A simple forecasting rule-of-thumb based on the money supply and share prices – a rule that correctly predicted that 2012 would be disappointing – suggests that 2013 will be the best year for the economy since (at least) 2006, when GDP climbed 2.6%.
The forecasting rule assesses growth prospects for the coming calendar year based on whether end-year levels of real (i.e. inflation-adjusted) money supply growth and share prices are higher or lower than 12 months earlier. Real money growth is measured by the annual rate of change of the broad M4ex measure deflated by the retail prices index (RPI). Share prices are measured by the domestically-orientated FT30 index, again deflated by the December RPI.
Annual GDP growth averaged 2.4% in the 47 calendar years from 1966 to 2012. The forecasting rule gave a “double-positive” signal in 16 of these years (i.e. both real money growth and share prices at the end of the prior year were higher than 12 months before). GDP growth in these years averaged 4.1%.
There were, by contrast, 11 years when the forecasting rule gave a “double-negative” signal. Growth in these years averaged just 0.5%. In the remaining 21 cases where the money supply and share prices gave conflicting signals GDP expansion averaged 2.1%.
As noted, the forecasting rule warned that the economy would perform poorly in 2012 – the December 2011 real level of the FT30 index was down by a whopping 20% from a year earlier, while the annual change in real M4ex was -3.4% versus -2.2% in December 2010. The currently-estimated* 0.2% GDP decline in 2012 is below the 0.5% growth average for double-negative years but the result was affected by a fall in oil and gas production, which subtracted about 0.3%.
The rule has also worked reasonably well in other recent years. A previous double-negative signal was given at the end of 2008, ahead of a 4.0% GDP slump in 2009. The money supply and share prices gave conflicting signals for 2010 and 2011: GDP growth was 1.8% and 0.9% respectively in the two years, or 2.0% and 1.5% excluding oil and gas.
What is the message for 2013? The FT30 index at the time of writing (17 December) was 19.9% higher than in December 2011, implying a real gain of 16% allowing for expected December RPI inflation of about 3%. The annual rate of change of real M4ex, meanwhile, was 0.9% in October versus -3.4% at end-2011. The rule, therefore, will give a double-positive signal barring a year-end stock market crash or implausible monetary relapse.
It is, of course, possible to accept the rule’s implication that 2013 will surprise favourably without believing that growth will equal the 4.1% average for double-positive years! The last double-positive signal was for 2006, which delivered GDP expansion of 2.6% – the minimum following such a signal. Assuming that potential growth has fallen since the 2000s, a “good” year might now involve a GDP rise of little more than 2%.
How could a positive growth surprise be generated? Possible drivers include:
Consumer spending. Spending is no higher than in 2006, suggesting pent-up demand. The real income backdrop has improved, despite weak wages, reflecting higher employment and lower inflation. The saving ratio is stable at close to its long-run average. Debt has fallen from a peak of 175% of disposable income to 146%, its level in 2004, while market gains have lifted financial wealth. Increased mortgage availability, partly due to the funding for lending scheme, should boost the housing market in 2013.
Exports. Recent global economic weakness was signalled by a dive in real money growth in early 2012 but monetary trends have recovered since the spring, suggesting stronger export markets in early 2013, allowing for the typical six-month lead. Sterling remains competitive, with the percentage of CBI industrial firms citing prices as a constraint on exports well below the long-run average.
Investment in plant and machinery. Business investment grew respectably in 2012 and could accelerate in 2013 as consumer / export pick-ups boost animal spirits. Corporate finances remain healthy, money holdings are rising, surveys indicate that spare capacity is limited and the temporary increase in the annual investment allowance announced in the Autumn Statement will be helpful at the margin.
Construction. Falling construction output lopped an estimated 0.6% from GDP in 2012 but orders – a leading indicator – have stabilised since late 2011, suggesting a neutral impact in 2013.
An additional reason for optimism is Mark Carney’s appointment as Bank of England Governor. Mr Carney may be a brilliant policy-maker but his career management skills are even more impressive; his decision to accept the role must reflect a judgement that UK economic performance in his coming five-year term will be considerably better than the dismal record under his predecessor.
*Estimate from the Treasury’s monthly survey of economic forecasters.