -21.3 15.2 -13.4
2010/2009 0.8 6.4 3.2 2.6
201112010 0.5 -0.9 -9.9 -1.8
2012/2011 -3.5 -2.2 -13.9 -4.9
2013/2012 7.2 9.0 -4.6 5.8
201412013 6.9 12.8 -1.4 7.3
2015/2014 3.6 12.0 2.4 5.8
2016/2015 2.9 8.6 2.5 4.6

 Corporate Capital stock
 profit
 share of Private Public (b)
 GDP (%)

2006 25.1 2286.0 590.0
2007 25.2 2370.0 605.0
2008 25.3 2442.0 621.0
2009 24.9 2473.0 641.0
2010 24.0 2492.6 660.5
2011 24.0 2508.8 675.4
2012 24.5 2516.9 684.9
2013 25.1 2536.2 692.7
2014 25.3 2569.1 699.8
2015 25.6 2611.6 707.4
2016 26.0 2660.9 715.5

Percentage changes

2006/2005 2.5 1.9
2007/2006 3.7 2.5
2008/2007 3.0 2.6
2009/2008 1.3 3.2
2010/2009 0.8 3.0
201112010 0.6 2.3
2012/2011 0.3 1.4
2013/2012 0.8 1.1
201412013 1.3 1.0
2015/2014 1.7 1.1
2016/2015 1.9 1.1

Notes: (a) Includes private sector transfer costs of non-produced
assets. (b) Including public sector non-financial corporations.

Table A7. Productivity and the labour market

Thousands

 Employment Population
 ILO of
 Employees Total (a) unemploy- Labour working
 ment force (b) age

2006 25095.0 29025.0 1674.0 30699.0 37708.0
2007 25212.0 29228.0 1654.0 30882.0 37916.0
2008 25408.0 29440.0 1783.0 31223.0 38090.0
2009 24924.0 28961.0 2394.0 31355.0 38236.0
2010 24852.0 29035.0 2479.0 31514.0 38481.0
1011 25015.0 29178.0 2538.0 31716.0 38725.0
2012 24908.0 29096.0 2760.0 31856.0 38981.0
2013 25186.0 29405.0 2640.0 32045.0 39242.0
2014 25694.0 29938.0 2294.0 32231.0 39505.0
2015 26053.0 30321.0 2095.0 32416.0 39760.0
2016 26295.0 30583.0 1988.0 32571.0 40066.0

Percentage changes
2006/2005 0.7 0.9 14.1 1.5 0.8
2007/2006 0.5 0.7 -1.2 0.6 0.6
2008/2007 0.8 0.7 7.8 1.1 0.5
2009/2008 -1.9 -1.6 34.3 0.4 0.4
2010/2009 -0.3 0.3 3.6 0.5 0.6
2011/2010 0.7 0.5 2.4 0.6 0.6
2012/2011 -0.4 -0.3 8.7 0.4 0.7
2013/2011 1.1 1.1 -4.3 0.6 0.7
201412013 2.0 1.8 -13.1 0.6 0.7
2015/2014 1.4 1.3 -8.7 0.6 0.6
2016/2015 0.9 0.9 -5.1 0.5 0.8

 Productivity Unemployment, %
 (2008=100)
 ILO unem-
 Manufact- Claimant ployment
 Per hour uring rate rate

2006 98.7 97.1 2.9 5.5
2007 101.4 100.0 2.7 5.4
2008 100.0 100.0 2.8 5.7
2009 98.3 97.3 4.7 7.6
2010 99.5 105.2 4.7 7.9
1011 100.4 109.4 4.8 8.0
2012 100.9 112.2 5.5 8.7
2013 102.1 116.1 5.1 8.2
2014 102.6 119.8 4.1 7.1
2015 103.5 123.2 3.6 6.5
2016 105.1 126.6 3.2 6.1

Percentage changes
2006/2005 2.0 5.0
2007/2006 2.7 3.0
2008/2007 -1.4 0.0
2009/2008 -1.7 -2.6
2010/2009 1.2 8.1
2011/2010 0.9 4.0
2012/2011 0.5 2.6
2013/2011 1.2 3.5
201412013 0.5 3.2
2015/2014 0.9 2.8
2016/2015 1.6 2.7

Notes: (a) Includes self-employed, government-supported trainees and
unpaid family members. (b) Employment plus ILO unemployment

