THE UK ECONOMY.

Young, Garry

Garry Young [*]

Section I. Recent developments and summary of the forecast

After last year's very modest slowdown in growth, the UK economy now appears to be on the brink of a period of much more rapid expansion. Even those sectors, such as manufacturing and construction, which had been stagnating, have picked up speed since the middle of last year and there are signs that all sectors of the economy will grow strongly this year.

A similar pattern is evident in the world economy. Growth is set to pick up, with those countries like Germany, Italy and the emerging Asian economies, that had been lagging behind the rest of the world, about to expand more quickly.

A general, broadly-based expansion is welcome, but there is a clear danger that it will be too rapid and jeopardise the outlook for inflation. Perhaps the greatest risk is that the apparently benign outlook for inflation in the world economy deteriorates suddenly as the global increase in demand takes effect. Policymakers are more likely to be surprised by such global developments than by those emerging from within their own economies which they monitor very closely. Our own forecast, discussed in the world economy chapter of this Review, is that consumer price inflation in the OECD economies will pick up this year to just under 2 per cent from 11/4 per cent in 1999. There are clearly upside risks to this forecast, although there is little evidence yet from commodity prices of stronger inflationary pressure in the world economy. Oil prices did rise sharply through 1999, but this appears to have been largely due to supply restrictions rather than evidence of rapidly increasing demand.

Even if global inflationary pressure were to strengthen, there would be no need for it to feed through into domestic prices since it can be offset by appreciation in the sterling exchange rate. Indeed the very strong exchange rate of the past three years has helped to create some disinflationary pressure in the UK. Domestically generated inflationary pressure has also been subdued for a number of years, but there is now a significant risk that it will pick up as economic activity expands strongly.

It is useful to scan the various determinants of inflationary pressure within the domestic economy and to consider the extent to which they pose a present threat to the outlook. The main determinants of inflation are generally reckoned to be aggregate demand and supply and expectations of inflation itself: inflation will be at its expected rate when aggregate demand and supply grow in line with each other.

The main component of aggregate demand is household consumption. This is estimated to have grown by 31/2 per cent in 1999. Because this is slightly faster than the growth in household incomes, the saving ratio fell marginally to about 6 per cent of household incomes. The factors underlying household spending are generally very positive. Employment is at record levels and real wages have grown quite strongly in the past year. With a cut in the rate of income tax in the pipeline, households can feel confident that disposable income growth will continue at a robust rate. Confidence is also supported by very buoyant asset prices which mean that household wealth (including housing) is now sufficient to finance seven years' consumption.

House prices are estimated to have been rising at a rate of about 15 per cent p.a. at the end of last year. Clearly this is not sustainable in a low inflation environment, but the momentum behind this increase is likely to continue into 2000 at least. Increases in house prices add to wealth and, to the extent that they lead to more property transactions, also add to spending on consumer durables. Generally then, the factors determining household spending are very positive, suggesting that it will continue to grow at a fast rate in 2000. Anecdotal evidence indicates that spending was strong in the new year sales. But this also draws attention to the widely-reported possibility that spending is now much more price sensitive than it used to be. Certainly, there appears to be such a wide variation in the prices of goods, both over time and across stores, that shoppers have a strong incentive to search for the lowest prices before making a purchase. This has encouraged many stores to offer lowest price guarantees and the Internet revolution is also having some influence in adding to the downward pressure on retail prices. This indicates that fast growth in household spending may to some extent be conditional on the continuation of low retail price inflation.

The second largest component of aggregate demand is gross fixed investment. This is estimated to have grown by about 4 per cent in 1999, driven mainly by 12 1/2 per cent growth in investment in the non-manufacturing business sector. As with household spending, the underlying factors supporting capital spending are very strong; interest rates and the cost of capital are relatively low, the stock market offers a cheap source of equity capital, profitability is high, corporate balance sheets are healthy and economic prospects are good. Despite this, there are some negative influences. First, the recent strong growth in investment might have raised the stock of capital to a level at which firms have sufficient capacity that they do not need to increase capital spending further. There is evidence of spare capacity in manufacturing, but this is less clear in the rest of the economy. Second, downward pressure on profit margins because of intensified competition will reduce the incentive to invest further.

The third largest component of aggregate demand is government consumption. This is now on a sharp upward path as the priorities of the Comprehensive Spending Review (CSR) are implemented. Total managed expenditure is set to rise at an average annual rate of 5 1/2 per cent over the three years starting in April 1999, about 3 per cent per annum in real terms. Government consumption is likely to rise a little more than this, given that spending on debt interest and social benefits are expected to be subdued. Government investment is also planned to rise rapidly, with net investment doubling over the period covered by the CSR. The public finances are discussed in more detail in the Fiscal Report on p. 29. Thus the prospects for growth in each of the three main sources of domestic demand are very good at present. The outlook for external demand has also improved over the past three months. Latest figures suggest that exports jumped by 10 per cent in the third quarter. More importantly, the outlook for the world ec onomy has improved making it easier for British exporters to sell abroad, despite the high exchange rate.

This suggests that aggregate demand growth has the potential to be very strong in 2000. By contrast, aggregate supply may have reached or exceeded its sustainable level. The key factor here is the labour market. Claimant unemployment fell to 1.164 million in December 1999, its lowest level for twenty years. Unemployment on the ILO definition in November was 1.726 million, the lowest level since the late 1970s and almost 200 thousand below its trough in the first quarter of 1990.

While these indicators suggest that the labour market is very tight, others provide a more comforting picture. In particular, the proportion of the working age population who are without work is not particularly low by historical standards. In the past this has proved as reliable a guide to the degree of slack in the labour market as other indicators. This is the measure of slack that is used within the econometric equation that we use to forecast wages. The other determinants of wages within this equation are prices, productivity, taxes and the composition of unemployment to reflect the different influence on wages of the short-term and long-term unemployed.

This particular version of the wage equation excludes a number of factors which are thought to affect wage setting, but have either not been found to be statistically significant in the relationships we have estimated or have been difficult to measure accurately. These include measures of union power, the level of unemployment-related benefits and the toughness of the benefit system. All of these variables have changed over time so as to put downward pressure on wages, but there is little evidence that the omission of these factors has led us to over-predict wages. According to our equation, wage rises were surprisingly low between 1993 and 1996, but have behaved broadly as expected since then.

With labour market tightness measured by the proportion of the working age population who are without work, this relationship suggests that the labour market is close to equilibrium so a further market tightening would tend to push up wage costs. In other words, economic growth in excess of what can be delivered by increases in productivity and the labour force will bid up wage costs beyond the rate consistent with the inflation target. We broadly accept the Treasury's analysis that this trend rate of growth is about 2 1/2 per cent per annum.

In the short term, growth above the trend rate need not raise inflationary pressure if it can be offset elsewhere. At present, the combination of the high value of the exchange rate and competitive forces in the product market are exerting some downward pressure on import prices and profit margins. Provided growth does not accelerate too fast, this should be sufficient to keep inflation on target despite some slight inflationary pressure from the domestic labour market.

However, the most important factor in ensuring that inflation remains under control is that it is expected to remain under control. Since inflation is ultimately a monetary phenomenon this requires that people continue to believe that monetary policy setting is credible.

Monetary conditions (Table I)

Interest rates are now widely expected to rise from their current rate of 5 3/4 per cent as the Monetary Policy Committee (MPC) seeks to dampen down prospective inflationary pressure. The short-term money markets are now expecting rates to reach 7 1/2 per cent in the early part of next year. Given that rates were only reduced from that same level towards the end of 1998 when the MPG became concerned about a global economic slowdown, it is a reasonable guess that rates will be raised to that level again now that world prospects have improved. Indeed, the economic picture appears much more inflationary now than it did eighteen months ago when growth was clearly slowing. Consistency would therefore suggest that the MPC raises rates to at least 7 1/2 per cent.

However, there are grounds for believing that rates do not need to be raised as far as that. It can be argued that it was never necessary to raise interest rates to 7 1/2 per cent in 1998, a view borne out by the subsequent behaviour of inflation which was below the target rate of 2 1/2 per cent throughout most of 1999 and is likely to remain so in the early part of this year. In addition, this experience has helped to embed the inflation target more firmly into price expectations as the MPC has gained credibility and this has lowered the rate of interest necessary to achieve a particular inflation target. Further, the removal of automatic fuel and tobacco tax escalators as announced in the Pre-Budget Report has reduced inflationary pressure. Finally, the current very strong level of the pound is exerting further downward pressure on inflation. In our view, an early interest rate rise to 6 1/2 per cent would be more than sufficient to keep inflation on target.

The strength of the exchange rate continues to surprise. Market interest rate differentials imply that a fairly slender depreciation in the sterling rate against the euro is expected and that by the end of 2003 the rate will have fallen to [epsilon]1.51. We have assumed that sterling is fixed against the euro at this rate from this time. This implies that the exchange rate against the dollar remains at around $1.65 over the next two to three years.

Summary of the forecast

Our initial estimate is for growth in the fourth quarter of 1999 of a little under 1 per cent, 2.8 per cent higher than a year earlier. This gives an average growth rate over 1999 of around 2 per cent.

Our expectation is that growth will continue at an annual rate of around 3 per cent per annum in 2000 before slowing marginally in 2001. This is expected to be led by strong growth in domestic demand of a little under 4 per cent with robust growth in all of the components. Household consumption is expected to grow by 3 1/2 per cent, the same rate as in 1999. As discussed above, the background to this is excellent and the risks are clearly to the upside. Government consumption is likely to be strong, growing by over 4 per cent with government investment also projected to rise substantially. We are expecting growth in private sector business investment to slow down to 2 per cent after substantial capital spending over the past four years. However, the risks are again on the upside.

There was a substantial gap between domestic demand growth and output growth of almost 1 1/2 per cent in 1999 as net trade made a negative contribution to growth. We expect this gap to narrow substantially this year as export growth responds to the general increase in world demand. Should domestic demand turn out to be much stronger than expected, then it is likely that imports would take up some of the slack and grow faster than the 8 per cent that we are currently forecasting.

The goods deficit in the balance of payments is estimated to have risen to [pounds]27 billion in 1999 partly due to the loss of competitiveness experienced by UK firms in recent years. We are not expecting this to worsen much further this year and the overall current account deficit is expected to rise to [pounds]15 billion, a little over 1 1/2 per cent of GDP.

This projected deficit is a reflection of company sector borrowing of 2 per cent of GDP offset by a government surplus of around 1/2 per cent of GDP. Household sector lending is expected to fall to around zero as the saving ratio declines to 6 per cent of household income. With both company sector and household sector balance sheets in good shape, the deficit is not problematic. However, it is fairly clear that should spending turn out to be stronger than we are expecting that it will need to be financed by greater private sector borrowing. An early indicator of stronger spending would be an increase in household or company borrowing and a larger than expected rise in the external deficit.

While manufacturing output is now showing signs of recovery, this is from a low level. We expect output growth in this sector of around 2 to 2 1/2 per cent in 2000 and 2001. With the exchange rate expected to stay strong, the traded sector is expected to continue its relative decline. The output of the private sector service industries is expected to pick up and grow by around 3-4 per cent over the same period.

In recent years, output growth has been achieved by expanding employment rather than by productivity gains. This has been achievable because of spare capacity in the labour market. However, it is doubtful that there is much more unused capacity to absorb. Consequently we expect further growth in the demand for labour to bid up average earnings. This will have two effects. First, it will encourage firms to economise on labour and improve productivity. Second, it will add to inflationary pressure.

Average earnings are now forecast to grow by about 5 per cent this year and in 2001. Productivity growth in the whole economy is forecast to rise from about 1 1/4 per cent in 1999 to around 2 per cent in 2000 and 2001. Manufacturing productivity growth is expected to exceed this as those firms hit by the high exchange rate attempt to improve their competitiveness by cutting costs.

Employment is set to grow at a relatively low rate, so that unemployment stabilises at around current levels of around 1.7 million on the ILO definition.

The increase in productivity growth is expected to exceed the growth in average earnings, hence reducing the rate of growth of unit labour costs from 4 1/2 per cent in 1999 to 3 1/2 per cent in 2000. Continued weakness in import prices and a slight fall in profit margins will contain retail price inflation with RPIX inflation forecast to stabilise at just under the 2 1/2 per cent target. The path for the headline RPI is expected to be more volatile, reflecting movements in interest rates, rising from 1.4 per cent at the end of 1999 to over 4 per cent by the end of this year.

The uncertainty surrounding the forecast is not thought to be any different from normal. In probabilistic terms, the likelihood of inflation remaining within 1 per cent of the target at the end of this year is 55 per cent, with a 34 per cent chance that it is in the same range at the end of next year. The lower probability reflects the greater difficulty in forecasting a longer period ahead rather than the small difference in the point forecast.

With respect to growth, the probability of growth being below 2 per cent this year is already fairly small at 14 per cent. There is estimated to be a 54 per cent chance that it will exceed 3 per cent. For 2001, the odds are well spread with an 11 per cent chance of output falling and a 16 per cent chance of it exceeding 4 per cent. The odds of growth of between 1 and 3 per cent are 42 per cent.

Section II The forecast in detail

The components of expenditure (Table 2)

Economic growth in 2000 is again expected to be driven by rapid expansion in domestic demand, offset partially by a further negative contribution from net trade. Household expenditure is forecast to grow by 31/2 per cent in 2000, around the same rate as in 1999. With fixed investment expected to grow at a similar rate and with government consumption projected to grow by 41/2 per cent, domestic demand is forecast to rise by almost 4 per cent, slightly faster than in 1999. On the trade side, export growth is expected to pick up sharply to 61/2 per cent in 2000 following a strong performance in the second half of 1999. But with imports forecast to grow by almost 8 per cent, net trade will again have a dampening effect on economic growth.

