This chapter is in two parts. The first gives a general survey of developments in the British economy last year. It begins with a description of trends in output and demand; succeeding sections deal with fiscal policy, monetary policy and the exchange rate, inflation, unemployment and the balance of payments. It concludes with a post mortem on last year's forecasts. The second part of the chapter contains a short-term forecast for 1986 and 1987

The most striking developments in the world economy in 1985 were a long-awaited fall in the US dollar, which lost about 15 per cent of its effective value between the first quarter and the fourth, and a general decline in rates of inflation in the industrial countries, especially in their manufacturing sectors, where producers' prices increased by only about ½ per cent during the second half of the year.

The service industries—that is, all activities apart from agriculture and the production and construction industries—account for more than half of gross domestic product and employ about two thirds of the civilian labour force. The size of the employed labour force alone makes a brief analysis of productivity worthwhile; additional interest stems from the importance of the contribution of the internationally tradeable services to the balance of payments.

UK national accounts statistics of government ‘output’ are based on inputs, especially employment; earlier UK conventions attempted to measure government output using statistics of activity (of the sort currently advocated in some quarters) but were dropped for reasons outlined below. The note provides some examples of revised activity-based ‘output’ measures and compares them with the old approach and with existing conventions. It concludes in favour of retaining existing conventions until more statistical research has been undertaken.

A fuller account of the issues, methodology and data summarised in this note is given in ‘Measuring output and productivity in government’ by M. S. Levitt and M. A. S. Joyce, NIESR Discussion Paper, no. 108.

This paper summarises research on the labour market done over the past two years at the National Institute. It incorporates research into the determinants of employment—including the role of forward-looking behaviour—wage inflation and real wage models, and comments on some policy issues which have arisen in the past five years or so. The research was not aimed at producing a single approach to labour market behaviour, but touched on several separate topics. In part the present paper reflects this relative heterogeneity, although we will try to emphasise common themes where these are relevant.

This paper will present a set of simulation exercises, and discuss some of the methodological issues arising from the new National Institute Model 8. This model has been developed from earlier models used at the National Institute and has much in common with those models. In particular, it adheres to a traditional income-expenditure framework and is, in broad outline, a Keynesian model. The new feature of Model 8 which distinguishes it from its predecessors is the explicit widespread treatment of expectations. Recognition of the importance of expectations in macroeconomics is widely disseminated and much attention has been given recently in the econometric literature to the modelling of expectations. Model 8 now includes explicit expectations terms in the following sectors: employment, stockbuilding, investment, wage formation, the exchange rate and the demand for money. The details of individual equation estimation and specification may be found in Hall and Henry (1985a) and will not be given here. In the estimation process much use has been made of the rational expectations hypothesis, while in the full model implementation expectations may be formed either consistently or on the basis of explicit expectations models.

In designing an expansionary fiscal package, a key consideration is the exchange rate. This is because undue and possibly destabilising movements in the exchange rate in response to domestic expansion could trigger expectations that the policy will be reversed, and such expectations might indeed be fulfilled. An understanding of the consequences of domestic expansion for the exchange rate is therefore crucial.

In both 1977 and 1978, on average over the year, using a standardised international definition, the rate of unemployment in Britain about 6 per cent. This was about 1 per cent higher than the rate recorded for the average of all countries in OECD. Since then the rate of unemployment has risen in most countries, but by more in Britain than elsewhere. Our rate has gone up from 6 per cent to 13 per cent, while the OECD average has gone up from 5 per cent to about 8 per cent.