Table A8. Public sector financial balance and borrowing requirement

[pounds sterling] billion, fiscal years

 2009-10 2010-11

Current receipts: Taxes on income 337.8 353.3
 Taxes on expenditure 168.2 191.5
 Other current receipts 8.6 5.5
 Total 514.6 550.3
 (as a % of GDP) 36.6 37.4

Current expenditure: Goods and services 330.6 340.6
 Net social benefits paid 188.8 196.4
 Debt interest 31.4 43.5
 Other current expenditure 51.3 54.6
 Total 602.0 635.0
 (as a % of GDP) 42.8 43.1

Depreciation 19.7 20.7

Surplus on public sector current budget(a) -107.2 -105.4
(as a % of GDP) -7.6 -7.2

Gross investment 67.5 59.0
Net investment 47.8 38.3
(as a % of GDP) 3.4 2.6

Total managed expenditure 669.6 694.0
(as a % of GDP) 47.6 47.1

Public sector net borrowing 154.9 143.7
(as a%ofGDP) 11.0 9.8

Financial transactions 28.5 111.5
Public sector net cash requirement 126.4 32.2
(as a % of GDP) 9.0 2.2
Public sector net debt (% of GDP) 53.1 60.8

GDP deflator at market prices (2008=100) 102.3 105.1
Money GDP 1406.3 1472.6

Financial balance under Maastricht (% of GDP) (b) -11.3 -10.2
Gross debt under Maastricht (% of GDP) (b) 68.2 76.0

 2011-12 2012-13

Current receipts: Taxes on income 363.4 377.1
 Taxes on expenditure 200.4 206.1
 Other current receipts 6.1 7.2
 Total 569.8 590.4
 (as a % of GDP) 37.7 37.7

Current expenditure: Goods and services 347.9 352.0
 Net social benefits paid 207.1 217.1
 Debt interest 48.6 50.2
 Other current expenditure 50.1 52.7
 Total 653.7 672.1
 (as a % of GDP) 43.3 43.0

Depreciation 21.9 23.0

Surplus on public sector current budget(a) -105.8 -104.7
(as a % of GDP) -7.0 -6.7

Gross investment 57.7 56.5
Net investment 35.8 33.4
(as a % of GDP) 2.4 2.1

Total managed expenditure 711.4 728.6
(as a % of GDP) 47.1 46.6

Public sector net borrowing 141.6 138.1
(as a%ofGDP) 9.4 8.8

Financial transactions -7.3 -8.0
Public sector net cash requirement 148.9 146.1
(as a % of GDP) 9.8 9.3
Public sector net debt (% of GDP) 69.2 75.8

GDP deflator at market prices (2008=100) 107.1 109.7
Money GDP 1510.1 1564.2

Financial balance under Maastricht (% of GDP) (b) -9.5 -8.8
Gross debt under Maastricht (% of GDP) (b) 82.8 89.1

 2013-14 2014-15

Current receipts: Taxes on income 397.3 419.9
 Taxes on expenditure 214.1 221.6
 Other current receipts 8.5 9.9
 Total 619.8 651.4
 (as a % of GDP) 37.9 38.2

Current expenditure: Goods and services 354.6 354.8
 Net social benefits paid 219.1 224.9
 Debt interest 52.6 54.7
 Other current expenditure 54.4 56.1
 Total 680.7 690.4
 (as a % of GDP) 41.6 40.5

Depreciation 24.0 25.0

Surplus on public sector current budget(a) -84.9 -64.0
(as a % of GDP) -5.2 -3.8

Gross investment 53.7 52.1
Net investment 29.8 27.1
(as a % of GDP) 1.8 1.6

Total managed expenditure 734.4 742.5
(as a % of GDP) 44.9 43.5

Public sector net borrowing 114.6 91.2
(as a%ofGDP) 7.0 5.3

Financial transactions -13.0 -6.0
Public sector net cash requirement 127.6 97.2
(as a % of GDP) 7.8 5.7
Public sector net debt (% of GDP) 80.0 82.5

GDP deflator at market prices (2008=100) 111.7 113.8
Money GDP 1637.4 1706.8

Financial balance under Maastricht (% of GDP) (b) -7.2 -5.5
Gross debt under Maastricht (% of GDP) (b) 92.6 94.3

 2015-16 2016-17

Current receipts: Taxes on income 441.8 462.3
 Taxes on expenditure 230.7 241.4
 Other current receipts 11.2 12.6
 Total 683.6 716.3
 (as a % of GDP) 38.4 38.6