Growth is expected to slow to a rate of around 2 1/4 per cent in 2001 and 2002, with a closer match between domestic demand and output growth. This is accounted for by a slowdown in the growth of domestic demand and by a better contribution from net trade as export price competitiveness improves slightly. Household consumption growth is expected to stabilise at about 2 1/2 per cent per annum while the growth in fixed investment is expected to settle at about 3 to 4 per cent per annum.

Household sector (Table 3)

It now appears that household spending grew by about 3 1/2 per cent in 1999, similar to the growth rate seen in every year since 1995. This is below our previous forecast when we had been expecting a growth rate of 4.2 per cent for 1999. This mainly reflects revisions to official estimates of household expenditure at the beginning of the year rather than a change in our view of the prospects for spending. Looking forward, we have revised upwards slightly our estimates of spending growth for this year and next.

Household income has been more volatile than usual over the past year as a consequence of sharp fluctuations in receipts of property income, mainly the distributed income of corporations. This is associated with changes in the timing of dividend payments due to the abolition of Advance Corporation Tax from April 1999. Receipts of property income fell from [pounds]30.1 billion in the last quarter of 1998 to [pounds]28.6 billion in the first quarter of 1999 before rising to [pounds]32.2 billion in the second quarter. The large fall to [pounds]27.5 billion in the third quarter more than accounts for a fall of [pounds]1.5 billion in real household disposable income at the same time. Since household consumption is relatively immune to quarterly fluctuations in property income, these mainly affect measured saving. The collapse in the saving ratio to 4.5 per cent in the third quarter is a reflection of the fact that the propensity to save out of property income is high, but property income itself was very low.

In order to focus more clearly on the income movements that affect spending we have developed a measure of household income incorporating only non-property income. This is expected to grow by around 3-3 1/2 per cent over the next two years, driven principally by growth in real earnings and employment.

In nominal terms, whole economy average earnings grew by 5.1 per cent in October, but by 3.7 per cent when bonuses are excluded. This is fairly consistent with other information indicating that median pay settlements were growing at 3 per cent in October. With no evidence yet of a pick-up in settlements, earnings are likely to continue to grow at a rate of about 5 per cent over the coming months. At current rates of price inflation this is consistent with real earnings growth of a little under 3 per cent per annum. This is slightly higher than is sustainable in the long run and we expect real earnings growth to slow down towards 2 1/4 per cent per annum in 2001. With the number of employees expected to grow by 1 1/2 to 2 per cent over the coming two years (as self-employment falls), real labour incomes are likely to show robust growth.

One of the key risks to this forecast is that real earnings and employment grow much more strongly in the short term as a consequence of a tight labour market. Another risk is that households respond strongly to the increases in wealth that they have enjoyed over recent years through asset price inflation. Between the end of 1996 and 1999, the net wealth of the household sector rose from [pounds]2,700 billion to [pounds]4,000 billion, and is now enough to fund almost seven years consumption. Given that annual household saving (defined to exclude capital gains) over the past four years has averaged around [pounds]50 billion per annum, it would take about twenty years to achieve such an increase in wealth simply by saving. Chart 4 compares the quarterly increase in net financial wealth and housing wealth with household saving since the end of 1994.

Increases in wealth of this magnitude are bound to add to spending as households see that their future consumption needs can be met from capital gains on their asset holdings rather than by giving up current consumption. However, the increase in spending is likely to be spread out over time rather than consumed immediately. Taking the long-run propensity to consume out of wealth as 0.06 suggests that a sustained increase in wealth of the magnitude seen since the end of 1996 would add about [pounds]70 billion to household consumption. This is greater than the total increase in annual consumption of about [pounds]50 billion over this period, suggesting that much of the wealth effect is yet to emerge in actual spending. This is partly accounted for by the fact that much of the increased wealth is held indirectly in pension funds and that increased housing wealth is not easily realised. One means of achieving this is through the withdrawal of housing equity through mortgage borrowing. There is some evidence that this is now increasing as mortgage borrowing is outstripping overall investment in housing assets, but it remains substantially less than in the 1980s.

There is little immediate prospect of a slowdown in house price inflation. There is clearly considerable upward momentum in the market and this is likely to fuel further growth in 2000. We are now forecasting house price inflation of 131/2 per cent in the year as a whole. House price inflation is then forecast to slow down as prices resume a more normal relationship with general inflation. Past instability in the housing market suggests that there is a significant risk that prices turn out to be less well behaved than we expect and the prospect of speculative profits encourages a more prolonged boom.

Our central forecast for household spending is for it to grow broadly in line with real non property income, expanding by about 31/2 per cent in 2000 before slowing to just under 3 per cent in 2001. However, the risks that we have identified are mainly on the upside. Even without faster growth than we are expecting in real incomes or house prices there is a risk that households are confident enough to increase their spending sharply. But with additional upside risks to both real incomes and house prices, there is potential for very strong growth in consumption in the short term. The main downside risk is to share prices, but this would be unlikely to affect spending much in the short term since there is little clear evidence that consumption has reacted significantly to their recent rise.

The relatively low level of household saving seen in 1998 and 1999 has meant that the net acquisition of financial assets by households has been very low. It is likely that households will have been net borrowers in 1999 for the first time since 1988. This pattern with approximate balance between household saving and investment is expected to continue over 2000 and 2001 as the saving ratio remains broadly constant. In this case the stock of consumer credit and mortgage debt outstanding would grow at around 10 per cent as in 1999. However, more rapid growth in consumption not fuelled by faster income growth would need to be financed by stronger growth in household indebtedness. As such, a rapid pick-up in household borrowing would be an early indicator of faster spending growth than we are currently anticipating.

Fixed investment and stockbuilding (Tables 4 and 5)

After growth of 11.2 per cent in 1998, there was a deceleration in fixed investment to a growth rate of about 4 per cent in 1999. This was accounted for by estimated falls in manufacturing, general government and private housing investment. Non manufacturing business investment is estimated to have grown by 12 1/2 per cent reflecting the strong performance of this sector more generally.

The prospects for capital spending in the business sector are quite favourable with demand now clearly picking up. The incentives for private investment are clearly very strong at present. The rate of return on capital has been at historically high levels in recent years, even in the manufacturing sector. This is reflected in the above average share of corporate profits in the economy. The high rate of return in relation to the cost of capital can be seen also in the high value of the market value of private non-financial companies in relation to the replacement cost of their capital stock.

Despite this, the non-manufacturing business sector is not expected to sustain investment growth at above 10 per cent per annum for much longer. There must soon come a time when its stock of capital has reached a desirable level. From the end of this year, we expect investment growth to slow to a more sustainable rate of about 4 per cent per annum. Manufacturing industry is now growing again, creating a need for extra capital, although the relatively low level of capacity utilisation suggests that much of this is already in place. After a period of stagnation, growth is expected to pick up to about 2 per cent per annum in 2001. Overall business investment growth is forecast to slow to 2 per cent in 2000 before picking up to 3 1/2 per cent in 2001. But as with household consumption, the risks with respect to the business investment forecast appear to be mainly positive.

Private sector housing investment is expected to grow by around 2 per cent this year, consistent with the relatively subdued rate of housing starts last year. Our expectation is that increases in house prices will encourage growth in housing investment of 4 1/2 per cent in 2000, but this will not be sustained. Public sector housing investment is expected to pick up very sharply this year, rising by around 27 per cent, albeit from a low level. Other general government investment is expected to rise broadly in line with the government's plans. This is estimated to have been weak in 1999, 3 per cent lower than in 1998. More rapid growth from now on is expected to lead to growth of 22 per cent this year from the low level reached last year and 10 per cent in 2001.

We now estimate that there was very modest stock-building in 1999 of [pounds]0.2 billion. A fall of [pounds]1.6 billion in manufacturers' stocks was broadly offset in the rest of the economy. We now expect stockbuilding of a little over [pounds]1 billion in 2000 and 2001.

Saving by the private non-financial sector is estimated to have fallen slightly in 1999. With higher levels of investment, companies have needed to increase their borrowing. We are expecting net borrowing by non-financial companies to grow to about [pounds]22 billion per annum in 2000 adding to corporate indebtedness. However, with corporate gearing levels relatively low at present, there is room in the corporate balance sheet to absorb this.

Balance of payments (Tables 6 and 7)

In the first half of 1999, manufactured exports were running at almost 2 per cent below their level in 1998. But trade in the third quarter grew very sharply with the volume of manufactured exports up by almost 10 per cent on the second quarter. Monthly figures indicate that exports have continued at a high level in October, albeit a little lower than in the third quarter, suggesting that this might be a turning point. We are now expecting export growth to continue at a similar rate to that of world trade despite the high level of the exchange rate.

The main impact of the higher exchange rate has been on export prices and export profitablility. Export prices have fallen sharply as firms have fought against the effect of the exchange rate on their price competitiveness. We expect to see a modest improvement in price competitiveness over the next few years and this should contribute to a pick-up in the growth of export volumes. After a fairly flat year in 1999, we expect growth in exports of around 5 1/2 per cent in both 2000 and 2001.

Import prices have also fallen as a consequence of the higher exchange rate leading to some increase in import penetration. The prices of manufactured imports are expected to be fairly flat this year and to rise by about 2 per cent next year, broadly in line with the price of domestically manufactured goods.

As with exports, there was a sharp increase in the volume of imports in the third quarter. We are expecting the growth of manufactured imports to pick up to around 8 per cent this year, before slowing slightly in 2001.

The deficit on the goods balance is forecast to grow slightly to [pounds]28.5 billion in 2000 from [pounds]27 billion last year as the rise in imports outstrips that in exports. The surplus on the balance on services, transfers and income is expected to decline somewhat from [pounds]15.4 billion in 1999 to [pounds]13.6 billion in 2001. The overall current balance deficit is forecast to widen to just under [pounds]15 billion in 2000 and [pounds]17 billion in 2001.

Even though we expect the current deficit to rise over the next two years, it is likely to remain a relatively small proportion of national income and will not have a substantial effect on the net foreign asset position.

Output and employment (tables 8 and 9)

Growth in 1999 was not very well balanced with the private services sector expanding at a faster rate than the manufacturing and construction sectors. But the current outlook shows a much more consistent picture across the main industrial sectors is in prospect for 2000.

Manufacturing output grew strongly in the third quarter of 1999 and early indications are that the fourth quarter was also very good. This suggests that manufacturing industry is now beginning to recover from the exchange rate-induced slowdown witnessed in the second half of the 1990s.

Relatively speaking, manufacturing has lost a lot of ground in recent years. We do not expect that it can make this up without improving its competitiveness. Instead, our forecast is that growth this year and for the next two years will be a little less than in the other main sectors of the economy.

The lack of competitiveness of manufacturing is likely to lead to downward pressure on employment and upward pressure on productivity within the industry. It is estimated that manufacturing productivity grew by 3.5 per cent in 1999. This is expected to accelerate into 2000 to almost 5 per cent as employment is reduced at the same time that output is increased.

Productivity in the economy more widely is also expected to improve as the economy picks up steam. The main reason for this is that there is now little scope for further employment growth beyond that associated with increases in the population of working age. Further increases in the demand for labour are likely to bid up real wages, thus encouraging firms to economise on the number of workers they employ. We anticipate that employment will grow by a little under 1 per cent this year and by about 1/2 per cent next year. The number of employee jobs is expected to increase more quickly than this as the recent shift from self employment continues.

The projected rise in employment is broadly equal to the increase in the working age population. Unemployment will then remain broadly steady over the next two years at about 53/4 per cent of the workforce on the ILO definition and at just over 4 per cent on the claimant count measure.

Earnings and prices (Tables 3 and 10)

After the recession of the early 1990s, the rate of unemployment fell considerably from its peak of 10.3 per cent in 1993 without putting any upward pressure on inflation. Few people would claim to know the equilibrium rate of unemployment with any precision, but this experience suggests that actual unemployment was substantially above its equilibrium value in 1993 and is a good deal closer to it now. What the exact position is now is very difficult to judge, but this forecast suggests that unemployment has possibly fallen slightly below its equilibrium value. Either way, wage costs now appear to be growing more quickly than is consistent with the monetary authority's inflation target. Unit labour costs are estimated to have grown by 4 1/2 per cent in 1999, reflecting growth of just under 5 per cent in average earnings and productivity growth of a little over 1 per cent (other influences on unit labour costs are employer contributions made to the national insurance scheme and other payments on behalf of emplo yees).

Growth in average earnings is expected to pick up very marginally to 5 per cent this year and remain at this rate in 2001. With productivity growth also improving slightly, this translates into a slowdown in the growth of unit labour costs to around 3 1/2 per cent over the coming two years. This rate of growth cannot be sustained if the inflation target is to be met, but competitive pressures will inhibit the extent to which the increase in costs can be passed on in the form of higher prices. With the high exchange rate also exerting downward pressure on import prices, this growth in earnings is easily consistent with the inflation target over a two-year horizon. Our forecast is for the target measure of inflation to remain a little under 2 1/2 per cent over the next two years.

National and sectoral saving (Table II)

The current account deficit of the economy as a whole is a reflection, subject to a statistical residual, of the financial position of the individual agents in the economy. Table 11 shows how the saving and investment behaviour of the individual sectors of the economy is financed. Ultimately, any investment that cannot be financed by domestic saving needs to be financed abroad.

Household sector saving is expected to remain at about 4 1/2 per cent of GDP, close to the rate of investment by the sector. This means that the household sector will not be a net lender to other sectors as is usually the case. Company sector saving is expected to fall sharply such that the deficit of saving relative to investment is set to be of the order of 2 per cent of GDP. The government sector is now meeting the Golden Rule so that its saving is positive and is forecast to remain in excess of its investment over the next four years or more.

