Budget 2015: Here's the outlook for the economy – regardless of what Osborne says

There are six ways in which the world economy might develop over the life of the next Parliament

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The Independent Online

A Budget today, and a supremely political one. But what will determine our financial futures over the next Parliament is what will happen to the world economy.

The Budget matters and the general election matters, but if the world economy does reasonably well, we will do well. And if it does not – well, we will have a rough time, too.

Economists are notorious for getting things wrong, and there are a string of jokes about that. The one I like most is JK Galbraith’s: “The only function of economic forecasting is to make astrology look respectable.” But if the experience of the last recession has taught us anything, it is that there is a global economic cycle and policy-makers have not been able to eliminate it. With that in mind, here are six propositions as to how the world economy might develop over the life of the next Parliament.

1) A solid cyclical recovery is in place. Different countries are at different points on that curve. Within the developed world, the US is clearly leading, a little ahead of ourselves. But there is still plenty of spare capacity there (and here), so growth can continue for quite a while without running into constraints. Core Europe, notably Germany, is following the US and UK into a phase of decent growth, while fringe Europe and Japan have come off the bottom. That is an oversimplification, for some bits of fringe Europe are doing better than others (Ireland leading, Italy dragging), and there are advanced economies such as Canada and Australia where growth is coming down. But the general picture of a developed world gradually picking up speed, with the US as the prime locomotive, is surely right. This growth phase should have another three years or so to run.

2) We are about to start the upward phase of the interest rate cycle. Markets today will be focusing much more on what comes out of the Federal Reserve meeting than anything said in Parliament, for they are expecting a hint that the first rise in US rates will come in June. It might seem strange that rates should rise when inflation is subdued, but the fall in inflation is the result of a one-off event, the more than halving of oil prices. Strip out the impact of that and underlying inflation has not fallen at all. Meanwhile the US labour market is starting to tighten and the Fed will want to act in advance of any inflationary pressure that might generate.

Once the US moves, others – including ourselves – will follow. Had it not been for that plunge in the oil price, we would have had higher rates by now. Eventually, although this could be two or three years off, even Europe will get higher rates, for the global interest cycle inevitably follows the global economic one.

There is a debate as to whether rates will go up as far as they did in previous cycles, with the suggestion that they will not. The argument here is that the world is so indebted that it cannot stand higher interest rates, or put another way, because debt levels are so high that a small increase in rates would have the same dampening effect as a larger one would have had in previous cycles. I don’t think we know the answer to this and a lot will depend on what happens to inflation, but the core idea that interest rates will start an upward climb surely stands.

3) There will be disruption in Europe. There is the Greek thing and it is hard to see that ending well. More important will be what happens to Italy and Spain. They have to do better, for it is intolerable for the present stagnation to continue for years into the future. But whatever view you take of the longer-term outlook for Europe, a decent working assumption is that for the next three years or so (and against a slowly improving backdrop) the disruption will be contained.

4) It will be against that prospect that we in Britain will probably hold our EU referendum. It is for the political commentators to opine on the likely outcome. From an economic perspective, you can make a decent case that it will not matter too much either way. We will either be in an enlarged European Free Trade Area and therefore closely associated with whatever happens in Europe, or we will be a semi-detached EU member – semi-detached because there is no question of our joining the euro. It is unfashionable to say so, but the economic arguments are finely balanced. Whatever happens, we remain part of the European economy, as do Switzerland and Norway, both of which have much higher GDP per head than we do.

5) Beyond the developed world, growth will continue strongly. There is a switch at the moment, with India currently growing faster than China, and we don’t know whether this switch will be maintained. Over the very long period, you would expect India to grow more quickly, partly because it has a younger and faster-growing population but also because it is further behind in development. But on a three-to-five year view, it seems likely that both giants will continue to push forward. The gradual shift of economic weight between the so-called advanced economies and the emerging ones will continue. Whether the other two BRICs, Brazil and Russia, improve their economic performance is largely a matter for politics rather than economics, but the general proposition that the shift towards the emerging world continues must be right.

6) The final and more disagreeable proposition is that out there in the future another global recession will occur. We know neither the timing nor the severity, but we do know it will happen. My guess would be it will come sometime between 2018 and 2020, based simply on the timing of past cycles. It will not be particularly severe, but that is just because the last one was such a humdinger. But knowing what we know, it would be mad not to plan for bad economic times as well as good. The argument for building up a budget surplus is not an ideological one, but a practical one: to give fiscal firepower against the next recession. But I doubt there will be much of that in today’s Budget.

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