Current expenditure: Goods and services 357.7 364.3
 Net social benefits paid 233.9 243.9
 Debt interest 56.5 58.1
 Other current expenditure 57.8 59.6
 Total 705.8 725.9
 (as a % of GDP) 39.7 39.1

Depreciation 26.0 27.2

Surplus on public sector current budget(a) -48.1 -36.8
(as a % of GDP) -2.7 -2.0

Gross investment 51.5 51.1
Net investment 25.5 24.0
(as a % of GDP) 1.4 1.3

Total managed expenditure 757.2 777.0
(as a % of GDP) 42.6 41.9

Public sector net borrowing 73.6 60.7
(as a%ofGDP) 4.1 3.3

Financial transactions -7.0 0.0
Public sector net cash requirement 80.6 60.7
(as a % of GDP) 4.5 3.3
Public sector net debt (% of GDP) 83.5 83.3

GDP deflator at market prices (2008=100) 115.8 118.0
Money GDP 1779.0 1855.8

Financial balance under Maastricht (% of GDP) (b) -4.1 -3.2
Gross debt under Maastricht (% of GDP) (b) 94.8 94.3

Notes: These data are constructed from seasonally adjusted national
accounts data. This results in differences between the figures here and
unadjusted fiscal year data Data exclude the impact of financial sector
interventions. (a) Public sector current budget surplus is total
current receipts less total current expenditure and depreciation.
(b) Calendar year.

Table A9. Accumulation

As a percentage of GDP

 Households Companies General government

 Saving Invest- Saving Invest- Saving Invest-
 ment ment ment

2006 2.1 6.1 12.4 9.7 -0.2 1.7
2007 1.8 6.1 14.3 10.5 -0.3 1.7
2008 2.0 4.6 15.1 10.2 -1.5 2.2
2009 5.4 3.3 13.8 8.3 -6.5 2.6
2010 5.2 3.6 14.4 9.3 -6.7 2.4
2011 4.7 3.9 14.6 8.3 -6.0 2.3
2012 5.0 3.8 14.1 7.8 -5.9 2.0
2013 5.0 4.1 13.5 8.4 -4.7 1.7
2014 5.1 4.5 12.7 8.7 -3.1 1.5
2015 5.1 4.9 11.9 8.8 -2.0 1.3
2016 5.1 5.2 11.1 8.8 -1.2 1.2

 Whole economy Finance from abroad
 Net
 Saving Invest- Total Net factor national
 ment income (a) saving

2006 14.3 17.5 3.2 -0.8 3.2
2007 15.8 18.3 2.5 -1.6 4.8
2008 15.6 17.0 1.4 -2.3 5.0
2009 12.7 14.2 1.5 -1.5 1.8
2010 12.9 15.4 2.5 -1.6 2.1
2011 13.3 14.6 1.2 -2.5 2.6
2012 13.1 13.7 0.5 -1.6 2.4
2013 13.9 14.2 0.3 -1.l 3.2
2014 14.7 14.7 0.0 -0.8 4.0
2015 15.1 15.0 0.0 -0.5 4.3
2016 15.1 15.2 0.1 -0.3 4.4

Note: (a) Negative sign indicates a surplus for the UK.

Table A10. Long-term projections

All figures percentage change unless otherwise stated

 2008 2009 2010 2011 2012

GDP (market prices) -1.1 -4.4 1.8 0.9 0.8
Average earnings 1.8 2.7 3.3 1.1 3.3
GDP deflator (market prices) 3.2 1.6 2.8 1.9 2.5
Consumer Prices Index 3.6 2.2 3.3 4.4 2.3
Per capita GDP -1.8 -5.0 1.0 0.3 0.1
Whole economy productivity (a) -1.4 -1.7 1.2 0.9 0.5
Labour input (b) 0.4 -2.9 0.5 0.0 0.4
ILO unemployment rate (%) 5.7 7.6 7.9 8.0 8.7
Current account (% of GDP) -1.4 -1.5 -2.5 -1.2 -0.5
Total managed expenditure
 (% of GDP) 43.2 47.4 47.5 47.2 46.8
Public sector net borrowing
 (% of GDP) 4.8 10.9 10.3 9.5 9.1
Public sector net debt (% GDP) 39.0 47.9 56.2 63.8 71.9
Effective exchange rate
 (2005=100) 90.8 81.2 81.0 80.7 80.6
Bank Rate (%) 4.7 0.6 0.5 0.5 0.5
3 month interest rates (%) 5.5 1.2 0.7 0.9 1.0
10 year interest rates (%) 4.5 3.7 3.6 3.1 2.4