The current account is expected to move into deficit this year and in following years by about 1 1/2 per cent of GDP. It is fairly clear that the movement into deficit of the current account of the balance of payments is associated with the increased deficit of the company sector. This can be traced back partly to the strength of the pound which has encouraged spending to be switched away from domestic goods and towards foreign goods, thereby reducing profits (from a high level) and company saving. If this situation were to continue, then companies would at some stage need to adjust their saving or investment to prevent their indebtedness rising too quickly. This would feed through either directly, through lower spending on foreign investment goods, or indirectly through the effects of lower dividend payments on household spending on imports, to the current account. The process of adjustment would also affect prices in such a way that competitiveness is eventually restored. Through these channels, a current a ccount deficit is ultimately corrected.

The economy in the medium term (Table 12)

The way in which the economy behaves over the medium term is determined partly by a range of shocks that are inherently unpredictable. But there are other important influences on its development that can be foreseen. These include trends in the size and composition of the population, forthcoming changes in the policy framework as well as adjustments to existing disequilibria. It can be argued that the development of the British economy over the 1990s has been largely shaped by the need to adjust to the recession of the early part of the decade. The main problem for the economy over the past two years or more has been its grossly over-valued exchange rate. The adjustment to this will have a continuing effect on the economy over the coming years. But in other ways the economy is well balanced with inflation low and unemployment probably close to its sustainable rate.

Foremost among the policy influences is whether the UK decides to adopt the euro. We have assumed that this will take place in 2003, but that sterling will be stabilised at [epsilon]1.51 (equivalent to DM2.95), a rate broadly consistent with market expectations, in advance of EMU membership. Many would regard this rate as being too high and it is certainly higher than our estimates of an equilibrium exchange rate. But since the end of 1996 the economy does appear to have adjusted to a high exchange rate. At first exports appeared not to be affected by the strong pound, but these then weakened sharply both in 1998 and 1999. The contraction in the manufacturing sector was also probably a consequence of the high pound. But we now see grounds for expecting exports and manufacturing output to recover without a substantial depreciation of the nominal exchange rate. Partly this will be achieved by a depreciation of the real exchange rate as manufacturers restore competitiveness by keeping their export prices down.

Inflation is forecast to remain low over this period. This is based on a view that the European Central Bank (ECB) will be as successful in controlling inflation as the Bundesbank has been in recent years. With the sterling exchange rate fixed, there will not be room for large differences in inflation across the Euro Area. So long as this is clearly understood, expectations, which are crucially important in the inflationary process, should help anchor inflation itself.

The outlook for interest rates and inflation is consistent with real interest rates of around 3 to 4 per cent. Short-term interest rates are expected to rise slightly, reaching 6 1/2 per cent. They are then protected to fall, converging on euro rates by the end of 2003.

Fiscal policy is assumed to be tight on average over the period in line with the current government's targets. But if the UK adopts the single currency, then fiscal policy will need to be used for stabilisation purposes. To have sufficient flexibility for this purpose, it will be necessary for the budget deficit to be small on average. In keeping with this, government consumption is expected to grow by less than GDP. This would allow some increased spending on transfer payments as the proportion of pensioners in the population rises.

Unemployment, on the ILO definition, is forecast to settle at about 6 1/4 per cent of the working population. This is slightly higher than is the case now, and is a reasonable estimate of the sustainable rate of unemployment. The rate of real wage growth is sensitive to which deflator is used. Using the GDP deflator at basic prices, the real wage is forecast to grow at about 2 per cent per annum, similar to the rate of growth of productivity.

The government has identified slow productivity growth as one of the important problems of the UK economy and it is possible that policy action over the coming years will be successful in raising it or that there will be substantial benefits from the introduction of information technology. However, we have made no special allowance for this. Our forecast of productivity growth is consistent with past long-term trends in the economy.

On this basis we would expect to see economic growth of between 2 to 2 1/2 per cent per annum over the next ten years following slightly faster growth next year, with lower growth beyond that as the population of working age slows down. Among the expenditure components, household and government consumption are expected to grow by about 2 per cent per annum with slightly faster growth in fixed investment.

The current account deficit is set to average about 1 per cent of GDP throughout the period.

Forecast errors and probability distribution (Tables 13 and 14)

Table 13 provides a set of summary information as regards the accuracy of forecasts that have been published in the January Review. The latest complete National Accounts information available when these forecasts are constructed is for the third quarter of the year.

A rule of thumb is that a 70 per cent confidence interval for a variable of interest can be obtained by adding a range of one absolute average error around our central forecast. Thus we can be 70 per cent sure that GDP growth in 2000 will be between 2.2 and 4.2 per cent. The size of the average errors indicates that some variables are easier to forecast than others. For example, the errors in forecasting consumers' expenditure are smaller than those in forecasting fixed investment. It is also the case that the error in forecasting GDP growth is smaller than that made in forecasting its components. This arises because of offsetting movements among the components.

The probability distributions around the growth and inflation forecasts have been calculated assuming that the distributions are normal and are shown in table 14. The standard errors have been calculated from the historical forecast errors underlying table 13. These estimates of the probability distribution around our central forecasts provide a quantitative assessment of the limits of our forecasts.

Our estimates suggest that there is about a 68 per cent chance that growth this year will turn our to be in the range of 2 to 4 per cent, with only a 14 per cent chance of growth below 2 per cent. For next year, growth prospects are much more uncertain. There is approximately a one in ten chance that it will be negative and a one in four chance that it will be less than 1 per cent. There is a 42 per cent chance that it will be between 1 and 3 per cent and a one in three chance that it will be above that.

For inflation, there is a more than evens chance that it will end the year between 1.5 and 2.5 per cent. The risks are clearly larger looking ahead. In two years time, there is a 46 per cent chance that inflation will be above 2 1/2 per cent. However, the imprecision of the forecast is shown by the fact that there is a one in three chance that it will be below 1 1/2 per cent. The chances that it will be more than 1 per cent away from target in either direction is put at 66 per cent. The fact that it has stayed within this fairly narrow bound over the past two and a half years is an indication of either the skill of the Monetary Policy Committee or their good fortune.

 Exchange rates and interest rates
 UK exchange rates Oil FT
 Effective [a] $ Euro price [b] All-share
 $ index
1996 86.3 1.56 1.22 19.5 1895
1997 100.5 1.64 1.45 18.6 2236
1998 103.9 1.66 1.49 12.4 2626
1999 103.6 1.63 1.52 17.4 2943
2000 106.9 1.65 1.59 21.3 3136
2001 104.9 1.65 1.55 20.9 3291
2002 103.5 1.65 1.52 21.3 3446
1999 I 101.1 1.63 1.49 11.2 2772
1999 II 104.1 1.61 1.51 15.3 2965
1999 III 103.8 1.60 1.53 20.1 2934
Forecast
1999 IV 105.4 1.67 1.55 23.1 3100
2000 I 107.7 1.65 1.60 22.2 3079
2000 II 107.2 1.65 1.59 21.4 3116
2000 III 106.6 1.65 1.58 20.7 3155
2000 IV 106.1 1.65 1.57 20.7 3194
2001 I 105.5 1.65 1.56 20.7 3232
2001 II 105.3 1.65 1.55 20.8 3272
2001 III 104.7 1.65 1.54 20.9 3310
2001 IV 104.1 1.65 1.53 21.0 3350
Percentage changes
1997/96 16.5 4.9 19.2 -4.5 18.0
1998/97 3.4 1.2 2.3 -33.3 17.5
1999/98 -0.3 -1.8 2.2 40.6 12.0
2000/99 3.2 1.6 4.3 21.9 6.6
2001/00 -1.9 -0.2 -2.3 -1.8 4.9
2002/01 -1.4 -0.2 -1.7 1.8 4.7
1999IV/98IV 4.8 -0.5 8.7 104.0 23.9
2000IV/99IV 0.7 -0.9 1.3 -10.6 3.0
2001IV/OOIV -1.9 -0.4 -2.3 1.5 4.9
 Interest rates
 UK base Mortgage 20-year World inter-
 rate interest UK gilts [d] est rates [e]
1996 6.0 6.7 8.3 4.2
1997 6.6 7.2 7.1 4.0
1998 7.2 7.8 5.3 3.9
1999 5.3 6.5 4.7 3.3
2000 6.3 7.2 5.0 4.0
2001 6.5 7.5 5.0 4.6
2002 5.9 7.0 5.0 5.0
1999 I 5.7 6.8 4.4 3.3
1999 II 5.2 6.4 4.7 3.0
1999 III 5.1 6.3 4.8 3.1
Forecast
1999 IV 5.4 6.5 4.9 3.8
2000 I 6.0 7.0 5.0 3.7
2000 II 6.3 7.2 5.0 4.1
2000 III 6.5 7.4 5.0 4.2
2000 IV 6.5 7.4 5.0 4.2
2001 I 6.5 7.5 5.0 4.4
2001 II 6.5 7.5 5.0 4.5
2001 III 6.5 7.5 5.0 4.7
2001 IV 6.5 7.5 5.0 4.8
Percentage changes
1997/96
1998/97
1999/98
2000/99
2001/00
2002/01
1999IV/98IV
2000IV/99IV
2001IV/00IV
 Monetary
 aggregates [c]
 M4 MO
 ([pounds] billion)
1996 682 25
1997 721 26
1998 780 28
1999 805 30
2000 886 32
2001 978 34
2002 1065 35
1999 I 786 28
1999 II 792 29
1999 III 791 29
Forecast
1999 IV 805 30
2000 I 823 30
2000 II 843 31
2000 III 864 31
2000 IV 886 32
2001 I 909 32
2001 II 932 33
2001 III 955 33
2001 IV 978 34
Percentage changes
1997/96 5.7 6.5
1998/97 8.2 5.7
1999/98 3.3 7.1
2000/99 10.1 6.6
2001/00 10.3 6.0
2002/01 9.0 5.2
1999IV/98IV 3.3 7.1
2000IV/99IV 10.1 6.6
2001IV/00IV 10.3 6.0

Source: Economic Trends; Financial Statistics; NIESR estimates.

(a.)1990=100.

(b.)Per barrel, OPEC average.

(c.)Seasonally adjusted, end quarter figures.

(d.)Nominal zero coupon yields.

(e.)Average 3-month rates in G7 countries (excluding UK)

 Gross domestic product and components of expenditure
 [pounds] billion, 1995 prices, seasonally adjusted
 Final consumption Gross Capital
 expenditure formation
 Gross Change in
 Households General fixed inventories
 & NPISH [a] gov't investment [b]
1996 470.6 142.8 121.9 1.8
1997 488.9 140.8 131.3 3.8
1998 504.8 141.8 145.9 3.5
1999 522.8 147.1 151.9 0.2
2000 541.3 153.8 156.9 1.2
2001 555.7 157.5 162.4 1.1
2002 568.8 161.3 168.6 1.0
1999 I 129.2 36.2 37.8 0.9
1999 II 130.2 36.5 38.1 -0.6
1999 III 131.0 36.8 37.9 -0.5
Forecost
1999 IV 132.4 37.5 38.1 0.4
2000 I 133.8 38.1 38.7 0.3
2000 II 134.8 38.3 39.1 0.3
2000 III 135.9 38.6 39.4 0.3
2000 IV 136.8 38.8 39.7 0.3
2001 I 137.6 39.0 40.1 0.3
2001 II 138.5 39.3 40.4 0.3
2001 III 139.4 39.5 40.8 0.3
2001 IV 140.2 39.7 41.2 0.3
Percentage changes
1997/96 3.9 -1.4 7.7
1998/97 3.2 0.7 11.2
1999/98 3.6 3.7 4.1
2000/99 3.5 4.6 3.3
2001/100 2.7 2.4 3.5
2002/01 2.4 2.4 3.9
1999IV/98IV 4.1 4.6 0.9
2000IV/99IV 3.4 3.4 4.2
2001IV/00IV 2.5 2.4 3.6
 Domestic Total Total Total Residual GDP
 demand exports final imports at
 expenditure market
 prices
1996 737.1 217.6 954.7 224.0 0.0 730.8
1997 764.8 236.3 1001.1 244.6 0.0 756.4
1998 796.0 242.0 1038.0 266.2 1.0 772.8
1999 822.0 249.9 1071.9 284.9 0.7 787.7
2000 853.2 266.2 1119.3 307.4 0.7 812.6
2001 876.7 278.7 1155.5 324.9 0.7 831.3
2002 899.8 292.3 1192.1 341.4 0.2 851.5
1999 I 204.1 59.6 263.6 69.2 0.2 194.6
1999 II 204.2 61.1 265.4 69.5 0.2 196.1
1999 III 205.3 64.7 270.0 72.6 0.2 197.6
Forecost
1999 IV 208.4 64.5 272.9 73.7 0.2 199.4
2000 I 210.9 65.5 276.4 75.1 0.2 201.4
2000 II 212.6 66.1 278.7 76.3 0.2 202.6
2000 III 214.1 66.9 281.0 77.4 0.2 203.7
2000 IV 215.6 67.7 283.3 78.6 0.2 204.9
2001 I 217.0 68.5 285.5 79.6 0.2 206.0
2001 II 218.5 69.3 287.7 80.7 0.2 207.2
2001 III 219.9 70.1 290.0 81.8 0.2 208.4
2001 IV 221.4 70.9 292.3 82.8 0.2 209.7
Percentage changes
1997/96 3.8 8.6 4.9 9.2 3.5
1998/97 4.1 2.4 3.7 8.8 2.2
1999/98 3.3 3.3 3.3 7.0 1.9
2000/99 3.8 6.5 4.4 7.9 3.2
2001/100 2.8 4.7 3.2 5.7 2.3
2002/01 2.6 4.9 3.2 5.1 2.4
1999IV/98IV 3.4 7.1 4.2 8.2 2.8
2000IV/99IV 3.5 4.9 3.8 6.6 2.8
2001IV/00IV 2.7 4.8 3.2 5.4 2.3
 Adjustment to Gross
 basic value
 prices added at
 basic prices
1996 80.5 650.2
1997 84.5 671.9
1998 84.7 688.1
1999 86.1 701.6
2000 89.3 723.3
2001 91.9 739.4
2002 94.4 757.1
1999 I 21.3 173.3
1999 II 21.4 174.6
1999 III 21.6 176.0
Forecost
1999 IV 21.8 177.6
2000 I 22.1 179.4
2000 II 22.2 180.3
2000 III 22.4 181.3
2000 IV 22.6 182.3
2001 I 22.7 183.3
2001 II 22.9 184.3
2001 III 23.0 185.3
2001 IV 23.2 186.5
Percentage changes
1997/96 5.0 3.3
1998/97 0.2 2.4
1999/98 1.7 2.0
2000/99 3.6 3.1
2001/100 2.9 2.2
2002/01 2.7 2.4
1999IV/98IV 3.1 2.8
2000IV/99IV 3.6 2.7
2001IV/00IV 2.8 2.3

Source: Economic Trends; NIESR estimates.

