A post in May last year suggested that the annual rate of change of GDP would turn positive in early 2010 while the Treasury's forecast of 1.25% growth for the year as whole was achievable. This was based on a forecasting model that estimates the annual GDP change three quarters in advance using a range of monetary and financial inputs, including inflation-adjusted broad and narrow money supply growth, companies' liquidity ratio, three-month LIBOR, the yield spread between corporate and government bonds, share prices and the effective exchange rate. The consensus at the time was gloomier, with many economists and journalists embracing the "creditist" view that no meaningful economic recovery was possible without a revival in bank lending to the private sector. The Bank of England was also downbeat: in its May 2009 Inflation Report, the Bank's mean forecast for the annual GDP change in the first quarter of 2010 based on unchanged policies was -1.5%. (This was the infamous Report that also projected a fall in annual consumer price inflation to below 1% while estimating only a 7% probability that inflation would be above 3% in the second quarter of 2010 – the outturn was 3.4%.)
Recent official figures largely validate the predictions of the "monetarist" model. Excluding volatile oil and gas extraction, whole-economy output rose by an annual 0.2% in the first quarter of 2010 and by 2.0% in the second quarter. Assuming that quarterly expansion slows to 0.5% during the second half of the year (and ignoring possible upward revisions to earlier estimates), GDP will increase by 1.6% for 2010 as a whole – comfortably above the Treasury's derided 1.25% forecast. The Office for Budget Responsibility (OBR) displayed little originality in the economic projections underlying its post Budget fiscal analysis – its forecasts of GDP growth of 1.2% and 2.3% respectively in 2010 and 2011 were suspiciously close to consensus numbers of 1.2% and 2.2% reported in the Treasury's June survey of forecasters. Stronger 2010 expansion supports the view that the OBR was too pessimistic in projecting public sector net borrowing of £149 billion in 2010-11, a conclusion also consistent with recent monthly outturns, suggesting a full-year undershoot of at least £10 billion.
Will the recovery be sustained into 2011? While the model is not forecasting a boom, it suggests annual GDP growth of 2%-2.5% in the first half of next year, with the probability of a second recession – in the sense of an annual GDP contraction – rated at less than 10%. Prospects for later in 2011 depend on whether the recent acceleration in broad money supply growth is sustained – if so, full-year GDP expansion should exceed the current 2.1% consensus expectation reported in the Treasury's July survey. The model's other inputs are mostly favourable: narrow money is growing solidly, corporate liquidity is strong outside the beleaguered real estate sector, credit spreads have normalised, the trade-weighted exchange rate is at a competitive level and short-term interest rates, of course, remain at a record low. To the obvious Keynesian criticism that the model omits a direct measure of fiscal policy, the responses are that, first, fiscal effects are captured indirectly via forward-looking market variables (i.e. share prices and credit spreads) and, secondly, the model is able to explain historical growth adequately without including such a measure – see charts.
