A simplistic growth forecasting rule based on the money supply and share prices – a rule that correctly predicted that the economy would beat expectations in 2013 – suggests that 2014 will be another strong year; GDP is projected here to rise by about 3%.

The forecasting rule assesses growth prospects for the coming calendar year based on whether December 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 narrow M1 aggregate deflated by the retail prices index (RPI). Share prices are measured by the domestically-orientated FT30 index, again deflated by the RPI.

Annual GDP growth averaged 2.5% in the 47 calendar years from 1966 to 2012. The forecasting rule gave a “double-positive” signal in 23 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 3.8%.

There were, by contrast, 15 years when the forecasting rule gave a “double-negative” signal. Growth in these years averaged just 0.4%. In the remaining 9 cases where the money supply and share prices gave conflicting signals GDP expansion averaged 2.5%*.

As noted, the forecasting rule predicted that the economy would perform well in 2013 – the December 2012 real level of the FT30 index was up by 16.8% from a year earlier, while the annual change in real M1 was 3.6% versus -4.9% in December 2011. GDP is currently estimated to have risen by 1.8% in 2013 but the increase was 2.7% measured from fourth quarter to fourth quarter. Upward revisions are likely.

The rule also outperformed the consensus in 2012: a double-negative signal was given at the end of 2011, ahead of growth of only 0.3% in 2012 and associated double / triple dip scares. A prior double-negative was issued at end-2008; GDP slumped by 5.2% in 2009.

Both conditions are still positive for 2014. The FT30 index in December 2013 was 24.7% higher than a year before, implying a real gain of 21.5% allowing for December RPI inflation of 2.7%. Annual real M1 growth, meanwhile, was 7.4% versus 3.6% at end-2012**.

The forecast here of GDP growth of about 3% in 2014 is beneath the 3.8% average for double-positive years. This partly reflects a judgement that weak productivity performance has lowered potential output growth to below 2% per annum currently versus a long-run average of about 2.5%.

*Using a broad rather than narrow money measure produces similar results. For example, a rule based on non-financial M4 (i.e. M4 held by households and private non-financial corporations) yields average GDP growth in double-positive years of 3.9% (16 years) and in double-negative years of 0.7% (11 years).
**Broad money signals differ according to the aggregate used. Real growth of M4 and non-financial M4 was higher in December 2013 than December 2012 but that of M4ex (i.e. M4 excluding holdings of financial intermediaries) was lower (1.0% versus 1.9%). GDP growth has averaged 2.6% in previous years with positive stock market and negative M4ex signals.