Economic forecast for 2009

13 January 2009

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There is a well established consensus that 2009 will be a tough year, as the consequences of mistakes made by the financial sector continue to impact upon the real economy. In this article, Professor of Economics at the University of Central Lancashire, Phil Whyman, makes his predictions for the economic climate in the year ahead.

The Government's own forecast is for economic decline, with the economy shrinking by between 0.75 and 1.25 per cent, as consumers spend less and save more, business investment are deferred or cancelled due to the uncertainty surrounding future demand conditions and problems continue in the construction sector.

In fact, the only elements which the Government predicts will have a net boost to the economy will be exports, benefiting from a more competitive pound, and Government spending itself.

Combined with the fact that the UK barely grew during 2008, and slid into recession during the second half of the year, these numbers make uncomfortable reading. However, there is every reason to assume that these predictions are likely to prove overly optimistic.

Whilst a fall in the value of sterling will create a competitive edge for UK exporters, with most of Europe and the US in recession, this may mean improved share in a shrinking market. Imports into the UK will decline alongside smaller consumer expenditure, and this will act as a boost to the UK economy, but I am unsure if the combination will have as large a positive effect as the Government predicts.

Furthermore, evidence from sales figures over the Christmas period might suggest that consumers are a little more reluctant to spend at present than the Chancellor has predicted, which would, again, suggest a slightly less robust economic performance.

The housing market is likely to decline approximately by a further 20%, creating uncertainty for families with mortgages and making monetary policy less effective, as banks become reluctant to lend to individuals and businesses secured against declining house values.

As a result, the UK economy could experience a fall in GDP of between 2 and 3% in 2009, recovering slowly through 2010 and returning to above-trend growth in 2011.

Bearing in mind that trend growth rates are around 2¾-3% per annum, this would imply a loss to the economy of around one tenth of its potential value throughout the recession as a whole (2008-2010).

The Government further predicts that the rate of inflation will decline to 0.5% during 2009. This is perilously close to deflation, and they will have to remain vigilant to ensure that it does not tip over into a falling price spiral, which leads to a consumer belief that prices will be lower in the future, deferring non-essential purchases, and thereby saving money.

Also, even if banks reduce interest rates on savings accounts to zero, falling prices means that there is an incentive to save, thereby further reducing spending power and activity in the economy.

Consumers will spend less, businesses retrench by reducing costs and possibly wages, deferring investment and running down stocks, thereby further exacerbating the original recession. Under these type of conditions, the usual economic orthodoxies are suspended, and governments should print money, if necessary, to get out of this type of self-defeating downward spiral.

But the Government must watch these levels carefully, to ensure that price cuts result in more economic activity and not less. In conclusion, my prediction for 2009 is that this is the year of not caring about inflation – indeed, it is when the Government may deliberately create a little to prevent a deflationary spiral.

About the author

Phil Whyman is Professor of Economics at the University of Central Lancashire and an adviser to the FPB. Professor Whyman teaches Economic Theory and Economic Policy and also undertakes research and consultancy for government, corporations and charitable bodies, advising on various aspects of economic policy.

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