The saturday economist modeling uk investment september 2015

Modelling UK Investment
The Saturday Economist . com
Modelling Investment
Forecasts for the UK economy 2015 - 2016
September 2015

40,000
50,000
60,000
70,000
80,000
90,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Total Investment
£ million
The Saturday Economist.com
Data Source : ONS Quarterly Data
Gross fixed capital formation by sector and type of asset (£million at current prices seasonally adjusted)
We are forecasting an increase in investment
of 4.4% in 2015 and 5.5% in 2015.
Q2 2015
Latest
Data 4.9%
Up
year on year
Forecasts …
4.4% 5.5%
2015 2016
-20.0
-18.0
-16.0
-14.0
-12.0
-10.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
2000 2005 2010 2015 Untitled 2
The strong rally in investment is expected to
continue …
% Change year on year
2014 2015 2016
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
9.3 9.8 8.9 6.6 5.0 4.9 3.7 4.1 5.7 5.4 5.3 5.5
From 2000 - 2008 investment increased rapidly at an average rate of growth of 3.6%. The
average growth rate in the economy as a whole was 3.0%. The investment surge was driven by
an increase in commercial real estate.
Total Investment
£ million
Growth rate
year on year
Data Based on the ONS Business Investment Q2 : 28th August 2015
Modelling InvestmentSeptember 2015

21%
31% 22%
22%
5%
Transport Equipment
Machinery & Equipment
Dwellings
Commercial Real Estate
Intangible Fixed Assets
Averages 2000 - 2014
5%
22%
22%
31%
21%
Commercial Real Estate
Dwellings
Machinery & Equipment
Intangibles
Transport
In 2015 onwards, we anticipate a recovery in investment rising by 4.4% in 2015
and 5.5% in 2016. Strong growth is expected in business investment, including
plant and machinery and transport equipment.
The strength of the housing market will contribute to growth in dwellings
investment. Plus we expect the increase in corporate finance and M&A activity to
provide a further boost to intangibles investment.
The forecasts reflect our survey based model, based on capacity and investment
intentions, (notes slide 16 and chart slide 17), a recovery in corporate finance
activity (intangibles) and growth in transport investment.
When modelling investment, it is important to remember that over 53% of
investment, identified in the National Accounts, relates to property i.e. dwellings
and commercial real estate.
A further 21% is classified as intangible fixed assets and 5% transport equipment.
22% is defined as plant and machinery, the major contributor to the concept of
“capacity” within the economy.
The fall in overall investment in real terms and as a percentage of GDP is largely
determined by the collapse post 2007 of the commercial real estate market.
The actual fall in investment plant and machinery and the potential loss of
capacity tends to be over stated as our capital stock model, chart 4 suggests.
Modelling GDP(O)September 2015

150,000
160,000
170,000
180,000
190,000
200,000
210,000
220,000
230,000
240,000
250,000
260,000
270,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Gross fixed capital formation by sector and type of asset (£million at chained volume measures (reference year 2011) seasonally adjusted)
FourYear Capital Stock £million
6.0
6.5
7.0
7.5
2000 2002 2004 2006 2008 2010 2012 2014 2016
Capital productivity
GDP / Capital Stock

12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
20.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
18.5
17.8 17.8
17.6 17.7
17.5 17.5
18.0
17.2
15.4
16.0 16.1 16.1
16.4
17.3
17.6
18.0
Total Investment % GDP
Data Source : ONS Annual Ratios
Gross fixed capital formation by sector and type of asset
Between 2000 and 2008, investment
averaged 17.7% of GDP, rising to almost
18% in 2007.
In the recession, the investment ratio fell to
15.4% in 2009, rallying to 17.3% in 2014.
We expect a rally to over 18% by 2016.

30,000
35,000
40,000
45,000
50,000
55,000
60,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Business Investment £ million
Excluding the surge in the ﬁrst half of 2008
and excluding the spike in Q2 2005, business
investment has averaged just over £35 billion
per quarter.
We expect the strong recovery, evident since
the end of 2011 to continue, increasing by
5.3% in 2015 and 6.2% in 2016.

5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
13,000
14,000
15,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
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Government Investment £ million
Gross fixed capital formation by sector and type of asset (£million chained volume measure seasonally adjusted)
Government investment, experienced a trend
rate of growth of over 8% in the period from
2000 to 2010.
The slow down in expenditure, since 2010,
resulted in a total spend of £10 billion in
2013.
We are forecasting zero growth over the next
two years.

5,000
7,500
10,000
12,500
15,000
17,500
20,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Private Sector Dwellings £ million
The high levels on investment in private
sector dwellings, ended in 2008.
Given the strength of the housing market, we
expect an increase of 3.0% in 2015 and 4.7%
in 2016.

0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
13,000
14,000
15,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Ownership Transfers £ mn
Modest recovery envisaged in ownership
transfers …

0
1,000
2,000
3,000
4,000
5,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Transport Equipment £ million
Investment in transport equipment averaged
£3.5 billion per quarter in the period 2001 to
2010.
A recovery from the low in Q3 2012 is
evident. We are projecting a strong rally to
pre recession norms over the forecast period.

5,000
7,500
10,000
12,500
15,000
17,500
20,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Analysis by Asset - Machinery and Equipment £ million
Seasonally
adjusted

£
million
at
chained
volume
measures
(reference
year
2011)
Investment in machinery and equipment has
averaged around £14.3 billion per quarter
over the period 2000 to 2014.
We are forecasting an increase in 2015 of
5.0% and 7.2% in 2016.

