The biggest story in the Budget wasn’t big news. It had been well flagged in advance that the Office for Budget Responsibility (OBR) was revising up its GDP growth forecast to 2 per cent in 2017. In November last year, the OBR expected just 1.4 per cent GDP growth this year. HM Treasury’s latest monthly survey of independent forecasters, in February, shows average projections of 1.4 per cent GDP growth in 2017.
The really big story is why, and why the OBR and other forecasters are still far too pessimistic about growth prospects this year – in my view.
We’re all familiar with how forecasters revised down their growth forecasts post-Brexit, only to revise them back up again, in the wake of economic reality, in the final quarter of last year. The OBR’s Budget projections merely continue the trend of pain to come, but not yet. Also, the story has changed over time, from a Brexit-induced slowdown to the impact of higher inflation as it squeezes household budgets and real spending in the second half of this year.
The risk in this approach is that it potentially ignores the elephant at the table. From June of last year, broad money M4x growth accelerated sharply. The relationship between broad money and GDP growth is inevitably crude, but the pick-up in the second half of 2016, continuing into 2017, can’t be ignored.
M4x growth accelerated from 4.9 per cent (year-on-year) in May 2016 to 7.7 per cent (year-on-year) in September, easing slightly to 7.2 per cent (year-on-year) in December and 6.6 per cent (year-on-year) in January 2017.
My rule of thumb is that there is a rough six month lag, at least, between the shift in M4x and the impact on GDP. The impact is on nominal GDP and, via inflation, real GDP. This means that the lagged effects of the acceleration in M4x last year should still be felt on GDP in the first half of this year. And even allowing for higher inflation, it should permit continued 2 per cent plus real GDP growth this year.
Because the relationship between money and growth is difficult to estimate precisely, all that one can say is that rates of monetary growth at present don’t suggest a significant slowdown in activity yet. Indeed, fourth quarter 2016 monetary growth would suggest robust GDP growth in the first half of 2017.
If we want a clue as to GDP growth in the second half of this year, we will have to await M4x figures for February, March and April. If M4x growth remains around 7 per cent (year-on-year) or higher, a second half GDP slowdown seems unlikely. Quite the contrary in fact.
Of course, if rates of monetary growth weaken, we’re looking at a different story. We might then be looking at an economic slowdown in the second half of this year. The irony, of course, is that if the economy were to slow, Brexit would undoubtedly get the blame in the media. The Day of Reckoning would, supposedly, have arrived. But if that was the case, people would be looking in the wrong place.
Unsurprisingly, in the wake of a financial crisis, rates of broad money M4x growth have been a strong guide to future GDP growth over the past five years. I know of no other indicator that has performed better. Inevitably, the relationship is far from perfect. It’s a bumpy road. But the day after the flagship fiscal event of 2017, it’s good to reiterate the importance of monetary policy.