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Only if the underlying upward trend in exports continues is output this year likely to do better than recover its loss in the second half of last year. This review of the economic situation begins in the first section with exports so far, the world economic situation and exports prospects. The second section deals with home demand and output. The third section sums up the outlook for the economy and the balance of payments.

This appraisal of the economic situation was prepared before the Chancellor's measures announced on 25 July. The effects of these measures, and the modifications to the economic prospects for demand, are discussed on pages 15 and 16.

The July measures were followed by a halt to the increase in the gross domestic product and almost certainly by a slight down-turn. So far there is no indication of significant change in the balance of payments situation since the second quarter, although the measures halted speculation against sterling and have been followed by a renewed inflow of foreign funds. The world economic environment now seems somewhat less favourable to an improvement in the United Kingdom's payments situation than it did in September, in spite of the recovery in the United States. The main reasons for a more cautious prognostication now lie in a pause in the economic expansion of western Europe; this has contributed to the weakness of commodity prices and is therefore limiting the prospects for expanding exports to primary producing countries.

It still seems probable that the rise in output which can be expected in 1961 will be retarded for a while by reduced stock-building, in reaction to the heavy stock accumulation in 1960. Nevertheless, final demand is probably buoyant enough now to result in some expansion during the first half of 1961. British exports, which show signs of expanding rather faster than might have been expected, should benefit, of some extent later in the year from the revaluation to the German mark; but the balance of payments is likely to remain in substantial overall deficit—a situation the more serious after the heavy deficit of 1960. Budgetary policy is therefore unlikely (see page 14) to be expansionary.

It is increasingly clear that the United Kingdom economy is moving into a difficult period. The levelling out of production has continued: output and demand ceased to expand during the summer. An abnormally large part of output seems still to have been going into stock accumulation. When this stops, as is likely, output may well fall for a time. Even apart from this possibility, demand cannot be expected to regain its former expansiveness for some time. The Government's freedom to redress the internal balance of the economy is hampered in the short term by the weak balance of payments position, largely arising from our poor export performance. Nor is the world situation likely to make things easier for Britain: world markets are expanding much more slowly than last year.

This article discusses the world economy first, and attempts some forecast of movements in world production and trade between now and the middle of next year. Some assumption has to be made about the international political situation. We have assumed that the tension will not be heightened again and that consequently the effect on the world economy will not be substantial. If the tension were to be revived, then presumably Government expenditure on defence would rise, and there might be a burst of stock-building: the world prospect in general would be more inflationary than the one we outline below.From this world picture, and from an analysis of Britain's competitive position, a view is deduced about Britain's exports and her balance of payments up to the middle of next year. The second section discusses how much expansion there is likely to be in the home economy, on present policies, between now and the middle of next year.

The latest economic indications—which scarcely go beyond March-show demand and production continuing to expand rapidly. The main questions now are how far the growth of demand will be modified by the Budget and the new credit restrictions, and how the prospects for the balance of payments are developing.

SummaryThroughout the first nine months of 1976 the Australian economy has remained virtually stagnant, with output and employment increasing only marginally and unemployment rising also. With the government following a severely contractionary policy in an attempt to break inflation the economy seems poised for a further modest downturn in the next nine months so that a self‐sustaining recovery from the current recession does not seem to be in prospect before the second half of 1977. On the basis of existing policies our forecasts indicate a rate of growth of real GDP of only about 1.0 per cent in 1976–77, implying a further significant rise in unemployment during the financial year.There have been some hopeful signs in recent months of a reduction in inflation — the consumer price index increases in the first three quarters of 1976 were modest and wage rate increases remain closely in line with the wage indexation guidelines — but three factors have emerged to cast doubt on whether this improving trend will continue. The first is the effect of the recent drought on prices of foodstuffs, particularly meat, and the second is the expected 1.5 to 2.0 per cent increase in the consumer price index as a result of the changes in the method of financing hospital and medical services. These two factors mean that the December quarter increase in the consumer price index may be more than 5 per cent, threatening a further stimulus to inflation in 1977. Thirdly, present government policies could easily lead to a breakdown of the wage indexation system and a return to some form of collective bargaining over wage rates. Assuming nevertheless, a de facto continuation of partial indexation in 1977, we expect increases in male award wages and male average earnings of about 13 per cent during 1977, these increases being similar to those during 1975 and 1976 but much below the increases of 36 per cent and 28 per cent respectively recorded during 1974. Our forecasts also indicate increases in the consumer price index of 14 per cent during 1976 and 11 per cent during 1977, following increases of 16.3 per cent and 14.0 per cent during 1974 and 1975 respectively.These forecasts indicate that the government's fiscal, monetary, exchange rate and wage policies are likely to come under heavy challenge early in 1977, and decisions taken at that time are likely to be major determinants of economic developments in Australia in the next few years. The Institute would again urge a shift to a co‐operative package including full wage indexation, with cuts in indirect taxes and public sector charges to wind down inflation and expand the economy. On current indications, labour productivity will be no higher in 1976–77 than in 1973–74, because of the weakness of total output, so that the whole burden of wage increases in that three year period has fallen on unit costs of production. It is our belief that the twin problems of inflation and unemployment will only be defeated in Australia when both cuts in indirect or direct taxes and increases in productivity are applied to reducing inflation in the context of an orderly system of wage and price determination.