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Last Updated: Wednesday, 27 December 2006, 23:14 GMT
Interesting times
Evan Davis
By Evan Davis
BBC economics editor

Estate agents' boards
Have Britons borrowed too much?

This is the time of year when otherwise decent journalists write articles setting out their predictions for the twelve months coming.

Economics journalists are no exception. Forecasts are, after all, what economists do.

If I have to join this chorus, I'll make the following forecasts for 2007:

  • base rates will end the year at 5.25%;
  • house prices will rise by 5-10%;
  • inflation will edge back down towards its target;
  • the economy will grow by 2.5% or thereabouts; and
  • there will be a new Chancellor by this time next year.

I could add that 2007 will be a lacklustre year for retailers. And globally, that India and China will grow fast, while there will be a moderate slowdown in the US economy.

Unfortunately, none of these predictions are particularly interesting. They are either obvious, common currency or mere continuations of what's already happening.

The economy often does turn out to be very interesting - it's just that when it's interesting, it's generally unpredictable

I could give you some more remarkable predictions. That a major celebrity will turn into a werewolf for example. Or that a plague of frogs will descend upon Macclesfield. Unfortunately, while these would make more fascinating reading, they would perform badly in terms of likelihood-of-occurring.

The contrast between the interesting and the likely offers general lessons about economic predictions and the way they are framed. The economy is usually not terribly interesting - it conforms to conventional patterns, and moves rather slowly.

As a result, on any given day you are far safer predicting the economy will carry on with business as usual than you are predicting something more exciting.

And that's why for 2007, the forecast of the "business-as-usual" global economy is the right one to make.

Interesting times

However, 2007 might not follow the business-as-usual scenario.

The economy often does turn out to be very interesting. It's just that when it's interesting, it's generally unpredictable.

So as well as my rather dull predictions above, let me give you some "non-predictions": six more interesting things that probably won't happen next year - but which just might happen, and which are certainly worth preparing for.

First, the dollar falls substantially as international investors decide they have no desire to lend more to the US.

Yuan and dollar notes
China's economy will have a big effect on the rest of the world

Second, facing the reality of a weak dollar, the authorities in China allow the yuan to rise against other currencies; and the export prices of Chinese goods are marked up considerably.

Third, higher prices in the west, force central banks to raise interest rates causing our economies to slow down substantially. Consumers, instead of saving between zero and 5% of income revert to saving closer to 10%.

Fourth, a substantial proportion of households are crippled by higher interest rates having borrowed heavily in previous years, on the understanding that rates never rise above 5%.

Fifth, house prices fall as higher interest rates force buyers to reconsider what they can afford.

Finally, a wave of corporate insolvencies occur as heavily indebted private equity investors realise they, too, had borrowed money to buy companies on the understanding that interest rates never rise above 5%.

Trouble ahead?

OK. So they're pretty gloomy.

All six of these possible events relate to the great problem in the world economy: of the unsustainable imbalance between low savings in some of the large western economies, and very high savings in some of the Asian economies.

This imbalance in savings most obviously manifests itself in a large trade deficit in the US, and a huge trade surplus in much of Asia.

But it's a British problem too. We have a balance of payments deficit; consumers have borrowed a lot, they have saved less than usual and felt comforted by high house prices and strong equities.

Sale sign
Any downturn could turn people off shopping and back onto saving

None of us can be sure how our economy will perform if or when the Asian economies stop saving and stop sending us ever cheaper goods.

But my non-predictions provide one - albeit rather uncomfortable - scenario by which the imbalances resolve themselves.

Quakewatching

It is, incidentally, quite possible to think of other nicer or more gradual scenarios.

But perhaps, in outlining more interesting but less likely events, economists can take a lesson from seismologists.

What earthquake-watchers do not do, is make outlandish predictions that "there will be an earthquake on the west coast of the US, in the second half of next year". If forced to make a prediction about next year, it would probably be that life will be rather geologically unexceptional.

However, what their science does allow them to do, is to talk more generally about earthquake risks. There will probably not be a San Francisco earthquake next year. But there is a good chance, given the fault line beneath the city, that at some stage there will be an earthquake there. Or at least, a big series of rumbles.

Now, economic commentators might usefully adopt the same kind of approach in giving their predictions.

And right now, the seismological analogy is a good one - because in many respects, you might think of the world economy as residing in a place like San Francisco.

A place where the climate is benign, and the lifestyle comfortable, but a place located on top of a rather ominous fault-line of global imbalance.

So 2007 will probably be quite normal in the world economy - and in San Francisco too, for that matter.

But if those fault-lines get disturbed in some way, it could turn out rather differently.




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