Our forecast for the UK economy up to the end of 1982, which is summarised in table l, appears superficially very similar to that which we made in the last issue of this Review despite the intervening Budgetary measures and other events. We foresee GDP remaining roughly constant, at the level it held in the second half of last year, throughout the forecast period. Unemployment is expected to exceed 2½ million this year and to reach 3 million by the end of next year, while consumer price inflation falls slowly reaching 10½ per cent in the fourth quarter of this year and 8½ per cent by the fourth quarter of next. This similarity in aggregate behaviour, however, disguises some important changes in the distribution of incomes and expenditures and should not be interpreted as suggesting that events during the last three months, particularly the Budget, are without effect on the economy. A section of this chapter is devoted to a discussion of the expected consequences of the Budgetary changes introduced on 10 March.

Most recent data confirm that in the OECD area as a whole the fall in output in the second quarter of last year and the flattening out in the third quarter were followed by renewed growth in the fourth quarter. All the main components of final domestic demand contributed and, though fixed investment remained below the first quarter level (table 1), both private and public consumption may well have exceeded this. In Western Europe, however, industrial production declined further in both the third and fourth quarters and any recovery by the end of the year appears to have been no more than marginal even for GDP.

The purpose of this article is to examine in a non-technical manner the contribution of the hypothesis of rational expectations to the explanation of how people form expectations of the values of economic variables. In particular the article draws conclusions for what the hypothesis may and may not imply for the formation of macroeconomic policy in the United Kingdom. There is a short annotated biblography at the end of the article.