(a.)Non-profit institutions serving households.

(b.)Including acquisitions less disposals of valuables.

 Household income and expenditure
 Seasonally adjusted
 Compen- Gross
 Average [a] Employees sation of disposable
 earnings employ- income
 ees [d]
 1995=100 millions [pounds] billion,
 current prices
1996 103.3 22.7 404.5 521.2
1997 107.9 23.3 432.4 554.6
1998 112.9 23.8 463.8 569.1
1999 118.3 24.1 494.5 601.3
2000 124.3 24.5 528.3 641.7
2001 130.4 24.7 557.8 673.6
2002 136.1 24.9 585.2 704.0
1999 I 116.8 24.0 121.1 145.0
1999 II 117.8 24.0 122.6 150.4
1999 III 118.4 24.2 124.1 149.0
Forecast
1999 IV 120.3 24.3 126.6 156.9
2000 I 121.9 24.4 129.0 158.9
2000 II 123.5 24.5 131.1 159.3
2000 III 125.1 24.6 133.1 160.9
2000 IV 126.6 24.6 135.0 162.7
2001 I 128.2 24.7 137.0 164.3
2001 II 129.7 24.7 138.4 167.9
2001 III 131.1 24.8 140.1 169.5
2001 IV 132.6 24.9 142.3 171.9
Percentage changes
1997/96 4.4 2.4 6.9 6.4
1998/97 4.6 2.4 7.3 2.6
1999/98 4.8 1.3 6.6 5.7
2000/99 5.0 1.6 6.8 6.7
2001/00 4.9 0.9 5.6 5.0
2002/01 4.3 0.6 4.9 4.5
1999IV/98IV 4.8 1.4 6.8 7.8
2000IV/99IV 5.3 1.3 6.6 3.7
2001IV/00IV 4.7 1.0 5.4 5.6
 Real Real Final consumption
 household non- expenditure
 disposable property
 income [b] income [f] Total Durable
 [pounds] billion,
 1995 prices
1996 505.4 371.1 470.6 42.7
1997 524.5 385.7 488.9 48.0
1998 524.9 390.6 504.8 51.1
1999 541.3 399.1 522.8 53.9
2000 565.3 413.1 541.3 57.1
2001 579.0 425.6 555.7 57.6
2002 591.6 436.9 568.8 58.6
1999 I 131.8 98.5 129.2 13.2
1999 II 135.4 98.2 130.2 13.4
1999 III 134.0 100.3 131.0 13.5
Forecast
1999 IV 140.1 102.1 132.4 13.8
2000 I 141.1 103.1 133.8 14.4
2000 II 140.7 102.8 134.8 14.3
2000 III 141.3 103.3 135.9 14.2
2000 IV 142.1 103.9 136.8 14.2
2001 I 142.6 104.3 137.6 14.2
2001 II 144.8 106.4 138.5 14.3
2001 III 145.3 106.9 139.4 14.5
2001 IV 146.4 107.9 140.2 14.6
Percentage changes
1997/96 3.8 3.9 3.9 12.3
1998/97 0.1 1.3 3.2 6.6
1999/98 3.1 2.2 3.6 5.5
2000/99 4.4 3.5 3.5 5.8
2001/00 2.4 3.0 2.7 0.9
2002/01 2.2 2.6 2.4 1.8
1999IV/98IV 5.5 2.8 4.1 7.3
2000IV/99IV 1.5 1.8 3.4 3.0
2001IV/00IV 3.0 3.9 2.5 2.5
 Savings House
 ratio [c] prices [e]
 per cent 1995=100
1996 9.5 103.7
1997 9.3 112.8
1998 6.1 125.7
1999 6.0 139.7
2000 6.4 158.5
2001 6.2 168.5
2002 6.1 172.7
1999 I 5.1 130.3
1999 II 7.0 135.9
1999 III 4.5 143.8
Forecast
1999 IV 7.6 148.7
2000 I 7.4 152.7
2000 II 6.4 157.0
2000 III 6.1 160.8
2000 IV 5.9 163.6
2001 I 5.7 166.0
2001 II 6.5 168.0
2001 III 6.3 169.5
2001 IV 6.4 170.7
Percentage changes
1997/96 8.8
1998/97 11.5
1999/98 11.1
2000/99 13.5
2001/00 6.3
2002/01 2.5
1999IV/98IV 14.8
2000IV/99IV 10.0
2001IV/00IV 4.4

Source: Economic Trends; NIESR estimates.

(a.)Average earnings equal wages and salaries divided by the number of employees in employment.

(b.)Deflated by consumers' expenditure deflator.

(c.)Ratio of savings to disposable income.

(d.)Includes employers' social contribution.

(e.)Department of Environment, mix adjusted.

(f.)Real non-property income is wages and salaries plus social benefits received plus a share of the gross operating surplus less social contributions paid by households less taxes paid on non-property income.

 Forecasts of fixed investment
 [pounds] billion, 1995 prices, seasonally
 adjusted
 Business investment Housing
 Manufacturing Non-manufacturing Total Private Public
1996 17.8 65.4 83.2 19.9 2.3
1997 19.8 73.2 93.0 20.8 1.8
1998 20.7 85.4 106.1 22.1 1.7
1999 17.6 96.1 113.7 21.6 1.7
2000 17.2 98.6 115.7 22.0 2.2
2001 17.6 102.3 119.8 21.7 2.5
2002 18.0 106.2 124.1 21.7 2.9
1999 I 4.7 23.4 28.0 5.5 0.4
1999 II 4.5 24.4 28.8 5.4 0.4
1999 III 4.3 24.3 28.6 5.4 0.4
Forecast
1999 IV 4.2 24.1 28.3 5.4 0.5
2000 I 4.3 24.3 28.6 5.5 0.5
2000 II 4.3 24.5 28.8 5.5 0.5
2000 III 4.3 24.8 29.1 5.5 0.5
2000 IV 4.3 25.0 29.3 5.5 0.6
2001 I 4.4 25.2 29.6 5.4 0.6
2001 II 4.4 25.4 29.8 5.4 0.6
2001 III 4.4 25.7 30.1 5.4 0.6
2001 IV 4.4 25.9 30.4 5.4 0.7
Percentage changes
1997/96 11.3 11.9 11.8 4.6 -18.0
1998/97 4.2 16.7 14.0 6.0 -7.3
1999/98 -14.7 12.5 7.2 -2.0 -0.9
2000/99 -2.5 2.6 1.8 1.9 27.4
2001/00 2.2 3.8 3.5 -1.6 15.8
2002/01 2.2 3.8 3.6 0.1 15.0
1999IV/98IV -18.9 6.0 1.3 0.6 21.1
2000IV/99IV 3.1 3.7 3.6 1.4 18.2
2001IV/00IV 2.2 3.8 3.6 -1.5 15.4
 General Total Real Cost Corporate
 government [a] of capital profit share
 (excl. dwellings) (%) of GDP (%)
1996 10.3 121.9 4.3 27.1
1997 9.4 131.3 4.1 27.0
1998 10.2 145.9 3.8 25.8
1999 9.9 151.9 3.3 24.7
2000 12.0 156.9 3.2 25.0
2001 13.3 162.4 3.4 24.4
2002 14.7 168.6 3.3 24.3
1999 I 2.6 37.8 3.4 23.8
1999 II 2.1 38.1 3.5 24.5
1999 III 2.4 37.9 3.0 25.1
Forecast
1999 IV 2.8 38.1 3.3 25.4
2000 I 2.9 38.7 3.1 25.3
2000 II 3.0 39.1 3.3 25.0
2000 III 3.0 39.4 3.3 24.8
2000 IV 3.1 39.7 3.3 24.7
2001 I 3.2 40.1 3.3 24.5
2001 II 3.3 40.4 3.4 24.5
2001 III 3.4 40.8 3.4 24.5
2001 IV 3.4 41.2 3.4 24.2
Percentage changes
1997/96 -8.3 7.7
1998/97 7.9 11.2
1999/98 -2.9 4.1
2000/99 22.1 3.3
2001/00 10.4 3.5
2002/01 10.4 3.9
1999IV/98IV -0.9 0.9
2000IV/99IV 13.6 4.2
2001IV/00IV 10.4 3.6
Source: Economic Trends; NIESR estimates.
(a.)Includes public corporations not included within business investment.
 Inventory accumulation
 Change in inventories,
 [pounds] billion 1995 prices
 Manufacturing Distribution Other [a] Total
1996 -0.3 1.3 0.8 1.8
1997 -0.6 2.3 2.1 3.8
1998 0.7 0.8 2.0 3.5
Forecast
1999 -1.6 0.5 1.3 0.2
2000 -0.2 1.1 0.3 1.2
2001 -0.3 1.1 0.3 1.1
 Stock-output ratios
 (1995=100) Cost of
 Manufacturing [b] Distribution [c] Other Stocks (%)
1996 100.8 101.0 100.2 5.8
1997 99.5 103.2 98.4 10.2
1998 97.5 104.5 105.0 9.4
Forecast
1999 96.1 104.1 106.7 1.0
2000 93.8 102.7 104.0 6.7
2001 91.4 101.7 104.3 6.4

Source: Economic Trends and NIESER estimates.

(a.)Includes National Accounts quarterly alignment adjustment.

(b.)Manufacturers' stocks to manufacturing production.

(c.)Distributors' stocks to distribution output.

 Balance of payments: current account
 Seasonally adjusted
 Export volume Import volume Terms of
 Total Total trade [b]
 Manufactures goods Manufactures goods
 ([pounds] billion at
 1995 prices) [a] 1995=100
1996 140.0 165.5 149.5 180.4 101.0
1997 152.9 179.1 165.0 196.8 103.7
1998 156.1 181.4 181.4 213.5 106.0
1999 161.5 185.0 194.4 227.9 107.3
2000 174.0 199.0 211.6 246.1 108.8
2001 183.4 209.7 223.8 258.4 109.2
2002 193.9 221.4 236.1 270.4 109.3
1999 I 38.2 43.9 46.8 54.8 106.3
1999 II 38.8 44.6 46.8 55.1 107.4
1999 III 42.5 48.5 50.0 58.6 106.9
Forecast
1999 IV 42.0 48.1 50.8 59.3 108.5
2000 I 42.7 48.9 51.7 60.3 108.6
2000 II 43.2 49.4 52.5 61.1 108.7
2000 III 43.8 50.1 53.3 61.9 108.9
2000 IV 44.3 50.7 54.1 62.7 109.0
2001 I 44.9 51.4 54.8 63.5 109.1
2001 II 45.5 52.1 55.6 64.2 109.3
2001 III 46.2 52.8 56.3 65.0 109.3
2001 IV 46.8 53.5 57.1 65.7 109.3
Percentage changes
1997/96 9.2 8.2 10.4 9.1 2.7
1998/1997 2.1 1.3 10.0 8.5 2.2
1999/1998 3.4 2.0 7.2 6.7 1.1
2000/1999 7.7 7.6 8.9 8.0 1.4
2001/2000 5.4 5.3 5.8 5.0 0.4
2002/2001 5.7 5.6 5.5 4.6 0.0
1999/V/98/V 8.4 7.2 9.4 9.3 1.6
2000/V/99/V 5.5 5.5 6.5 5.7 0.5
2001/V/00/V 5.6 5.5 5.6 4.8 0.2
 Export Goods Services Current
 price com- balance transfers & balance
 etitiveness [c] income
 ([pounds] billion) [c] balance
1996 102.0 -13.1 13.2 0.1
1997 111.1 -11.9 19.3 7.4
1998 110.0 -20.8 20.8 0.0
1999 106.4 -27.0 15.4 -11.5
2000 105.9 -28.5 13.6 -14.9
2001 105.2 -29.1 12.2 -16.8
2002 104.5 -28.7 11.8 -16.9
1999 I 106.5 -7.4 3.8 -3.6
1999 II 107.2 -6.8 4.1 -2.6
1999 III 104.4 -6.2 3.6 -2.5
Forecast
1999 IV 107.2 -6.6 3.9 -2.7
2000 I 106.2 -6.9 3.6 -3.3
2000 II 106.0 -7.2 3.4 -3.7
2000 III 105.8 -7.2 3.3 -3.9
2000 IV 105.6 -7.3 3.3 -4.0
2001 I 105.4 -7.3 3.2 -4.1
2001 II 105.5 -7.2 3.1 -4.1
2001 III 105.1 -7.3 3.0 -4.3
2001 IV 104.8 -7.3 2.9 -4.3
Percentage changes
1997/96 9.0
1998/1997 -1.0
1999/1998 -3.3
2000/1999 -0.4
2001/2000 -0.7
2002/2001 -0.7
1999/V/98/V -0.3
2000/V/99/V -1.5
2001/V/00/V -0.8
 World
 trade [d]
 1995=100
1996 105.3
1997 118.7
1998 126.7
1999 134.3
2000 145.1
2001 153.3
2002 161.5
1999 I 128.5
1999 II 132.9
1999 III 136.3
Forecast
1999 IV 139.4
2000 I 141.8
2000 II 144.0
2000 III 146.2
2000 IV 148.4
2001 I 150.3
2001 II 152.1
2001 III 154.4
2001 IV 156.5
Percentage changes
1997/96 12.7
1998/1997 6.8
1999/1998 6.0
2000/1999 8.1
2001/2000 5.7
2002/2001 5.3
1999IV/98IV 10.8
2000IV/99IV 6.4
2001IV/00IV 5.4

Source: Economic Trends; NIESR estimates.

