Consumer confidence continues to sink, and house prices are now once more on a falling trend. The latter, at least, is not all bad news. The acceleration in house prices up to July had been something of a puzzle since the earlier fall had not been sufficient to burst the bubble. While I have not been amongst those economists predicting a 30% or more fall in house prices from their peak, I did expect the recovery in prices to be sluggish. Initially it wasn't, raising fears of more boom and bust in that market, and in this context the slowing down that we have seen over the summer is something to be welcomed.

The news on consumer confidence is more disturbing, and I await the August figures with interest.

The rate of growth of GDP accelerated sharply in the second quarter of 2010, with output in that quarter being 1.1% higher than in the first three months of the year. This is clearly very encouraging news. If the strength of the recovery is maintained over the remainder of the year, the economy could be better placed to withstand the government's plans for deficit reduction than appeared to be the case only a short time ago.

The world remains an uncertain place, however. Simultaneous fiscal retrenchment in many countries (including some of our important trading partners), a fragile housing market, the threat of renewed ossification in the banking sector (as evidenced by a rising LIBOR) all point to downside risks that remain significant.

It looks as though Vince Cable's graduate tax proposal, on which I commented in my last blog post, has been mercifully short lived. It is attractive to some because of the property that lifetime repayments rise with lifetime income. But, of course, if you want more progressivity, you can let the income tax system alone take care of that without recourse to graduate taxes.

The downside of the proposal would likely have been a cumbersome bureaucracy making controversial decisions on differential financial allocations to universities. And why, when the market could work out the appropriate resource allocations for free? To thrive, the higher education sector needs more freedom from bureaucracy, not another dose of Stalinism.

University funding is back in the limelight. Vince Cable is to speak in favour of replacing the current system of undergraduate tuition fees with a graduate tax. In many respects, this is not a radical change - students' loan repayments are already proportional to their income. In some ways, a move to a graduate tax might even be welcome - it has the rather nice property of being progressive.

In other ways, though, a shift to a graduate tax might pose problems. Like it or not, it is difficult to see how the UK can, in future, fund world class universities without funding them differentially. It would be reasonably straightforward to achieve this with a system of differential fees - where students who attend the best universities pay a premium (which would have to be covered by a loan). Universities could set their own fees according to their perception of where they stand in the market. This is not so easy to achieve with a graduate tax. For sure, the government could fund the best universities more generously than others - but would those students attending universities that are lower down the food chain be happy to see their graduate tax payments used, in effect, to subsidise students attending universities higher up the rankings? Suddenly the tax no longer seems so progressive. It might, of course, be possible to set differential rates of graduate tax - a lower rate for students attending institutions that offer two year degrees perhaps (such degrees being another proposal doing the rounds) - but that seems dreadfully clunky. And does the government really know better than the market which are the best providers?

As ever with these mechanisms, the devil is in the detail.

It is curious that any government minister should have chosen to preempt the outcome of the Browne review at this stage. That, in itself, suggests that there is a long way still to go on the politics of this issue.

The latest consumer confidence figures from the Nationwide do not make pleasant reading. Consumer confidence has been falling since February, and the worsening state of the index on expectations is particularly striking.

In February, some 39% of respondents expected that, within 6 months, the economic situation in the UK would have improved; only 15% expected the situation to worsen. But the corresponding figures for June are 27% and 24% respectively.

These prospective indicators have a track record of predicting actual fluctuations in the economy rather well. A downturn in confidence and expectations does not necessarily foreshadow a downturn in the real economy. But these figures should give us plenty of reason to be cautious about the sustainability of the present recovery.

Olivier Blanchard and Carlo Cottarelli have published their 'ten commandments for fiscal adjustment'. These are instructive. Commandment 2, which counsels against front-loading the fiscal adjustment, is particularly pertinent to the current debate in Britain.

The G20 summit in Toronto has finished. The limited extent of agreement achieved at the meeting is well encapsulated by the rather novel concept of a 'growth friendly fiscal consolidation plan'. If for nothing else, the authors of the document are to be congratulated on creating the illusion of consensus.

They claim, with some justification that 'efforts to date have borne good results'. The world economy is recovering. But there may be troubles ahead in the form of the dampening impact that is sure to come from simultaneous fiscal consolidation across many countries. Indeed, the International Monetary Fund's report on the summit paints a downside picture that is far from rosy. The markets today reflect some of this gloom. Coordination of policy across countries has never been more important.

Yesterday I wrote about the phasing of the fiscal retrenchment announced in the budget. Today I shall write about the extent of the retrenchment. For sure, a severe correction is needed - nobody questions that. Much of the debate centres around the size of the structural deficit - the bigger that deficit, the greater the consolidation has to be.

