Since our last forecast, in May, the uncertainty which we then stressed about the future of incomes policy has been resolved, though uncertainty about the actual future course of wage inflation itself has, with the abandoning of any attempt at a formal policy, if anything increased. In the May Review we attempted to deal with this uncertainty by exploring the broad implications of ‘low’ and ‘high’ earnings assumptions for the period from mid-1977 onwards, in addition to presenting a more fully worked-out forecast based on the assumption of a 15 per cent annual rate of increase. Although the uncertainty has in no way lessened—at any rate at the upper bound—we do not think it worthwhile to rehearse on this occasion the consequences of an unfettered pay explosion from now on. But although we present below a single forecast based on our assessment of the most likely outcome, this should not be taken to mean that we are now any more confident about the likely future pace of wage inflation. Our assumption is discussed in detail in the next section.

Industrial production has remained relatively depressed in the first six months of this year. The recovery from the dip in output in the third quarter of last year extended for only one quarter, so that output in the second quarter was no higher than the end-1976 figure. The pattern of output over the last few years is shown in chart 1. Industrial output is now only 3 per cent above its level in 1970 and is still 7 per cent below its peak level in 1973.

This article presents two models of sterling exchange rates, for which the starting-point is Cassel's synthesis of the purchasing power parity and the asset demand theory of exchange rate determination. The first model generates estimates of equilibrium exchange rates in 1970; the second is designed to explain subsequent monthly deviations of actual rates from these notional 1970 rates and so to provide a system for short-term forecasting of ‘effective’ exchange rates in terms of variables defined in the National Institute's larger model of the economy. Monthly forecasting equations for other major currencies are also estimated and the predictive power of the monthly model is tested—with encouraging results—over the period May-November 1976.

The construction of an economic forecast involves a blend of the use of a set of formal equations summarising to the best of the model-builders' ability the dominant characteristics of the past behaviour of the economy, together with a complex set of judgements about the way in which these equations have recently behaved and are likely to behave over the forecast period. We, in common with other forecasters, have published papers about the characteristics of our formal model and about particular equations, but little about the rather flexible way in which the model is actually used to produce a forecast. This Note is an attempt to redress the balance somewhat. It is also intended as an explanatory note to the table of residual adjustments which, beginning with this issue of the Review (see p. 19), we intend to publish regularly as part of the background to our quarterly forecasts.

This article traces the course of world commodity prices back to the middle of the 19th century and attempts to assess the changes in their purchasing value by deflating them by the export prices of manufactured goods. The purchasing power of commodity prices was in decline over long periods but they usually regained their earlier real value, or improved on it, in powerful upsurges of which the 1972-74 boom was the most recent; it was also unique in peacetime and, though with fluctuations, the purchasing value of commodities has since remained at a relatively high level.

Almost all trade among industrial countries is now invoiced in the currency of one of the trading partners, normally that of the exporter. Use of a ‘third country currency’ (normally the dollar) is important only in trade with developing countries. Except for the decline in sterling's use as an international currency, there is no evidence that exchange rate expectations are a strong influence on traders' choice of currency.