(a.) Balance of payments basis.

(b.) Ratio of average value of exports of goods to imports of goods.

(c.) Balance of payments basis.

(d.) UK export market weights.

(e.) A rise denotes a loss in UK competitiveness.

 Financial account
 [pounds] billion
 Basic Current Net direct Net portfolio Other investment
 balance [a] account investment [b] investment abroad [b,c]
1996 -47.4 0.1 -6.0 -41.6 -137.8
1997 -32.9 7.4 -16.3 -24.1 -169.7
1998 -47.9 0.0 -33.4 -14.5 -13.8
Forecast
1999 6.3 -11.5 -74.8 92.7 -140.0
2000 -9.9 -14.9 -22.3 27.3 -120.0
2001 -38.1 -16.8 -23.4 2.1 -120.0
 Other investment Balancing
 in the UK [b,c] item
1996 181.3 -3.9
1997 210.2 7.6
1998 79.9 18.2
Forecast
1999 133.7 0.0
2000 131.3 1.4
2001 158.1 0.1

Source: Economic Trends; NIESR estimates.

(a.)Current account plus net direct and portfolio investments.

(b.)A negative sign implies a capital outflow.

(c.)'Other' investment includes international bank loans and deposits.

 Output and productivity
 Seasonally adjusted, 1995=100
 Sectoral output [a]
 Manufac- Public Distri- Business Construct-
 turing bution services ion
 (0.216) (0.225) (0.146) (0.138) (0.052)
1996 100.4 102.0 103.2 105.6 101.5
1997 101.7 103.5 106.5 114.7 104.7
1998 102.0 105.6 108.7 122.6 106.0
1999 101.8 107.5 110.4 126.5 106.3
2000 104.2 111.6 114.0 130.9 109.4
2001 106.4 113.9 117.9 135.4 111.9
2002 108.9 116.2 122.4 140.5 114.2
1999 I 100.9 106.7 109.6 124.2 105.5
1999 II 101.2 106.8 109.9 126.5 105.9
1999 III 102.4 107.2 110.8 127.2 106.5
Forecast
1999 IV 102.8 109.2 111.4 128.0 107.2
2000 I 103.4 110.8 112.6 129.3 108.4
2000 II 103.9 111.3 113.4 130.3 109.1
2000 III 104.5 111.9 114.4 131.4 109.8
2000 IV 105.0 112.5 115.4 132.5 110.4
2001 I 105.5 113.0 116.3 133.6 111.0
2001 II 106.1 113.6 117.4 134.8 111.6
2001 III 106.7 114.2 118.5 136.0 112.2
2001 IV 107.3 114.7 119.6 137.3 112.8
Percentage changes
1997/96 1.3 1.5 3.2 8.6 3.2
1998/97 0.3 2.1 2.0 6.9 1.2
1999/98 -0.2 1.7 1.6 3.1 0.2
2000/99 2.4 3.9 3.2 3.5 3.0
2001/00 2.1 2.0 3.5 3.5 2.2
2002/01 2.3 2.0 3.8 3.8 2.1
1999IV/98IV 1.5 2.6 2.3 2.5 2.2
2000IV/99IV 2.2 3.0 3.5 3.5 3.0
2001IV/00IV 2.2 2.0 3.6 3.6 2.1
 GDP [b]
 Oil Rest Total Per Manufact-
 worker uring pro-
 ductivity [c]
 (0.021) (0.202)
1996 105.6 102.8 102.5 101.5 99.0
1997 104.8 107.3 106.0 103.1 100.0
1998 107.5 109.6 108.5 104.0 99.6
1999 112.5 113.7 110.6 105.3 103.1
2000 116.1 116.7 114.0 107.7 108.0
2001 118.5 117.5 116.6 109.6 112.2
2002 120.9 118.6 119.4 111.9 116.5
1999 I 109.0 111.7 109.3 104.3 100.8
1999 II 112.3 113.6 110.2 104.8 102.0
1999 III 114.1 114.3 111.0 105.7 104.2
Forecast
1999 IV 114.7 115.4 112.0 106.3 105.4
2000 I 115.2 116.3 113.1 107.0 106.4
2000 II 115.8 116.7 113.7 107.4 107.5
2000 III 116.4 116.9 114.3 107.9 108.6
2000 IV 117.0 117.1 115.0 108.4 109.7
2001 I 117.6 117.2 115.6 108.9 110.7
2001 II 118.2 117.4 116.2 109.4 111.8
2001 III 118.8 117.6 116.9 109.9 113.0
2001 IV 119.4 117.9 117.6 110.2 113.3
Percentage changes
1997/96 -0.7 4.4 3.3 1.6 1.0
1998/97 2.6 2.2 2.4 0.9 -0.4
1999/98 4.7 3.8 2.0 1.2 3.5
2000/99 3.2 2.6 3.1 2.3 4.8
2001/00 2.0 0.7 2.2 1.8 3.9
2002/01 2.0 0.9 2.4 2.1 3.8
1999IV/98IV 5.0 4.6 2.7 2.1 5.4
2000IV/99IV 2.0 1.4 2.7 1.9 4.0
2001IV/00IV 2.0 0.7 2.3 1.7 3.3

Source: Economic Trends; Labour Market Trends; NIESR estimates.

(a.)1995 share of output in parentheses.

(b.)Gross value added at constant 1995 basic prices.

(c.)Including self-employment.

 The UK labour market
 Seasonally adjusted, millions
 Employment, Unemployment,
 thousands [a] thousands
 Self
 employ- ILO
 ment Training defin-
 Employees Total schemes ition
1996 22723 3626 418 26767 2334
1997 23260 3592 381 27233 2020
1998 23822 3487 339 27648 1818
1999 24129 3433 282 27844 1752
2000 24518 3301 250 28069 1688
2001 24744 3199 250 28193 1713
2002 24901 3113 250 28263 1746
1999 I 23998 3451 317 27766 1822
1999 II 24046 3479 318 27843 1760
1999 III 24179 3421 245 27845 1728
Forecast
1999 IV 24292 3380 250 27921 1697
2000 I 24414 3347 250 28011 1683
2000 II 24492 3315 250 28056 1683
2000 III 24555 3285 250 28090 1689
2000 IV 24612 3257 250 28119 1697
2001 I 24661 3232 250 28142 1706
2001 II 24707 3208 250 28165 1715
2001 III 24751 3186 250 28186 1723
2001 IV 24859 3172 250 28281 1707
Percentage changes
1997/96 2.4 -0.9 -8.7 1.7 -13.5
1998/97 2.4 -2.9 -11.2 1.5 -10.0
1999/98 1.3 -1.6 -16.6 0.7 -3.6
2000/99 1.6 -3.8 -11.6 0.8 -3.6
2001/00 0.9 -3.1 0.0 0.4 1.5
2002/01 0.6 -2.7 0.0 0.2 2.0
1999IV/98IV 1.4 -2.3 -22.1 0.7 -5.7
2000IV/99IV 1.3 -3.6 0.0 0.7 0.0
2001IV/001IV 1.0 -2.6 0.0 0.6 0.6
 Participation,
 thousands
 Popul-
 Civilian ation
 Long- work- of work-
 Claimant term [c] force [d] Inactive ing age
1996 2103 1135 29101 5899 35001
1997 1586 776 29253 5879 35131
1998 1347 585 29466 5793 35259
1999 1246 523 29596 5786 35381
2000 1180 484 29757 5748 35505
2001 1212 497 29906 5750 35656
2002 1249 512 30010 5782 35791
1999 I 1311 566 29588 5748 35337
1999 II 1282 539 29603 5764 35367
1999 III 1210 500 29573 5824 35396
Forecast
1999 IV 1180 485 29618 5806 35425
2000 I 1171 481 29694 5760 35453
2000 II 1174 482 29739 5743 35482
2000 III 1182 485 29779 5743 35522
2000 IV 1192 489 29816 5746 35561
2001 I 1202 493 29848 5753 35601
2001 II 1213 497 29880 5761 35640
2001 III 1222 501 29909 5766 35675
2001 IV 1210 496 29988 5721 35709
Percentage changes
1997/96 -24.6 -31.7 0.5 -0.4 0.4
1998/97 -15.1 -24.6 0.7 -1.5 0.4
1999/98 -7.5 -10.7 0.4 -0.1 0.3
2000/99 -5.3 -7.4 0.5 -0.7 0.3
2001/00 2.7 2.7 0.5 0.0 0.4
2002/01 3.1 3.1 0.3 0.5 0.4
1999IV/98IV -10.6 -20.5 0.3 0.6 0.3
2000IV/99IV 1.0 0.8 0.7 -1.0 0.4
2001IV/001IV 1.6 1.6 0.6 -0.4 0.4
 Underutilisation % [b]
 ILO Claim- Popul-
 unem- ant un- ation
 ploy- employ- not em-
 ment ment ployed
 rate rate rate
1996 8.0 7.3 23.5
1997 6.9 5.5 22.5
1998 6.2 4.6 21.6
1999 5.9 4.3 21.3
2000 5.7 4.0 20.9
2001 5.7 4.1 20.9
2002 5.8 4.2 21.0
1999 I 6.2 4.5 21.4
1999 II 5.9 4.4 21.3
1999 III 5.8 4.2 21.3
Forecast
1999 IV 5.7 4.1 21.2
2000 I 5.7 4.0 21.0
2000 II 5.7 4.0 20.9
2000 III 5.7 4.0 20.9
2000 IV 5.7 4.1 20.9
2001 I 5.7 4.1 21.0
2001 II 5.7 4.1 21.0
2001 III 5.8 4.2 21.0
2001 IV 5.7 4.1 20.8
Percentage changes
1997/96
1998/97
1999/98
2000/99
2001/00
2002/01
1999IV/98IV
2000IV/99IV
2001IV/001IV

Source: Economic Trends; Employment Gazette; NIESR estimates.

(a.) Includes self-employed, excludes HM Forces. Average figure per quarter.

(b.) The ILO unemployment rate is expressed as a percentage of the civilian workforce. The claimant unemployment rate is expressed as a percentage of employment plus training schemes and claimant unemployment. The population not employed is expressed as a percentage of the population of working age.

(c.) Over six months.

(d.) Employment plus training schemes and ILO unemployment.