 2013 2014 2015 2016 2017-21

GDP (market prices) 2.6 2.5 2.3 2.4 2.6
Average earnings 2.9 2.5 2.7 3.0 3.4
GDP deflator (market prices) 1.9 1.8 1.8 1.9 1.9
Consumer Prices Index 1.7 1.8 1.8 1.9 2.0
Per capita GDP 1.8 1.8 1.6 1.6 1.9
Whole economy productivity (a) 1.2 0.5 0.9 1.6 2.2
Labour input (b) 1.4 2.0 1.4 0.8 0.4
ILO unemployment rate (%) 8.2 7.1 6.5 6.1 6.1
Current account (% of GDP) -0.3 0.0 0.0 -0.1 0.2
Total managed expenditure
 (% of GDP) 45.3 43.8 42.8 42.0 40.9
Public sector net borrowing
 (% of GDP) 7.5 5.7 4.4 3.5 2.1
Public sector net debt (% GDP) 77.4 81.1 83.0 83.5 80.0
Effective exchange rate
 (2005=100) 81.3 82.2 83.1 84.0 86.8
Bank Rate (%) 0.5 0.9 1.4 1.9 2.6
3 month interest rates (%) 0.7 1.1 1.6 2.1 2.8
10 year interest rates (%) 2.5 2.7 2.9 3.1 3.7

Notes: (a) Per hour. (b) Total hours worked.

ACKNOWLEDGEMENTS

The forecast was completed using the latest version of the National Institute Global Econometric Model (NiGEM). Thanks to E. Philip Davis, Dawn Holland and Jonathan Portes for helpful comments and suggestions. Unless otherwise stated the source of all data reported in charts and tables is NiGEM database and NIESR forecast baseline.

The forecast was completed on 26 October 2011.

REFERENCES

Barrell, R., Fic, T. and Liadze, I. (2009), 'Fiscal policy effectiveness in the banking crisis', National Institute Economic Review, 207, January, pp. 43-50.

Barrell, R. Kirby, S. and Davis, E. P. (2010), 'Modelling the UK banking sector', National Institute Economic Review, 214, pp. F67-72.

Barrell, R., Kirby, S. and Hurst, A.I. (2010), 'How to pay for the crisis or macroeconomic implications of pension reform', NIESR Discussion Paper No. 333.

Bell, D.N.F. and Blanchflower, D.G. (2010), 'UK unemployment in the Great Recession', National Institute Economic Review, 214, October, R3-25.

Everett, G. (2011), Method change in the 2011 Blue Book, Office for National Statistics, 29 September.

Holland, D., Kirby, S. and Orazgani, A. (2011), 'Modelling the sovereign debt crisis in Europe', National Institute Economic Review, 217, pp. F37-46.

Holland, D., Kirby, S. and Whitworth, R. (2010a), 'A comparison of labour market responses to the global downturn', National Institute Economic Review, 211, January, pp. F38-42.

--(2010b) 'An international comparison of employment in recovery', National Institute Economic Review, 214, October, pp. F35-40.

Mitchell, J, Weale, M., Solomou, S. (2009), 'Monthly and quarterly GDP estimates for interwar Britain', NIESR Discussion Paper No. 348.

Myers, M. (2011), The impact of the recession on household income, expenditure and saving, Office for National Statistics, 25 October.

Office for Budget Responsibility (2011), Fiscal Sustainability Report. Posen, M. (2011), Speech given at Wotton-under-Edge, Gloucestershire on 13 September.

NOTES

(1) In our July Review a key assumption was that the Euro Area debt crisis was contained with a gradual return to normality (see Holland et al., 2011). This has clearly not been the case to date.

(2) This number is flattered by the bounce-back from a contraction in output in the final quarter of last year, attributed to adverse weather.

(3) The commonly used method to date recessions is two consecutive quarters of falling output. Probabilities are derived from stochastic simulations using our global econometric model, NiGEM.

(4) The Chancellor has announced that the government will undertake credit easing of some kind. This, together with further QE or fiscal stimulus, is an example of policy responses that would reduce the chance of recession.

(5) See the market notice: http://www.bankofengland.co.uk/ markets/marketnotice 111006.pdf.