The Office for Budgetary Responsibility (OBR) has estimated the size of the structural deficit by, first, estimating the output gap (how far output is from what it would be if the economy were operating at full capacity), and then working out what the balance of government spending would be if the economy were at full capacity. Its estimate of the output gap depends in part on estimates of how much premature scrapping of capital equipment has been going on during the recession. If its estimate of this is too high (and it may well be), its estimate of the structural deficit and of the extent of fiscal consolidation that is needed will also be too high. Until we see how fast the budget deficit shrinks as the economy recovers, we will not know for sure how big is the structural deficit. This provides another reason to think that the phasing of the consolidation needs to be carefully constructed.

Yesterday's budget effectively put off a lot of the real decisions until the autumn statement on spending. But it is clear that the government is looking for 25% cuts over the next 4 years. The public sector pay freeze will go some way towards achieving this, but there will be much ground left to be recovered. There are some quick wins - why, for example, do well-off parents receive child benefit? We shall see in the autumn how economics and politics mix in determining where the cuts fall.

A week ago, the Office for Budgetary Responsibility (OBR) reckoned there was less than a 10% chance of Britain falling back into recession. Today's new estimates suggest that there is about a 20% chance of this happening by 2015. At the same time, the central growth forecast has been downgraded from 2.6% to 2.3%. This is all in the course of a week. The change is, of course, the result of the new measures announced in today's budget.

The deflationary nature of the budget has come as no surprise - expectations were well managed in advance of the event. If the OBR's forecasts are in the right ballpark, then the policies announced in the budget make a great deal of sense. By 2014-15, the government is planning to have phased in a reduction of the deficit amounting to £113 billion per year - half as much again as was planned by the previous government. In itself that may or may not be inappropriate; of course it makes sense to for the government to spend when times are tough, but rein in that spending as the economy improves. Whatever the merits of the extent of retrenchment, the way that it is phased is a matter of great debate.

The plan set by both this government and its predecessor has been to introduce the consolidation gradually, so that about one third of the total deficit reduction (that is, one third of £73 billion in Labour's case, one third of £113 billion in the case of the current government) comes in over the next two years. This means that the cuts announced by the present government over the next couple of years amount to taking £15 billion more out of the economy in 2011-12 (and £8.1 billion - most of which had already been announced) in the current financial year. That is tough medicine for an economy that is still in a fragile state.

To use Donald Rumsfeld's famous terminology, there are 'known unknowns' and 'unknown unknowns'. While one may not wish to argue too much with the central forecast, the risks from the unknowns that do not feature in the OBR model - or in the pretty fan charts - appear to be on the down side. While any budget has to be built on a forecast of how many chickens will hatch, in this particular case the risks of getting it wrong are greater than usual.

An interesting feature of the Office for Budgetary Responsibility's Pre-Budget Forecast concerns the calculation of the 'output gap'. This is the difference between actual output in the economy and the output that would be possible if spare capacity were fully utilised. During a recession, the output gap tends to rise - some firms reduce hours of work so that capital equipment is underutilised, some firms close down leaving premises and other resources unused. At the same time, pulling in the other direction, some capital might be scrapped. It is difficult to get a handle on how much capital scrapping takes place.

In trying to evaluate how the balance of demand and supply factors has affected the output gap over the course of the recent recession, the OBR has had to come to a judgement about (amongst other things) the reduction in capacity. This leads it to estimate that the output gap is currently around 4% of Gross Domestic Product.

This looks like an underestimate. According to the OBR's own figures, that would make the output gap smaller than it was in the 1980s recession.

Does that matter? The smaller the output gap is believed to be, the less potential is there for expansionary monetary and fiscal policies to promote economic growth without resulting in inflation. And the smaller the output gap is believed to be, the higher the proportion of the government budget deficit that is labelled 'structural' rather than 'cyclical'. Both of these are contentious issues.

In general in its report, the OBR has done an admirable job of documenting the uncertainty that attaches to its forecasts. Its estimate of the current output gap is subject to some uncertainty too, is highly policy-relevant, and - as it feeds into next week's budget - carries some danger.

The newly created Office for Budget Responsibility (OBR) has produced its estimates of growth for next year. In the Budget earlier this year, the then Chancellor of the Exchequer predicted that the economy would grow by at least 3% in 2011. The forecasts released today by the OBR suggest that that was too high an estimate. Indeed the OBR expects growth of just 2.6% - well below the previous 3% estimate, albeit higher than some observers had expected.

Whether this correction reflects the fact that the forecasters were subject to political influence before the election or the possibility that they are still (whatever the rhetoric) subject to such influence now is moot. But conjecture on that issue should not hide the fact that, in many respects, the economic picture is not rosy. The austerity measures introduced in other European countries (needed though they are) do little to encourage confidence in growth over the next couple of years.

The good news (inasmuch as there is any) is that the last government did not run up as large a deficit over the last year as had been expected. To some extent this will cancel out the detrimental impact on the public finances of the slower than expected growth over the next 18 months.

