News & Events | Seminar

Scenarios for the economic outlook for 2008
Wednesday 9th January 2008
at National Portrait Gallery, St Martin's Place, London, WC2H 0HE

Extracts from a speech by Evan Davis, the BBC's economics editor and host of Dragon's Den, delivered at a drinks reception at the National Portrait Gallery. 

Good evening ladies and gentlemen.

It is the 9th of January, so may I be perhaps the last to wish you all a happy new year.

It was suggested that I might give you some relevant thoughts about what 2008 will be like – the economy in particular...

I will attempt to keep my remarks to ten minutes (although it might feel longer than that to you.)

Now I don’t know whether you have signed up to any new years’ resolutions.. it’s quite popular at this time of year to engage in some kind of detox programme.. Boots sell the requisite bottled water, mud packs and soaps.

And detox might be the right thought to have in mind as we look at the year ahead.

A possible Detox thought is that it isn’t much fun… but it can do us some good. And that I think might be the way we should view the opportunities for the UK economy in 2008.

Let me explain what I mean about the detox in the economic sphere by sketching out a two or three scenarios for the economy this year.. and making some semi-provocative comments about them.

Deep down in some of your minds I suspect you are hoping for a scenario that 2008 won’t be too bad – that it’ll go like this

-that the credit crunch will carry on easing;
-Libor rates will settle down to Bank Rate,
-Bank rate will come down,
-property prices will stabilise and
-consumers will keep on spending enough to prevent an inevitable slowdown turning into a slump.

I suspect that many of you are in the “it’ll will (or at least can if the Bank of England cuts rates enough) all be over soon” mindset.

If you that is what you think, you are not alone. I’m looking at the Consensus Forecasts publication 

(this is the really quite brilliant publication that collates all the forecasts for the economy, adds them together and divides by the number you started with to derive an average – thus telling you what forecasters in general think.. rather than what one forecaster in particular thinks)

..looking at that, I notice the benign scenario is what the professionals are expecting.

UK growth is expected to be 1.9 per cent this year – which is ok.

Consumer spending grows by about the same amount, not bad at all, and underpinning growth.

Rates come down to about five per cent,

Inflation ends the year on target..

Sterling ends the year about where it is now,

The euro depreciates, the eurozone and the US each grow at about two per cent.

Now that is a possible scenario for 2008,
it’s quite respectable..
Some of my best friends believe it
and I wouldn’t rule it out.

In fact, I’d put about a one in five chance that something like that occurs.

But let me make a couple of provocative points about this scenario.

First, .. it isn’t in my view very likely.

When we are at turning points in the economic cycle, and that is where I think we are.. people typically underestimate the duration of the cycle, and get overly-anchored in their thinking to the way things have been.

People for example, tend to think the new phase will be short – when in fact it might be quite long.

So 2008 is probably a good time for an open mind about the different scenarios that might play out, without us assuming that the way things have been, is the way they have to be. 

Just by way of example, I dug out some of the things written this very week in the year 1991. That was the year the economy shrank by one and half per cent..

Had there been a party like this, economic forecasters would have been saying 1991 was going to be bad, but the economy would still grow.  And it would be in full recovery by 1992.

That was wrong of course.

And to make the point more pointedly -- here’s a headline from the Times – 2nd January 1991..

“1991 expected to be a good year for residential property”

“1990 it says was a disastrous year” says the article – 1991 will be the year of recovery.. “, with estate agents views to back it up.

It was really another few years before that recovery came.

And I mention this not to say a correction can’t be quick – more that we shouldn’t just never assume it will be.
It’s true that after the dot com crash, we had it pretty lucky, it was quick. And we went back to life as before.

But that was mostly because as share prices deflated, easy money prompted a jump in other asset prices. We deflated one bubble, and created another.

That may not be possible this time. We’ve run out of bubbles to create.

So don’t assume anything about the duration of this economic episode. (And incidentally, be very wary of economists forecasts at this kind of turning point!).
 
The second thing about the “it can all be over soon” scenario is this: even if it was likely, do we want it?

-in particular, do we want consumers to keep the economy strong?

-do we want commercial and residential property prices to stabilise?

-do we want interest rate cuts to maintain growth by encouraging these things?

We’ve heard a lot today, about retailers suffering, and the need for interest rate cuts to entice consumers to spend

But if consumers need to make an adjustment to their balance sheet, as asset prices correct.. then it is better the economy slows down than that we encourage consumers to try and do the impossible.

Now at this point you have to decide whether consumers really need to spend more and save less, as part of some kind of patriotic duty. My own feeling is that with the savings ratio at about three per cent, over-saving is definitively not a problem that afflicts the UK economy.

In my view, we want consumer spending to slow down. When we on the news report slow sales we should be more inclined to call that good news, than bad news.. and we should think of what is occurring as a necessary adjustment, not an unfortunate malaise.

It’s back to detox you see. If asset prices need to change and balance sheets need to be repaired, they need to be repaired.

We can’t wish that away.

Interest rate cuts can be very helpful to the economy. The goal of policy is to prevent a slowdown becoming precipitous. To keep it gentle. Not to prevent it. They can limit a slowdown, put a floor under asset price falls, ease financial distress. I’m in favour of them. But not to stimulate the economy through the consumer. 
 
OK, I have been a little dismissive on the likelihood of the it all be over soon scenario, and on the desirability of it all being over soon if the result is simply to delay inevitable adjustments.

So let me outline what I think is an alternative to that scenario.. 

I’m not quite going to predict this – but I do urge you to look out for it as a possible path..

It is that in the UK, you get a slowdown led by consumers..

The slowdown allows interest rates to be cut..

Those cuts stimulate the economy not by gee-ing up shoppers or house prices.. but by depressing sterling.

It falls, and the trade position improves, limiting the degree to which the economy slows.

On this alternative economic scenario, sterling is the story for 2008..

it does what the dollar has done in 2007, and what has started to do already.. it slides against the euro.. and precipitates the big shift – the shift from domestic spending, to improving international trade.

Such a shift has already started in the US.. it may start here.

Now this is not necessarily good news for the eurozone, because its trade suffers as the euro rises. But you know, the eurozone needs more of its own domestic spending.

It needs – Germany in particular – needs to make the reverse flip that the UK needs to make.

If this scenario materialises, it’s not great for the shops, or for property prices..  but it is good for household balance sheets.

The sterling story for 2008, rather than the consumer story offers a closer description of how we can clean up some imbalances without a recession.
 
There is a third scenario though..
the consumer doesn’t keep the economy alive..
exports don’t keep the economy alive..
…the third scenario is that nothing keeps the economy alive..

This nastiest of scenarios can occur under a couple of conditions..

-if inflation sticks around.. (maybe if sterling falls and that pushes up prices).

-we might end up in more dire straits if the slowdown or the fall in property prices escalates into an uncontrollable collapse -- with a vicious circle of declining confidence, declining asset prices, declining spending and further declining confidence. 

Then we are in a more serious problem. But I’m not one who thinks this is the most likely scenario.

I don’t want to end on a negative note.. I genuinely think this year might feel pretty awful, but if it does, there’s a very good chance at least, it might well be doing us some good..

…an adjustment in our economy, in the US economy, in asset prices.

All these things are probably necessary, they needn’t be too severe, IF inflation doesn’t turn out to be embedded, and if we can stop ourselves spiralling into a tail spin – or talking ourselves into one.

And then by the end of 2008, (or actually, by 2009/10 maybe!) we can feel satisfied that we have detoxed the economy and that we can start drinking again.

And talking of drinking again, ladies and gentleman, is what I propose we should do now!

Thank you very much

Back to seminars