 Price indices
 Seasonally adjusted, 1995=100
 Whole- Harmonised
 Unit sale Consumer index of
 labour Imports price price consumer
 costs deflator index [b] index prices
1996 102.5 100.3 102.0 103.1 102.5
1997 106.0 93.6 102.2 105.7 104.4
1998 111.0 87.7 102.1 108.4 106.0
1999 116.1 85.6 101.7 111.1 107.4
2000 120.3 85.2 103.2 113.5 109.3
2001 124.2 86.9 105.2 116.3 111.5
2002 127.3 89.0 107.0 119.0 113.5
1999 I 115.1 86.1 101.7 110.0 106.5
1999 II 115.7 85.6 101.5 111.1 107.7
1999 III 116.1 85.5 101.6 111.2 107.4
Forecast
1999 IV 117.4 84.9 102.0 112.0 107.9
2000 I 118.4 84.9 102.4 112.6 108.0
2000 II 119.7 85.1 102.9 113.2 109.6
2000 III 120.9 85.3 103.4 113.8 109.6
2000 IV 122.0 85.7 103.9 114.5 109.8
2001 I 123.1 86.1 104.4 115.2 110.1
2001 II 123.7 86.6 104.9 116.0 111.9
2001 III 124.5 87.1 105.4 116.7 112.0
2001 IV 125.7 87.7 105.9 117.4 112.0
Percentage changes
1997/96 3.4 -6.7 0.2 2.5 1.8
1998/97 4.8 -6.3 -0.1 2.5 1.5
1999/98 4.6 -2.5 -0.4 2.5 1.3
2000/99 3.6 -0.4 1.4 2.2 1.8
2001/00 3.3 1.9 1.9 2.5 2.1
2002/01 2.4 2.4 1.7 2.3 1.8
1999IV/98IV 3.9 -1.2 0.2 2.2 1.2
2000IV/99IV 3.9 0.9 1.9 2.2 1.8
2001IV/00IV 3.1 2.4 1.9 2.5 1.9
 Retail price index [a]
 Excluding
 mortgage GDP
 Excluding interest & deflator
 All mortgage indirect (basic
 items interest taxes prices)
1996 102.4 103.0 102.6 103.4
1997 105.6 105.8 104.8 106.2
1998 109.3 108.6 107.0 109.1
1999 110.9 111.1 108.7 111.8
2000 115.3 113.7 110.0 114.7
2001 119.0 116.5 112.1 117.7
2002 121.4 119.1 114.4 120.4
1999 I 109.8 109.8 107.7 110.6
1999 II 111.0 111.3 108.8 111.8
1999 III 111.0 111.3 108.8 112.1
Forecast
1999 IV 111.8 112.0 109.6 112.9
2000 I 112.9 112.2 108.9 113.6
2000 II 115.6 114.0 110.1 114.3
2000 III 116.1 114.1 110.1 115.1
2000 IV 116.6 114.5 111.1 115.9
2001 I 117.2 114.9 110.6 116.6
2001 II 119.3 116.9 112.1 117.4
2001 III 119.6 117.1 112.3 118.1
2001 IV 119.9 117.1 113.4 118.8
Percentage changes
1997/96 3.1 2.8 2.2 2.7
1998/97 3.4 2.7 2.0 2.7
1999/98 1.5 2.3 1.6 2.5
2000/99 4.0 2.3 1.2 2.6
2001/00 3.2 2.5 1.9 2.6
2002/01 2.0 2.2 2.0 2.2
1999IV/98IV 1.4 2.2 1.7 2.5
2000IV/99IV 4.3 2.2 1.3 2.7
2001IV/00IV 2.8 2.3 2.1 2.5
 GDP Manufac-
 deflator turing
 (market capacity
 prices) utilisation
1996 103.3 98.8
1997 106.3 98.3
1998 109.7 98.2
1999 112.8 96.0
2000 116.2 97.1
2001 119.2 97.9
2002 121.8 98.6
1999 I 111.3 95.4
1999 II 112.6 95.5
1999 III 112.9 96.5
Forecast
1999 IV 114.3 96.6
2000 I 115.0 96.8
2000 II 115.8 97.0
2000 III 116.5 97.2
2000 IV 117.3 97.4
2001 I 118.1 97.6
2001 II 118.8 97.8
2001 III 119.5 98.0
2001 IV 120.2 98.2
Percentage changes
1997/96 2.9 -0.5
1998/97 3.2 -0.1
1999/98 2.9 -2.3
2000/99 3.0 1.2
2001/00 2.6 0.7
2002/01 2.2 0.8
1999IV/98IV 3.0 2.0
2000IV/99IV 2.6 0.9
2001IV/00IV 2.5 0.7

Source: Economic Trends; NIESR estimates.

(a.)Not seasonally adjusted.

(b.)Excluding food, drink, tobacco and petroleum.

 National and sectoral savings
 As a percentage of GDP
 Household sector Company sector
 Saving Investment Saving Investment
1996 6.7 4.2 12.3 11.2
1997 6.6 4.2 11.8 11.8
1998 4.2 4.2 12.0 12.7
Forecast
1999 4.2 4.3 9.8 12.5
2000 4.5 4.4 9.9 12.0
2001 4.3 4.5 9.9 11.8
2002 4.2 4.5 10.0 11.8
2003 4.1 4.4 10.2 11.8
 Government Sector Whole economy Finance
 from
 Saving Investment Saving Investment Overseas
1996 -2.2 1.5 16.8 16.9 0.0
1997 -0.4 1.2 18.1 17.2 -0.9
1998 1.9 1.2 18.1 18.1 0.0
Forecast
1999 2.6 1.1 16.6 17.9 1.3
2000 2.1 1.4 16.5 17.9 1.6
2001 2.1 1.5 16.3 17.8 1.7
2002 2.3 1.7 16.5 17.9 1.6
2003 2.4 1.8 16.8 18.1 1.5
 Residual
1996 0.1
1997 0.1
1998 0.0
Forecast
1999 0.0
2000 -0.2
2001 -0.2
2002 -0.2
2003 -0.2
 Medium-term projections
 Seasonally adjusted
 1998 1999 2000 2001
Growth rate of expenditure and output (per cent)
 Household spending 3.2 3.6 3.5 2.7
 Government spending 0.7 3.7 4.6 2.4
 Fixed investment 11.2 4.1 3.3 3.5
 Exports of goods and
 services 2.4 3.3 6.5 4.7
 Imports of goods and
 services 8.8 7.0 7.9 5.7
 GDP at market prices 2.2 1.9 3.2 2.3
Manufacturing output 0.3 -0.2 2.4 2.1
Growth rate of costs and prices (per cent)
 Average earnings 4.6 4.8 5.0 4.9
 RPI 3.4 1.5 4.0 3.2
 RPIX 2.7 2.3 2.3 2.5
 Consumer price index 2.5 2.5 2.2 2.5
 GDP deflator (basic prices) 2.7 2.5 2.6 2.6
Productivity growth 0.9 1.2 2.3 1.8
ILO unemployment rate 6.2 5.9 5.7 5.7
Manufacturing capacity
 utlisation 0.9 0.9 0.9 0.9
Base rates 7.2 5.3 6.3 6.5
Effective exchange rate 103.9 103.6 106.9 104.9
Current account
 (as % of GDP) 0.0 1.3 1.6 1.7
PSNCR (as a % of GDP) -0.9 -0.9 -0.4 -0.2
Government debt
 (as % of GDP) 48.4 45.2 42.0 39.7
 2002 2003 2004 2005
Growth rate of expenditure and output (per cent)
 Household spending 2.4 2.1 2.1 2.1
 Government spending 2.4 2.4 2.3 2.0
 Fixed investment 3.9 4.0 3.6 3.0
 Exports of goods and
 services 4.9 4.9 4.8 4.7
 Imports of goods and
 services 5.1 4.7 4.4 4.1
 GDP at market prices 2.4 2.5 2.4 2.4
Manufacturing output 2.3 2.5 2.5 2.4
Growth rate of costs and prices (per cent)
 Average earnings 4.3 4.2 3.8 3.6
 RPI 2.0 1.8 1.9 1.9
 RPIX 2.2 1.8 1.6 1.5
 Consumer price index 2.3 1.9 1.6 1.5
 GDP deflator (basic prices) 2.2 1.9 1.6 1.5
Productivity growth 2.1 2.5 2.4 2.3
ILO unemployment rate 5.8 6.0 6.1 6.2
Manufacturing capacity
 utlisation 0.9 0.9 0.9 0.9
Base rates 5.9 5.5 5.5 5.5
Effective exchange rate 103.5 102.9 103.1 103.2
Current account
 (as % of GDP) 1.6 1.5 1.4 1.2
PSNCR (as a % of GDP) -0.2 -0.2 -0.1 -0.1
Government debt
 (as % of GDP) 37.7 35.9 34.4 33.0
 2006 2007 2008
Growth rate of expenditure and output (per cent)
 Household spending 2.2 2.1 2.2
 Government spending 2.0 2.0 2.0
 Fixed investment 3.1 3.1 3.1
 Exports of goods and
 services 4.7 4.7 4.7
 Imports of goods and
 services 4.1 4.1 4.1
 GDP at market prices 2.5 2.5 2.5
Manufacturing output 2.3 2.1 2.0
Growth rate of costs and prices (per cent)
 Average earnings 3.8 4.1 4.5
 RPI 2.0 2.2 2.5
 RPIX 1.6 1.8 2.1
 Consumer price index 1.6 1.9 2.2
 GDP deflator (basic prices) 1.5 1.8 2.2
Productivity growth 2.3 2.2 2.1
ILO unemployment rate 6.3 6.3 6.3
Manufacturing capacity
 utlisation 0.9 0.9 0.9
Base rates 5.5 5.5 5.5
Effective exchange rate 103.4 103.6 103.8
Current account
 (as % of GDP) 1.0 0.7 0.5
PSNCR (as a % of GDP) -0.2 -0.3 -0.4
Government debt
 (as % of GDP) 31.6 30.0 28.3
 Average absolute errors, NIESR forecasts made in January/February [*]
 All figures per cent unless otherwise indicate
 Current year
 Average error Error range
Real GDP growth 1.0 0.1 - 2.3
Domestic demand growth 1.1 0.2 - 2.2
Consumers expenditure growth 1.4 0.0 - 4.2
Investment growth 3.0 0.2 - 8.7
Export volume growth 2.4 0.5 - 4.5
Import volume growth 2.7 0.3 - 4.9
Real personal disposable income growth 1.5 0.2 - 4.0
Current account ([pounds]bn) 5.1 0.1 - 12.7
Public sector borrowing requirement 7.3 0.1 - 24.0
([pounds]bn) [a]
Retail price inflation (Q4) 1.1 0.3 - 2.7
 Year ahead Average
 outturn
 Average error Error range 1982-98
Real GDP growth 1.4 0.1 - 3.2 2.6
Domestic demand growth 1.9 0.2 - 5.6 2.9
Consumers expenditure growth 2.0 0.0 - 5.9 3.0
Investment growth 4.1 0.1 - 12.6 4.2
Export volume growth 2.3 0.1 - 5.6 4.7
Import volume growth 3.9 0.1 - 10.5 6.0
Real personal disposable income growth 1.9 0.3 - 6.3 2.9
Current account ([pounds]bn) 7.1 0.0 - 20.4 -5.8
Public sector borrowing requirement 11.1 0.0 - 27.1 11.5
([pounds]bn) [a]
Retail price inflation (Q4) 1.8 0.4 - 5.1 4.5
(*.)All errors defined by subtracting the forecast from the outturns for
1982-98.
(a.)Financial year.
 Probability distribution of growth and
 inflation forecasts
 Inflation: probability of 12 month RPIX
 inflation falling in the following ranges
 2000Q4 2001Q4
less than 1.5 per cent 29 36
1.5 to 2.5 per cent 30 18
2.5 to 3.5 per cent 25 16
more than 3.5 per cent 16 30
 100 100
 Growth: probability of annual growth rate
 falling in the following ranges
 2000 2001
less than 0 per cent - 11
0 to 1 per cent 2 14
1 to 2 per cent 12 21
2 to 3 per cent 32 21
3 to 4 per cent 36 17
more than 4 per cent 18 16
 100 100

FISCAL REPORT

The public finances were transformed in the second half of the 1990s as the economy recovered from recession, a range of fiscal measures were implemented and there was unexpected buoyancy in revenues from existing taxes. The budget surplus that this produced looks set to continue for a number of years, provided that the economy does not suffer any major unfavourable shocks. Indeed, the underlying budgetary position is sufficiently strong that it would take a serious adverse macroeconomic shock to raise the deficit to threatening levels.

A slightly different concern is whether the government's tax and spending plans are themselves feasible. The complaints of many interest groups suggest that tight control of public spending has been achieved by impoverishing those with limited market power. For example, the pay of university lecturers has fallen substantially in relative terms over the past twenty years, while linking the state pension to prices rather than earnings has had a serious effect on its purchasing power. The announcement in the Pre-Budget Report that fuel and tobacco escalators would from now on be applied on a discretionary basis indicated the extent to which certain measures are not enforceable, especially when they are against the interests of strong lobbies. Similar questions apply to the government's departmental spending plans and whether they can provide the level of services that people expect. A topical case in point is the National Health Service (NHS).

There is a widespread perception that the NHS is under-funded and does not deliver the level of service that people expect. Comparative figures [1] for 1997 indicate that overall health spending in the UK is lower than in most other industrial countries. For example, national healthcare expenditure in the UK (including both private and public sector spending) is 6.8 per cent of GDP, compared with 13.9 per cent in the US, 10.7 per cent in Germany, 9.6 per cent in France and 8.0 per cent in the EU as a whole.

The Prime Minister (16 January) has pledged to raise health spending in Britain substantially over the coming years, aiming for it to reach the European average by 2005. This will involve a substantial increase in public spending, over and above that which is already committed. In this Fiscal Report, we first examine the state of the public finances as they appear on the basis of existing plans. We then look at the implications of extra spending on the NHS for both the public finances and the national economy.

Table 1 sets out our forecasts of public sector spending, receipts and borrowing on a financial year basis. Government spending decisions for the years 1999-2000 to 2001-2 were set out in the Comprehensive Spending Review (CSR). We have assumed that these plans are adhered to. Total Managed Expenditure (TME), the sum of current and capital spending, is set to grow by an annual average rate of 5 per cent over the next three fiscal years. This is a real terms increase of 21/2 per cent per annum when deflated by the GDP deflator which is expected by the government to grow at 21/2 per cent per annum over this period (our own forecast of the GDP deflator is shown in the table). Within this total, net capital spending is due to double to around [pounds]10 billion in 2001-2. This is a substantial percentage rise, but from a very low base.

Total managed expenditure is expected to remain below 39 per cent of GDP over the next three years. The government's spending plans beyond 2001-2 are to be determined in the next CSR. In the absence of other information, our main forecast assumes no significant change from the trends implicit in the plans already announced. In particular we assume government consumption rises by 2 to 2 1/2 per cent per annum for the following ten years.

Our forecast of government receipts is based on announced tax rates, together with our expectations about the development of the tax base. Receipts rose by about 1 1/2 per cent of GDP between 1996-7 and 1998-9, but are expected to remain at just over 39 per cent of GDP in the current fiscal year. Table 2 sets out in more detail our forecasts for the components of revenue as shares of nominal income. Our forecast shows the share remaining at this level in 2000-1 before falling back slightly. This level is high by recent historical standards, having risen from 36 per cent in 1993. We do not expect company taxes to be as buoyant over the next three or four years. Partly this reflects our forecast of a slight fall in the profit share, and because companies have sizeable capital allowances to offset against profits. With the corporate tax rate being reduced and Advance Corporation Tax (ACT) having being abolished there are also structural reasons for there being some fall in company tax payments. Personal tax rece ipts are expected to remain high at over 11 per cent of GDP, having risen from 10 per cent as recently as 1997-8.