8,000
10,000
12,000
14,000
16,000
18,000
20,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Analysis by Asset - Dwellings £ million
Seasonally
adjusted

£
million
at
chained
volume
measures
(reference
year
2011)
Total investment in dwellings has clearly
slumped from the highs of 2003 and 2007.
The nadir of Q4 2009 is marked, as is the
subsequent recovery. We expect the rally to
continue with growth of 3.1% in 2015 AND
3.8% in 2016.

6,000
10,000
14,000
18,000
22,000
26,000
30,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Analysis by Asset - Commercial Real Estate* £ million
* Other Buildings and Structures
Seasonally
adjusted

£
million
at
chained
volume
measures
(reference
year
2011)
From the highs of 2006 to 2008, the setback
has averaged around £21 billion per quarter
from 2009 onwards.
We expect a moderate rally over the next two
years, increasing by 1.4% in 2015 and 3.4%
in 2016.

10,000
11,000
12,000
13,000
14,000
15,000
16,000
17,000
18,000
19,000
20,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Analysis by Asset - Intangible Fixed Assets - £ million
Seasonally
adjusted

£
million
at
chained
volume
measures
(reference
year
2011)
Strong growth to continue, we forecast
growth of 5.9% in 2015 and 5.6% in 2015

Notes on Investment Models : Saturday Economist
1 Survey Model ; The Manchester Index
Our model is derived from the GM Chamber of Commerce Quarterly Economic Survey
“Manchester Investment Index”. Data is derived from capacity and investment intentions in
the manufacturing and service sectors. Highest correlations and predictive fit are derived
from capacity (-4) lagged by four quarters and investment intentions (-2) lagged by two
quarters.
The model over predicts overall investment, we assume this is because of the current
state of over investment in commercial real estate. A better performance is obtained when
forecasting “Business Investment”. The model is similar but an enhancement to model 6 in
the Bank of England suite of investment models identified in Burgess et al (2013).
2 ARIMA and Box Jenkins Model
We also use a conventional ARIMA and Box Jenkins models forecasting investment as a
function of lag dynamics. [See Section 2]
3 A disaggregated Model
A disaggregated model accepts that over investment in the commercial real estate market
may have a significant overhang in the resumption of our long term [I (f) Y) relationship.
Reflecting a Hyman Minsky distortion.
4 Cost of Capital and Forecast Horizon
Our model accepts that cost of capital is a relatively low factor in the investment payback
calculation and the investment decision process. Relative certainty of demand over the
forecast horizon is a key factor in the investment decision. Akin to the confidence fairy
proposition, reflected in Krugman 2010, Bloom, 2009, MacCaferty 2014
5 Disaggregated Pattern recognition
Our models are reconciled with a “pattern recognition” of the forecast outlook for the
disaggregated variables before final model build and projection is made.
The Bank of England Investment Models.
According to Burgess et al, 2013, there are seven models in the Bank of England Model
investment suite, described below. Figure 8 shows a comparison of the forecasts from these
seven models.
1. ARMA model: A simple baseline model, expressing business investment as a function of
lag dynamics (see Box et al. (1970)).
2. Simple financial accelerator model: An ECM which assumes that in the long run, the level
of investment depends on the level of GDP, the capital stock and the cost of capital, but that in
the short run, financial channels such as firms’ cash flow, interest payments and net financial
assets play an important role.
3. Gearing model: An ECM, which assumes that in the long run, investment is determined by
GDP, the cost of capital and the *gearing disequilibrium: *the extent to which firms' debt levels
are away from a target" level determined by tax incentives and the risks of distress (Bunn and
Young (2004)).
4. Money, lending and investment system: A three-equation VECM which jointly models
business investment, non-financial companies' money holdings and M4 lending to non-
financial companies. A range of other explanatory variables are included, such as spare
capacity and firms' retained earnings. See Brigden and Mizen (1999)
5. Tobin's Q model: A model for the ratio of investment to the capital stock, which in the long
run depends on a proxy for Tobin's Q, the value of the firm. (see Kapetanios et al. (2006)).
6. Survey model: This uses the investment intentions balances in the BCC Quarterly
Economic Survey to project investment in the year ahead.
7. VECM: A four-equation system embodying two assumed long-run relationships. One relates
investment to the size of the capital stock; the other is based on a profit-maximising condition
and links the capital-output ratio to the real cost of capital. See Ellis and Price (2004).
References
Bloom, N (2009), ‘The impact of uncertainty shocks’, Econometrica, Vol. 77, pages 623–85.
Box, G., G. Jenkins, and G. Reinsel (1970): Time series analysis: forecasting and control, Wiley.
Brigden, A. and P. Mizen (1999): Money, credit and investment in the UK corporate sector, Bank of England Working Paper 100, Bank of England.
Bunn, P. and G. Young (2004): Corporate capital structure in the United Kingdom: determinants and adjustment," Bank of England Working Paper 226, Bank of England.
Burgess, S., Fernandez-Corugedo, E., Groth, C., Harrison, R., Monti, F.,Theodoridis K, and Waldron, M., The Bank of England’s forecasting platform: COMPASS, MAPS, EASE and the suite of models.
Working Paper No. 471 May 2013
Dixit, A and R Pinkyck (1994), Chapter 2 of Investment Under Uncertainty, Princeton University Press, Princeton.
Kapetanios, G., V. Labhard, and S. Price (2006): Forecasting using predictive likelihood model averaging, Economics Letters, 91, 373-379.
Krugman P, (2010) Myths of Austerity, New York Times.
McCafferty, I., Achieving a sustainable recovery: where next for business investment? January 2014 Bank of England Speech 703.
Minsky, H.P. The Financial Instability Hypothesis Working Paper No. 74 The Jerome Levy Economics Institute of Bard College, May 1992.

The saturday economist modeling uk investment september 2015

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The saturday economist modeling uk investment september 2015