(6) The risk of losses from the purchase of assets in both instances is ultimately born by the Exchequer, and therefore the taxpayer, given that it is the government's balance sheet that will probably be directly exposed in credit easing, while the assets purchased through quantitative easing have been indemnified by HM Treasury.

(7) However, Posen's analog of securitising SME loans along the lines of US mortgage agencies (before they were required to hold sub-prime) is incomplete as the agencies were originally designed to create preferred mortgage contracts (fully amortising and longer maturity) to reduce re-financing risk and not to take credit risk that others would not accept. Successful agencies in other countries, such as Canada, require private insurance before accepting the loan and even the original US agency mortgages were insured by the Federal Housing Administration. It may be that credit easing can be more effectively delivered by government insurance rather than accepting the entire credit risk.

(8) Although unlikely to affect the primary target given that financial transactions are not included in the deficit figures It could affect the target for reducing public sector net debt, were it not for the fact that financial sector interventions are excluded from the target measure.

(9) The rate of CPI inflation was 5.2 per cent September 2011. This is the inflation rate that will probably be used to up-rate most working age benefits and the state pension in April 2012.

(10) The 5 year window means that we now look at 2016-17 for an evaluation of the current budget balance.

(11) This is on an annual average basis. In the first three quarters of 1997 the UK ran a current account surplus.

(12) This reform has yet to become an Act of Parliament and as such has not been incorporated into the projections presented in table A10.

(13) Barrell, Hurst and Kirby (2009) have argued that extending working lives should be part of the solution to the need for fiscal consolidation over the medium to longer term.

(14) Basel III includes a counter-cyclical capital buffer of 2.5 per cent of risk-weighted assets but we do not include that in this discussion.

(15) A more detailed discussion of the banking sector model can be found in Barrell, Kirby and Davis (2010).

(16) Note the simulation is for an increase in UK capital adequacy only. A global introduction of Basel III is likely to have a slightly more negative effect. With forward looking financial markets the exchange rate 'jumps' downwards in response to an expected loosening of monetary policy in the UK. In the context of a global increase in capital adequacy this positive offsetting effect on output is likely to be less pronounced.

doi: 10.1177/002795011121800110

Table 1. Summary of the forecast

Percentage change

 2008 2009 2010 2011 2012 2013

GDP -1.1 -4.4 1.8 0.9 0.8 2.6
Per capita GDP -1.8 -5.0 1.0 0.3 0.1 1.8

CPI Inflation 3.6 2.2 3.3 4.4 2.3 1.7
RPIX Inflation 4.3 2.0 4.8 5.2 2.7 2.2

RPDI 0.2 I.6 0.1 -1.8 1.0 2.1

Unemployment, % 5.7 7.6 7.9 8.0 8.7 8.2
Bank Rate, % 4.7 0.6 0.5 0.5 0.5 0.5
Long Rates, % 4.5 3.7 3.6 3.1 2.4 2.5
Effective exchange rate -11.8 -10.6 -0.2 -0.3 -0.1 0.8

Current account as -1.4 -1.5 -2.5 -1.2 -0.5 -0.3
% of GDP

PSNB % of GDP 6.9 11.0 9.8 9.4 8.8 7.0
PSND % of GDP 43.9 53.1 60.8 69.2 75.8 80.0

 2014 2015 2016

GDP 2.5 2.3 2.4
Per capita GDP 1.8 1.6 1.6

CPI Inflation 1.8 1.8 1.9
RPIX Inflation 2.3 2.4 2.5

RPDI 2.4 2.4 2.6

Unemployment, % 7.1 6.5 6.1
Bank Rate, % 0.9 1.4 1.9
Long Rates, % 2.7 2.9 3.1
Effective exchange rate 1.2 1.1 1.1

Current account as 0.0 0.0 -0.1
% of GDP

PSNB % of GDP 5.3 4.1 3.3
PSND % of GDP 82.5 83.5 83.3

Notes: RPDI is real personal disposable income. PSNB is public
sector net borrowing. PSND is public sector net debt.

(a) Fiscal year, excludes the impact of financial sector
interventions.

Table 2. The impact on GDP of a temporary 1 per cent
of GDP fiscal expansion

 Increased
 Base borrowing
 case constraints

Direct tax rebate 0.24 0.44
Direct tax 0.17 0.35
Indirect tax 0.25 0.36

Source: Barrell, Fic and Liadze (2009).

Notes: Year one effects, only the direct tax rebate is
delivered in one quarter. The remaining two are
delivered over four quarters.