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 Monday, 23 December, 2002, 08:23 GMT
What will 2003 bring?

JK Galbraith once said there are two types of economists: those who don't know; and those who don't know they don't know.

At the moment, most seem to be in the latter camp.

Most British forecasters (and Gordon Brown) expect 2003 to deliver reasonable growth, a gentle rebalancing of the economy (in other words, a slowdown in consumer spending growth, and a pick-up in manufacturing output) and a turnaround in business investment.

Similarly, for the US, it is supposed that growth, investment and industrial production will pick up, while consumption growth slows down.

This may be a plausible scenario, but in a sense it is a remarkable one, for if it is right, somehow all the sins of dot com madness and the stock market bubble will have been more or less purged.

Normally, we expect bubbles to be followed by difficult hangovers, protracted recessions. This time, it seems we might have enjoyed a roister with barely a twinge.

Dangerous sport

More remarkable than the apparent optimism of the consensus is the apparent unanimity of it.

Of the 26 main forecasts of the US economy for example, no fewer than 19 put growth in the relatively narrow range of 2.4-2.9%.

Surely, there should be more variation?

As it happens, for my money, forecasting at the moment seems to me a dangerous sport.

It is easier to posit several, distinct scenarios that might occur, than it is to make a sensible judgement about which particular one will pertain.

Looking up...

Let's have a look at some of those scenarios.

Certainly, the rosy consensus forecast is one.

It might be that this cycle can be more benign than previous ones.

In particular, it might be that because the nineties boom was associated with a remarkable accumulation of global manufacturing capacity, (or more accurately, overcapacity), we are now able to enjoy a consumer boom in which we use up the capacity created.

The boom can't last forever of course, but it can last a while, as companies try to offload the products they are now too good at making.

On this story, the excess capacity keeps prices, inflation and interest rates low.

If the story is right, the process is not as painless as the overall growth figures may suggest, because the savers who paid for the investment boom (many of them in Japan, as it happens) will have been disappointed by the returns they are making.

But as long as the pain of those savers, and the joy of consumers who benefit from low prices and easy availability of cheap goods are slowly and gently unwound, then it may be the economy will enjoy the relatively rosy scenario being projected.

... and looking down

Even if things get a little wobbly, in Britain at least, we still have monetary policy to stabilise them, and ensure that no panic occurs, and that the economy doesn't crash when consumers try to pull in their spending.

After all, if consumers do try to repair their balance sheets, and stop spending too quickly, then interest rates can fall (after all, there's little inflation to worry about) and that will ease the transition for consumers.

So much for the optimistic forecast. It may fall into place.

Alas, one can also paint scenarios for Britain and the US in which it does not happen.

Here are two main such scenarios: common to each is the fact that consumer spending falls sharply, and in each, for some reason, interest rates can't be used to help consumers sort out their finances.

Spending crunch

The first scenario (call it the Japan syndrome) is that consumers have a violent moodswing, which lower interest rates simply can't counter.

Spending crashes, economies feel the lack of demand, and no amount of interest rate cut can alleviate the public's gloom.

After all, lower interest rates may help borrowers, but they do so at the expense of savers (for every borrower who is helped by them, there's a poor lender who is worse off from lower rates).

So, if it is savers who are trying to increase their wealth, lower rates may induce people to save more.

Back to the future

The second scenario (call it "Back to the 1980s") is that the exchange rate tumbles.

After all, the pound and dollar have been too high, for too long.

A falling currency pushes up prices, makes the Fed or Bank of England worried about high inflation, and so rates rise, or at least can't fall.

Then, as consumers try to retrench, there is no lower interest rate policy that can help them.

This is a less extreme version of the 1980s boom-bust cycle, when higher rates were used to reduce inflation, at the expense of overstetched consumers.

Who knows?

Overall, we have three scenarios - the good, the bad and the ugly.

On the one hand, I am struck by the fact that we never have a consumer boom like this one without it ending in tears.

It seems too easy to get off as lightly as the pundits are saying.

On the other hand, I am also struck that we do not often have consumer booms like this without significant inflation problems, which are apparently absent at the moment.

So it may be different this time.

I put myself in the camp that simply doesn't know what will happen - and at least I can say I know that I don't know.

Bitter medicine

But one point which seems to me to be more certain: we would have been better off if 2002 had seen slower consumer spending and slower overall growth.

Then it would have been easier to resolve the imbalances that have accumulated more gently.

It is ironic that the problems that now may lie in store are less to do with the 1990s excesses, and more to do with the 2002 consumer boom.

We took the medication of low interest rates to allevate the pain of a 1990s hangover, and now face the possibility that the medication itself has led to a dangerous dependency which is worse than the original problem it was designed to cure.

World perspective

UK in focus
See also:

20 Dec 02 | Business
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