Inflation on road to recovery: Michael Artis presents his exclusive quarterly analysis of the UK economy

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The Independent Online
THE LATEST figures from the Central Statistical Office show the economy to be well set on a path of recovery. We see that revival carrying through to next year, with unemployment falling throughout. However, a lot of the traditional problems of the British economy are set to re-emerge.

Our forecast, summarised in the table, is produced from a quarterly Bayesian Vector Autoregressive (BVAR) model of the British economy. We use this unorthodox method simply because the record of conventional forecasting models has proved to be so poor.

BVAR models do not set up theories that are then tested against the data: they go directly to the economic figures, exploiting to the full the statistical relationships to be found in the data. So far, our BVAR forecasts (reported each quarter in the Independent) have had a good record in forecasting.

In particular, the present recovery vindicates previous predictions, although the fall in unemployment has come sooner than expected. This may mean that output has been recovering more rapidly than the figures now suggest.

But there are problems. The model suggests that inflation is set to increase throughout the next two years. The Retail Prices Index is predicted to rise by 2.2 per cent on average this year and by 3.6 per cent in 1994. The underlying inflation rate, excluding mortgage rates, may go through the top of the target band (4 per cent) by November of this year. The Government may have to relax its target unless it wants to tighten policy and possibly reverse the recovery of output.

Another problem is the balance of payments, where the deficit in the current account may rise to pounds 16bn this year and then to pounds 20bn in 1994. The forecast suggests the PSBR will also continue to rise, to pounds 43bn in 1994.

The current forecast of continued recovery in output and sustained decline in unemployment appears to presage another turn in the familiar British cycle, with inflation turning up and the external accounts continuing to deteriorate. As before, the upturn may be sowing the seeds of its own demise.

Forecast prepared by Professor Artis, Robin Bladen-Howell and Wendy Zhangof of the University of Manchester.

----------------------------------------------------------------- THE FORECAST* ----------------------------------------------------------------- Output Inflation Unemployment growth (RPI) rate % 1992 -0.5 - 3.7 9.7 1993 1.5 2.2 10.3 1994 2.8 3.6 9.3 *Figures are annual average percentages -----------------------------------------------------------------