On this basis, the government's fiscal plans are expected to be easily met. The current surplus is expected to rise from this year's estimate of [pounds]10 billion to about [pounds]11 billion in 200 1-2. The overall budget is not expected to go into deficit over this period despite the assumed rise in capital investment. Public sector net lending is expected to fall from [pounds]8.7 billion in the current fiscal year to about balance in 2001-2.

The outlook for the public finances described here is very similar to that shown in the Pre-Budget Report for the years to 2001-2. Beyond that the PBR shows public sector borrowing rising, whereas we foresee the continuation of small overall surpluses. This may partly reflect the cautiousassumption in the PBR that growth will be 21/4 per cent, despite the Treasury's belief that trend growth is actually 21/2 per cent per annum. These diverse projections reflect quite small differences in assumed spending and receipts totals. Both forecasts agree that the overall budget will not be more than 1/2 per cent of GDP away from balance. The current surplus, the extent to which the Golden Rule is met, is expected to be in surplus by over 1 per cent of GDP at least until 2005-6.

With projected surpluses of this magnitude it would appear that there is scope for the government to increase current spending by an average of [pounds]17 billion between the years 2001-2 and 2005-6 while still meeting the Golden Rule. Is this sufficient to meet the Prime Minister's aspiration with respect to NHS spending?

According to the OECD Health Database, spending on health in the UK in 1997 was 6.8 per cent of GDP. In addition to government spending on the NHS, worth 41/2 per cent of GDP, this also includes other government spending on health, private spending on medicines, other health products and private health care. This is 1.2 per cent of GDP less than the EU average. Thus, at minimum, it will be necessary to raise NHS spending by the equivalent of 1.2 per cent of GDP to bring UK spending up to the European average. To the extent that much private spending on health is carried out because of the deficiencies of the NHS, it is possible that the increase will have to be bigger to make up for some drop-off in private spending. But ignoring this possibility suggests that NHS spending would need to rise to about 53/4 per cent of GDP by 2005-6. At today's prices, this is equivalent to [pounds]52 billion, compared with actual NHS spending of [pounds]41 billion.

Existing government spending plans show that more resources are already being committed to the NHS. The plans set out in the CSR show NHS current spending rising from [pounds]36,916 million in 1998-9 to [pounds]44,509 million in 2001-2.2 This represents an annual percentage increase of 6.4 per cent in nominal terms and 3.9 per cent in real terms. Over the same period, capital spending by the Health Department and NHS trusts is set to grow from [pounds]1,010 million to [pounds]2,285 million, an annual percentage increase of 31.3 per cent in nominal terms and 28.8 per cent in real terms. But the total change represents only a small increase as a share of national income. With money GDP forecast to rise from [pounds]857 billion in 1998-9 to [pounds]1014.1 billion in 2001-2, total NHS spending is rising from 4.5 per cent of GDP in 199 8-9 to 4.6 per cent of GDP in 2001-2.

Given these increases in NHS spending as a share of GDP that are already planned as part of the CSR, how much extra spending is necessary to reach a target of 53/4 per cent of GDP by 2005-6? According to our forecast, nominal GDP will be [pounds]1,180 billion in 2005-6, 50 NHS spending would need to be [pounds]68 billion to meet the target. It is already planned to reach [pounds]46.8 billion by 2001-2 and would reach [pounds]56.1 billion by 2005-6 if NHS spending were to grow in line with government consumption generally. Clearly there is a gap of about [pounds]12 billion. Assuming that there is little flexibility to increase spending before 2001-2, spending would need to rise at an annual average nominal rate of 10.7 per cent, or 8.2 per cent per annum in real terms from 2002-3 to 2005-6 to reach the EU average. Simply raising spending by 5 per cent per annum in real terms from next financial year, as the Prime Minister has pledged, would not be sufficient to reach the target over this period. This would rai se NHS spending only to 5 1/4 per cent of GDP.

Our projections of the budget surplus on current account suggest that there is scope within the existing budget to increase NHS spending substantially and still meet the Golden Rule. To meet such a target, we have assumed that the volume of government consumption and investment grow more quickly than in the main forecast, with additional spending assumed to be on the NHS. In particular, we have assumed that the volume of government consumption grows at an annual rate of 3.8 per cent for three years from the beginning of 2002-3 rather than an average rate of 21/2 per cent as in the main forecast. Public investment is also assumed to grow more quickly. By 2005-6, public sector current and capital spending is higher by around [pounds]10 billion at 1995 prices, equivalent to [pounds]12.2 billion at the prices prevailing in 2005-6 in our main forecast. In table 3 this is shown as an increase in current spending on the NHS of [pounds]10.2 billion and extra capital spending of [pounds]2.2 billion relative to what is assumed in the main forecast. With no change in prices or output elsewhere in the economy, this would reduce the current surplus in 2005-6 to [pounds]8.9 billion and raise public sector net borrowing to [pounds]11 billion, just under 1 per cent of GDP.

However, an increase in spending of this magnitude would have a range of macroeconomic implications. [3] To assess this, we have re-run our main forecast with these revised assumptions for government consumption and investment. We have maintained the same assumptions for other variables as in the main forecast. In particular, sterling is assumed to be fixed against the euro from the end of 2003 at [epsilon]1.51 and UK interest rates are set at euro levels from this time. While there would be scope for some adjustment of monetary policy before EMU entry, we assume that this does not occur. In the very long term we have assumed that public spending growth slows down to the same level as in the main forecast.

The fiscal expansion raises demand in the economy, raising employment and output in the short term and so putting upward pressure on prices. This has a major effect on government spending and receipts in nominal terms. Table 3 indicates the effect of the changed policy on the public finances. This shows that by 2005-6, total current spending would be [pounds]460 billion, compared with [pounds]420 billion in the main forecast. The difference of around [pounds]40 billion is predominantly due to the effect of higher inflation raising the cost of public services by about 7 per cent by 2005-6. Public expenditure as a share of GDP rises by 1 percentage point. This is in line with the increased spending target, but allows for the fact that some items of spending, such as debt interest, are less affected. Higher prices and higher economic activity generally also raise government receipts so that the current surplus is reduced only by [pounds]4 billion deficit. However, higher investment spending means that overall pu blic sector net borrowing goes up by [pounds]10 billion to [pounds]9.5 billion.

The effect of the policy on the economy more widely is shown in Chart 2. RPI inflation is raised by 1 per cent per annum during the time that government consumption is raised and the level of prices is 8 per cent higher by 2009. Apart from the adverse effect on inflation, the other main cost to this policy is that manufacturing output is reduced sharply relative to what it would otherwise have been. It is clear that some cost must be borne if resources are to be shifted into the public sector. The mechanism by which this comes about is that prices are bid up, so worsening the competitiveness of the traded sector and leading to a fall in output in that sector. This is also apparent in a worsening of the current account of the balance of payments by about 1 per cent of GDP.

Another adverse factor is that government debt rises relative to the level it would have reached in the absence of extra spending. In the base case, government indebtedness is falling and the extra spending merely slows down this process. Nevertheless, debt as a share of GDP is 3 per cent of GDP higher than it would otherwise have been by 2009. Gradually this process raises debt interest payments in a cumulative process that needs eventually to be stabilised by some policy adjustment unless the rate of interest is less than the growth rate. Here we have assumed that the increase in real spending is not sustained for ever and that the rise in the deficit to GDP ratio is restricted to about 1 percentage point.

An alternative perspective can be gained by considering the inter-generational consequences of this policy. This can be quantified using the National Institute's generational accounts model. [4] This requires that sustained changes in spending are eventually financed by higher taxes. Governments have a choice as to when these taxes are raised. To pay for a sustained rise in spending of 1 per cent of GDP, tax receipts would have to rise by the same amount if levied immediately, but by more than this if the increase is delayed. The model indicates that total tax receipts would have to rise by 3 per cent if implemented at the same time as spending is increased, with larger increases needed if they are deferred. These options have different implications for different generations. The net present value of the lifetime taxes paid by a person born today would rise by about [pounds]2000. By contrast, the old benefit by the policy. Today's 60 year-olds would gain approximately [pounds]5000 of lifetime resources.

Another risk to the policy is that economic circumstances turn out to be different from what we are now expecting. There is a vast range of shocks that might hit the economy over the next decade, and not all of these are bad. Nevetheless, in order to explore the risks of this policy, we have added some shocks to world demand, consumer demand and technological change such that the growth rate turns out to be about a percentage point lower than we are currently forecasting. Clearly this is significantly worse than the main case scenario, but not the worst possible case. Chart 4 shows the effect on the public finances. The deficit now reaches 31/2 per cent of GDP by 2010 and the debt stock rises to 40 per cent of GDP, 14 percentage points above the main case.

This is only one example of the risks that the economy faces over the next ten years. Even if the economy behaves broadly as expected, substantial risks surround forecasts of the budgetary position. Recently, the public finances have been much stronger than forecast as income tax receipts have been surprisingly buoyant. There is every chance that the public finances will suffer shocks in the opposite direction in the next few years, in which case, extra spending of the type considered here will turn out to be much less affordable than it appears at present.

Summary and conclusions

The outlook for the public finances described here on the basis of the government's existing spending plans is enviable. Spending control has benefited from the excellent economic background as low interest rates have reduced the government's debt interest bill and high employment has contributed to savings on a range of social benefits.

Total spending has now fallen below 40 per cent of GDP and is expected to remain low despite a surge in government consumption and capital investment.

With spending under control, the budgetary position is expected to benefit from a period of sustained economic growth. This is projected to generate sufficient income that the surplus on the current budget will be above [pounds] 10 billion per annum over the next three years, with prospects of bigger surpluses in the years beyond.

There are basically three ways in which such surpluses can be used. First, they can be used to pay off debt. The public sector balance sheet worsened dramatically in the early 1990s and there is a respectable case to be made that the surpluses be used to replenish the balance sheet now. With an ageing population, public sector saving now is likely to find many uses in the future. However, the government's commitment to the Golden Rule implies that it is comfortable with the overall state of its balance sheet and has no wish to save up now for spending in the future. The second possible use of the surpluses is to cut taxes. Medium term current surpluses of around 1 per cent of GDP could be used to cut the basic rate of income tax by 3p in the pound and the top rate by 5p in the pound. Alternatively they could be used to make radical changes to the personal income tax system so as to eliminate the tax liability of the lowest paid altogether.

The third possible use of the surpluses is to raise spending. Inevitably, projected surpluses of the size shown here create expectations of further spending, especially when there is widespread dissatisfaction with the existing provision of public sector services. Although the government has stressed that education is its priority, there is no shortage of competition for more resources, as demonstrated by the Prime Minister's commitment of more spending on the NHS.

Our analysis of the Prime Minister's aspiration to raise health spending in the UK to the European average shows that it appears to be affordable within the existing budget with no need for higher taxation to fund it. In effect, the unexpectedly high levels of tax receipts seen recently would be used to fund extra NHS spending. Rather than seeing a current surplus of [pounds] 19 billion and an overall surplus of [pounds] 1.5 billion in 2005-6, the current surplus would be reduced to [pounds] 15 billion and an overall deficit of [pounds] 9.5 billion would emerge when spending is raised by 1 per cent of GDP to improve the health service. These figures are affected by the extra economic activity and higher prices that would result from extra public spending.

Not only can the Prime Minister's pledge be met, but there would still be room within the current budget for additional spending on other priorities. However, it would be wrong to suggest that it could be achieved without cost. First, when there is little spare capacity in the economy, the health service can only have more resources if other activities have less. While extra public spending will raise economic activity and output in the short term, in the longer term it will crowd out other activity. The traded sector, especially manufacturing, would be most adversely affected. In our analysis, manufacturing output would be 2 per cent lower than it would otherwise have been by 2006 as a consequence of higher public spending. Prices will also be raised, with inflation about 1 per cent higher than otherwise for a number of years. Second, extra spending on health or other public activities must ultimately be financed by taxation higher than it would otherwise have been. In the present case, the choice appears to be between more spending and foregone tax cuts rather than actual tax increases. This also transfers resources between the generations. Our figures suggest that extra health spending of 1 per cent of GDP would benefit 60 year-olds by the equivalent of a lump sum of [pounds] 5000 and penalise those just born by [pounds] 2000. The young would have to forgo the benefits of tax cuts to pay for extra health spending which mainly benefits the old. Third, there are costs that would arise if the public finances turn out to be in worse shape than we think. Relatively small changes in the economic outlook or in tax yields can change the outlook significantly. One of the main problems with the new system of setting spending plans for three-year periods is that it allows very little flexibility to change course when the unexpected occurs. As a consequence, it may be difficult to reverse any extra spending granted at a time when the outlook is favourable and this in turn could lead to a return to very large deficits or e mergency tax increases in the future.

Nevertheless, policy cannot always be set in fear of the worst. The current outlook for the economy generally and for the public finances is good. If the Prime Minister wants to commit more resources to the health service, then this appears to be affordable within the existing budget.

Notes

(1.) Source: OECD Health Data 1999. Figures for 1997. Reported in Financial Times, January 15/16, 2000.

(2.) Source: Public Expenditure 1999-2000. HM Treasury. March, 1999.

(3.) See Church et al. on page 107 of this Review for an explanation of their effects in a range of different models.

(4.) Cardarelli, R., Sefton,J. and Kotlikoff, L.J. (1999), 'Generational accounting in the UK', NIESR Discussion paper no. 147, www.generationalaccounting.com.

