A recent issue contained an analysis of the accuracy of the National Institute's forecasts of GDP over the period since the inception of the Review in 1959. This note reports on the application of the same analysis to forecasts of inflation.

The US economy appears to have avoided a technical recession this year. In the June issue of the quarterly accounts, which are considered as the first full estimate for the first quarter, first quarter GDP rose by 1 per cent on an annual basis, compared with 0.6 per cent growth recorded the quarter before. The relatively good growth was driven by net trade, with exports expanding at an annual rate of 5.3. The first-quarter contribution of net exports to GDP growth accounted for 0.8 percentage points of GDP growth expressed in annual terms.

Our last forecast, which was published in August, was moderately optimistic about prospects for the world economy, and especially for the United States. Since the summer the Yen has risen strongly, the US has begun to look like it is facing a recession, and it is now clear that the united Germany will face a very large Government budget deficit after monetary and political union. Meanwhile prospects for war in the Gulf remain high, and although EC farm ministers have managed to agree amongst themselves about cuts in agricultural subsidies it is not clear that these cuts are large enough either to prevent the GATT round stalling or stop the US erecting trade barriers in retaliation. As a result of all these factors our forecast is hedged around with rather more uncertainties than usual. Table 1 sets out our short-term forecast. We assume that oil prices will peak at $35 pb in the last quarter of 1990, and will then fall to $28 pb by the end of 1991.

In 2006, global output, measured in terms of purchasing power parities, expanded by 5.4 per cent, the fastest rate of growth since 1973. Despite a higher oil price and the recent rise in global long-term interest rates, we expect world growth to remain above 5 per cent this year, with a slowdown in the US offset by the rapidly expanding China and stable growth in the EU and Japan. In this issue we explore the widening divergence between the return on investment and real interest rates in the major economies. This suggests that despite the recent rise in long real rates it remains profitable for firms to invest in many countries.

In the four quarters from the end of 1979 to the end of 1980, industrial production fell 12 per cent and manufacturing 14 per cent. The average changes for the year were 8 per cent and 9 per cent. The largest previous post-war fall in manufacturing, in 1974-5, was 8 per cent over two years. In the first quarter of 1980 manufacturing output would, but for the steel strike, have been only slightly below the average level that had been maintained through 1977-79. In the subsequent quarters, excluding the recovery of steel output, it fell 6 per cent, 3 per cent and 3½ per cent (Statistical appendix table 2). There are only two manufacturing sectors in table 1 that do not show a decline for the year as a whole. It is essential to emphasise the unprecedented extent and size of this fall because individual industrial falls of 10 or 15 per cent can otherwise look like exceptional disasters, requiring special explanations and demanding special measures of assistance. Although there were of course influences that made the position of individual industries even worse than that implied by the general fall in demand (some of these are discussed in the next section), it is against the background of a general fall of 9 per cent that their relative importance must be measured.

The importance of the engineering industry to the United Kingdom economy is attested both by its absolute size (excluding vehicles, its weight in the industrial production index is currently 232 in 1,000) and by its contribution to visible exports (nearly 27 per cent by value in 1969). When it is also considered that engineering products make up a large part of manufacturers' investment in plant and machinery, and that the industry produces to order, it is apparent that an examination of this industry might yield some useful information for the Institute's forecasting work. In particular, the published figures of engineering orders on hand and net new orders and deliveries for both the home and export markets contain information relevant to forecasts for investment and exports. The difficulties of obtaining usable and reliable behavioural relationships for these two variables are well known—in the first case because of the importance of unquantifiabll ‘confidence’ considerations and in the latter because of the need to forecast economic factors and conditions in a large number of overseas markets.

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

Immigration has become one of the most discussed and controversial topics in recent public and political debates. This is true not just in the United Kingdom (UK), but also elsewhere in Europe, as well as in many other advanced economies, most notably the United States (US). For example, immigration became a major discussion point during the recent general election campaign in the UK, in spite of what appeared to have been an initial reluctance of some participants to engage in such debates. The importance of immigration is demonstrated by the strong attitudes that are displayed by the public. For instance, race and immigration has consistently been viewed as one of the most important issues facing Britain in recent years according to IPSOS/Mori's monthly Issues Index. Typically, more than 30 per cent of those questioned since 2002 have considered race and immigration to be the most important issue. This peaked at over 40 per cent in late 2007 and early 2008, which corresponds with the time when migration from Central and Eastern Europe to the UK was at its highest. This made it the top ranked issue for the British public, since when it has been replaced by concerns over the economy. Attitudes have also been found to vary by skill group, with Scheve and Slaughter (2001) reporting a significantly greater preference for limiting immigrant flows to the US amongst less skilled workers.

Sterling has fallen markedly against other currencies in the past few months, and in January reached its lowest point against the euro (or its equivalent) since the last quarter of 1996, as we can see from figure 1, which uses the first three weeks of January 2008 as an indicator of the value that will be achieved in the whole first quarter. Sterling has also weakened against the dollar in the past few months, although it remains at a high level. In effective terms, sterling fell on average by 2.5 per cent in the fourth quarter, and in early January it was more than 6 per cent lower than the average for the previous quarter. The fall was largely unanticipated, and the effective exchange rate for the first quarter of 2008 is more than 7 per cent below where we assumed it would be in October 2007.

In discussions of defence policy and of disarmament there are often references to the economic aspects of defence expenditure. This article is intended to provide a background to such discussions. It is a factual and statistical analysis of the level and pattern of defence expenditure over the past ten years. The sources and methods used in the estimates are described in an appendix.

The transition to monetary union in Europe, which began formally when Stage 2 started in January 1993, is now well over half way to completion, according to the deadlines set in the Maastricht Treaty. The first decisions on Stage 3 are approaching fast, yet the prospects for its commencement are still very unclear, and many important practical and policy issues are still in doubt. This article provides an overview of the EMU debate, covering the latest developments on convergence (Section 1), the main institutional matters still to be resolved before Stage 3 begins (Section 2), the key problems awaiting policy-makers in Stage 3 (Section 3), and finally the controversy about the economic rationale of EMU (Section 4). It concludes that the UK Government was wise to defer a decision on whether to participate in Stage 3 until the implications became clearer, but that it would be unwise to abandon the option, which it presently risks doing, by design or default.

The UK and world economies have reached a position where it is not clear whether they are going to continue expanding at a reasonable trend like rate or whether the slowdown from above trend growth in 1995 is about to intensify into a recession in 1996.