 Public sector financial balance and borrowing requirement
 [pounds] billion, fiscal years
 1999-00 2000-1 2001-2
Current expenditure: Goods and services 166.0 177.6 186.6
 Net social benefits paid 111.7 118.0 122.8
 Debt interest 29.9 28.8 27.7
 Subsidies 5.3 5.6 5.9
 Other current expenditure 16.5 15.9 19.0
 Total 329.4 346.0 362.0
Gross investment 20.4 22.5 25.4
Net investment 6.2 7.6 10.1
Total managed expenditure 349.7 368.5 387.4
(As a % of GDP) 38.7 38.6 38.2
Memo items: GDP deflator at
 market prices 113.7 116.9 119.9
 Money GDP 903.6 955.4 1014.1
Current receipts: Taxes on income and oil royalties 146.2 152.7 153.8
 Taxes on expenditure 129.9 139.4 148.5
 Social security contributions 67.7 72.2 73.6
 Gross operating surplus 13.3 14.3 14.8
 Other current receipts -3.7 -4.7 -2.9
 Total current receipts 353.4 373.8 387.8
Public sector current balance 9.9 12.9 10.5
Public sector net borrowing -8.7 -5.3 -0.4
Financial transactions -4.0 0.0 0.0
Public sector net cash requirement -4.8 -5.3 -0.4
(As a % of GDP) -0.5 -0.6 0.0
Memo items (calendar years, per cent of GDP)
Govt deficit under Maastricht -1.1 -0.2 0.0
Govt debt under Maastricht 45.2 42.0 39.7
 2002-3 2003-4 2004-5
Current expenditure: Goods and services 195.1 203.2 210.7
 Net social benefits paid 127.9 133.5 139.6
 Debt interest 26.8 25.9 25.2
 Subsidies 6.2 6.5 6.7
 Other current expenditure 23.0 24.0 24.9
 Total 378.9 393.1 407.2
Gross investment 27.8 31.4 33.5
Net investment 12.2 15.4 17.1
Total managed expenditure 406.7 424.5 440.7
(As a % of GDP) 38.8 38.8 38.8
Memo items: GDP deflator at
 market prices 122.4 124.5 126.4
 Money GDP 1048.3 1093.0 1136.3
Current receipts: Taxes on income and oil royalties 163.0 169.5 175.6
 Taxes on expenditure 155.4 161.7 167.7
 Social security contributions 77.1 80.6 83.9
 Gross operating surplus 15.1 15.4 15.8
 Other current receipts -0.9 -1.0 -1.5
 Total current receipts 409.6 426.2 441.5
Public sector current balance 15.1 17.1 17.9
Public sector net borrowing -2.9 -1.7 -0.8
Financial transactions 0.0 0.0 0.0
Public sector net cash requirement -2.9 -1.7 -0.8
(As a % of GDP) -0.3 -0.2 -0.1
Memo items (calendar years, per cent of GDP)
Govt deficit under Maastricht -0.1 -0.1 0.1
Govt debt under Maastricht 37.7 35.9 34.4
 2005-6
Current expenditure: Goods and services 218.0
 Net social benefits paid 145.4
 Debt interest 24.6
 Subsidies 7.0
 Other current expenditure 25.9
 Total 420.9
Gross investment 34.5
Net investment 17.6
Total managed expenditure 455.4
(As a % of GDP) 38.6
Memo items: GDP deflator at
 market prices 128.2
 Money GDP 1180.3
Current receipts: Taxes on income and oil royalties 181.7
 Taxes on expenditure 174.0
 Social security contributions 87.3
 Gross operating surplus 16.2
 Other current receipts -2.4
 Total current receipts 456.9
Public sector current balance 19.1
Public sector net borrowing -1.5
Financial transactions 0.0
Public sector net cash requirement -1.5
(As a % of GDP) -0.1
Memo items (calendar years, per cent of GDP)
Govt deficit under Maastricht 0.0
Govt debt under Maastricht 33.0
Note: Public sector current balance is total current
receipts less total current expenditure and depreciation.
Depreciation is the difference between
gross and net investment.
 Public sector receipts
 % GDP
 1996-7 1997-8 1998-9 1999-00 2000-1 2001-2
Taxes on company income 3.2 4.0 3.8 3.3 2.4 2.3
Personal income tax 10.2 10.0 10.9 11.2 11.9 11.3
Council tax 1.3 1.3 1.4 1.4 1.4 1.4
Taxes on income 14.9 15.4 16.3 16.2 16.0 15.3
VAT receipts 6.1 6.2 6.1 6.4 6.5 6.5
Other indirect taxes 7.7 7.8 8.0 7.9 8.1 8.3
Taxes on expenditure 13.8 14.0 14.1 14.4 14.6 14.8
Social security contributions 7.4 7.6 7.7 7.5 7.6 7.3
Gross operating surplus 1.5 1.5 1.5 1.5 1.5 1.5
Other receipts -0.1 -0.1 -0.3 -0.4 -0.5 -0.3
As a share of GDP 37.6 38.4 39.2 39.1 39.1 38.7
 2002-3 2003-4 2004-5 2005-6
Taxes on company income 2.5 2.5 2.4 2.4
Personal income tax 11.3 11.4 11.4 11.4
Council tax 1.4 1.4 1.4 1.4
Taxes on income 15.5 15.5 15.4 15.4
VAT receipts 6.5 6.5 6.5 6.4
Other indirect taxes 8.3 8.3 8.3 8.3
Taxes on expenditure 14.8 14.8 14.8 14.7
Social security contributions 7.4 7.4 7.4 7.4
Gross operating surplus 1.4 1.4 1.4 1.4
Other receipts -0.1 -0.1 -0.1 -0.2
As a share of GDP 39.1 39.0 38.9 38.7
 NHS spending
 [pounds] billion, fiscal years
 1999-00 2000-01 2001-02
NHS spending plans CSR
Current 39.2 41.9 44.5
Capital 1.6 1.9 2.3
Total 40.8 43.8 46.8
(As a % of money GDP) 4.5 4.6 4.6
With 5% real growth from 1999-2000 40.8 44.0 47.4
(As of % of money GDP) 4.5 4.6 4.7
With extra 1% of GDP by 2005-06 40.8 43.8 46.8
Ex-ante budgetary effects of attempt to
 raise spending by 1% of GDP
Additional spending on goods and services
Additional spending on gross investment
Revised current balance
Revised PSNB:
Revised public finance forecast incorporating
 raised NHS spending
Current expenditure Goods and services 166.0 177.7 188.5
 Net social benefits paid 111.7 118.0 123.3
 Debt interest 29.9 28.8 27.6
 Subsidies 5.3 5.6 6.0
 Other current expenditure 16.5 15.8 16.7
 Total 329.4 346.0 362.0
Gross investment 20.4 22.5 25.4
Net investment 6.2 7.6 9.9
Total managed expenditure 349.7 368.5 387.4
(As a % of GDP) 38.7 38.5 38.2
Memo items: GDP deflator at
 market prices 113.7 117.0 121.1
 Money GDP 903.6 956.2 1014.3
Current receipts: Taxes on income and oil
 royalties 146.2 152.8 155.9
 Taxes on expenditure 129.9 139.6 150.3
 Social security contributions 67.7 72.2 74.5
 Gross operating surplus 13.3 14.3 14.8
 Other current receipts -3.7 -4.8 -5.8
 Total current receipts 353.4 374.0 389.7
Public sector current balance 9.85 13.1 12.21
Public sector net borrowing -8.7 -5.5 -2.3
Financial transactions -4.0 0.0 0.0
Public sector net cash requirement -4.8 -5.5 -2.3
(As a % of GDP) -0.5 -0.6 -0.2
Govt deficit under Maastricht -1.1 -0.2 -0.02
Govt debt under Maastricht 45.2 42.0 39.2
 2002-03 2003-04 2004-05
NHS spending plans projections
Current 46.5 48.5 50.4
Capital 2.6 2.9 3.2
Total 49.1 51.4 53.7
(As a % of money GDP) 4.7 4.7 4.7
With 5% real growth from 1999-2000 50.8 54.3 57.9
(As of % of money GDP) 4.8 5.0 5.1
With extra 1% of GDP by 2005-06 50.9 56.2 63.7
Ex-ante budgetary effects of attempt to 4.9 5.1 5.6
 raise spending by 1% of GDP
Additional spending on goods and services +1.7 +4.7 +8.4
Additional spending on gross investment +0.1 +0.1 +1.6
Revised current balance 13.4 12.4 9.5
Revised PSNB: -1.1 3.1 9.2
Revised public finance forecast incorporating
 raised NHS spending
Current expenditure Goods and services 201.8 216.5 231.6
 Net social benefits paid 130.0 137.7 146.1
 Debt interest 26.5 25.6 25.1
 Subsidies 6.3 6.7 7.1
 Other current expenditure 23.6 25.0 26.5
 Total 388.3 411.5 436.3
Gross investment 28.3 32.5 37.3
Net investment 12.3 15.8 19.9
Total managed expenditure 416.6 444.1 473.7
(As a % of GDP) 38.7 38.9 39.3
Memo items: GDP deflator at
 market prices 125.4 129.4 133.3
 Money GDP 1077.6 1141.9 1206.3
Current receipts: Taxes on income and oil
 royalties 167.9 177.7 187.2
 Tax on expenditure 159.5 168.3 176.9
 Social security contributions 79.5 84.5 89.7
 Gross operating surplus 15.4 16.0 16.7
 Other current receipts -1.3 -1.6 -1.7
 Total current receipts 421.0 445.0 468.8
Public sector current balance 16.6 16.8 15.1
Public sector net borrowing -4.4 -0.9 4.9
Financial transactions 0.0 0.0 0.0
Public sector net cash requirement -4.4 -0.09 4.9
(As a % of GDP) -0.4 -0.1 0.4
Govt deficit under Maastricht -0.3 0.0 0.4
Govt debt under Maastricht 36.5 34.1 32.3
 2005-06
NHS spending plans
Current 52.4
Capital 3.6
Total 56.1
(As a % of money GDP) 4.8
With 5% real growth from 1999-2000 61.7
(As of % of money GDP) 5.2
With extra 1% of GDP by 2005-06 68.3
Ex-ante budgetary effects of attempt to 5.8
 raise spending by 1% of GDP
Additional spending on goods and services +10.2
Additional spending on gross investment +2.2
Revised current balance 8.9
Revised PSNB: 10.9
Revised public finance forecast incorporating
 raised NHS spending
Current expenditure Goods and services 244.3
 Net social benefits paid 154.2
 Debt interest 25.0
 Subsidies 7.4
 Other current expenditure 27.8
 Total 458.7
Gross investment 42.8
Net investment 24.6
Total managed expenditure 501.5
(As a % of GDP) 39.6
Memo items: GDP deflator at
 market prices 136.8
 Money GDP 1267.6
Current receipts: Taxes on income and oil
 royalties 196.1
 Tax on expenditure 185.4
 Social security contributions 94.6
 Gross operating surplus 17.4
 Other current receipts -1.5
 Total current receipts 492.0
Public sector current balance 15.1
Public sector net borrowing 9.5
Financial transactions 0.0
Public sector net cash requirement 9.5
(As a % of GDP) 0.7
Govt deficit under Maastricht 0.8
Govt debt under Maastricht 31.2

(*.)The forecast was compiled using the latest version of the National Institute Domestic Econometric Model. I am grateful to Ray Barrell, Richard Kneller, Nigel Pain, Rebecca Riley and Martin Weale for comment and discussion.

AT A GLANCE

The UK economy

* The economy will grow by 3.2 per cent in 2000 and 2.3 per cent in 2001.

* Manufacturing will enjoy its best year since 1994, with output expanding by 2.4 per cent in 2000.

* Inflation will stay just below the government's 2.5 per cent target in 2000 and 2001.

* The current account deficit will widen to [pounds]17 billion in 2001.

* The Prime Minister's new objective to raise health spending as a proportion of GDP to the EU average by 2005 can be met without breaking the golden rule.

The economy is poised to grow strongly in 2000, powered by a brisk increase in domestic demand and a recovery in exports. The swift return to buoyant economic conditions will push wage earnings growth to 5 per cent. However, a rise in productivity growth, the strong pound and rising competitive pressures in retail markets will keep inflation at bay over the next two years. The inflation target can be met with a rise in base rates to 6.5 per cent.

Domestic demand will rise by almost 4 per cent in 2000, somewhat faster than in 1999. Household spending will grow at 3.5 per cent, sustained by a healthy increase in real household disposable income and the 50 per cent rise in household wealth since 1996. The drag from net trade will be considerably less than in 1999, as exports stage a recovery. Exports will increase by 6.5 per cent in 2000, double their annual rate of growth in 1998 and 1999. Exporting firms will benefit from the upturn in trade as the world economy picks up speed.

With economic growth above trend, the labour market will tighten still further and average earnings growth will pick up to 5 per cent. However, a rise in productivity growth should contain annual unit labour cost growth to around 3.5 per cent over the next two years. With continuing import price deflation in 2000 and keener price competition in the retailing sector, this should be compatible with the inflation target, but only with falling profit margins.

The medium-term outlook for the public finances is sufficiently favourable to make affordable the Prime Minister's new objective for health spending. On existing plans, we project a current account surplus of [pound]19 billion by 2005/6. If health spending were to rise by then to the EU average of 8 per cent of GDP, this would involve extra expenditure of [pound]12 billion, so that the new goal can be attained without breaching the golden rule.

But the fiscal boost will push up annual inflation by almost 1 per cent from 2001. GDP will be higher but the exporting sector of the economy will suffer. And, taking into account the demographic structure of the population, income tax revenues need to be 13 per cent higher than would otherwise be the case in order to pay for the increase in health spending. Given our budgetary projections this does not necessarily mean that taxes need to rise, but it would leave standard rate tax almost 3p and higher rate tax 5p higher than they would be without the increased health spending.