A double dip should be avoidable. But the guardians of our public finances are walking a difficult tightrope. They need to be careful not to believe too much of their own political rhetoric.

In a presentation given in London today, John Philpott of the Chartered Institute of Personnel and Development (CIPD) predicts that unemployment will rise close to 3 million by the end of 2012, and that it will stay at roughly that level for a further three years. This represents a marked increase in the CIPD forecast of unemployment, following the announcement of the government's fiscal deficit reduction plans.

An optimistic outlook for the next few years is for slow growth - certainly below the rate required to maintain unemployment at a steady level - so Philpott's forecasts have the ring of truth about them.

If there were to be a double dip, would this be caused by fiscal retrenchment or fiscal profligacy? Curiously, a mix of both. For some countries - Greece has been the most prominent - debt is a serious issue and there have been real concerns about the prospect of those countries honouring that debt. In consequence interest rates on their debt have risen, and there has been nervousness about their ability to raise further borrowing - thereby setting in motion a viscious spiral of concern. If these countries default, their creditors in other countries will lose out. If they do not default, substantial support is nevertheless likely to be needed from other countries. Either way, the sovreign debt problems of certain countries will have an impact on the public finances of other countries, most notably on the engine rooms of the European economy. This will almost inevitably dampen growth in the major European economies over the next couple of years. Those countries that have themselves engaged in significant fiscal retrenchment may find that they are tipped back into recession by the double whammy of tight tax and spend policies alongside the fallout from the sovreign debt problems of other countries.

Where does the UK fit into this? We sit uncomfortably somewhere in the middle. Fiscal retrenchment is needed, but since government borrowing in the UK has been longer term than in some other countries, the need is not quite so immediate, and premature contractionary fiscal policy might still cause a lot of damage. We clearly cannot rely too heavily on growth in Europe helping us out. Yet if a double dip were to happen, we would be hopelessly bereft of policy options - interest rates are virtually zero, quantitative easing would do little but generate inflation, and there would be no further scope for fiscal relaxation. Better to manage a long, slow recovery - but therein lies a real tightrope walk.

Studying time series of a single variable can be a hazardous activity - as indeed can any forecasting exercise. But a reasonable forecast of the 2008 recession could have been made using a neural network analysis of the index of industrial production. (I tried with 24 lags of the dependent variable, 2 neurodes in the hidden layer, and a hyperbolic tangent squasher, using monthly data that go back to 1968 - just in case you wanted to know.) This same model predicted the recovery quite well too. The same model shows the recovery in industrial output stalling somewhat from now onwards, staying at just above zero growth over the next 15 months. But then the forecast indicates a nasty dive in the last quarter of 2011.

One should not place too much confidence in long range forecasts that come out of such a simple model. But we know enough about the general macroeconomic environment to know that we are far from being out of the woods just yet. The growth rate of the Eurozone economies is likely to be severely dampened by the need to address fiscal deficits of the southern states - and the UK trades a lot with (and so its fortunes depend a lot on) the Eurozone. At the same time, the deficit reduction policies being implemented at home will themselves have a deleterious impact on growth. On balance, I would still expect the next few years to be characterised by a long, slow recovery. But a double dip cannot be ruled out, and is, if anything, getting to look more rather than less likely.

In this month's Inflation Report, the Bank of England argues 'that the
recovery in economic activity is likely to gather strength over the
next year or so. But the downside risks to growth in the near
term have increased somewhat, reflecting in particular
heightened market concerns about the prospects for fiscal
consolidation' - here and around the world. Specifically in the UK context, the Bank notes that the pace of the
'recovery will be dampened by several factors: the need for a
substantial fiscal tightening; further strengthening in the
balance sheet of the UK banking sector; and the private sector’s
desire for higher savings in an environment of increased
uncertainty'. Put simply: proceed with care.

There are now reports that the Liberal Democrats have won from the Conservatives a concession that the £6b spending cut will not go ahead in full this year if signs develop that the economy is weakening. If the reports are correct, then we have some unambiguously good news.

It has taken some time for the various negotiations to come to a conclusion, but we now have a new government in the UK. The Liberal Democrats succeeded in gaining some concessions from the Conservatives, but these have overwhelmingly been in the area of political reform. On economic policy, there will now be an accelerated fiscal retrenchment, with £6bill spending reductions this year. This risks tipping the economy back into recession before the recovery gets fully under way.

For sure, the budget deficit needs to be addressed - and over the course of a parliament more needed to be done than Labour were offering. But the timing of this is potentially critical. Accelerating retrenchment by only a few months could have a major detrimental impact.

The markets appear to like the deal that the EU and IMF have reached to prevent the debt crisis in Greece from spreading to other southern European states. The deal involves the Eurozone countries in guaranteeing 440b in loans, with a further 250b coming from the IMF. In addition, the European Commission is injecting 60b of emergency funding (some of which will, of course, come from non-Eurozone EU members such as the UK). The scale of this deal is impressive, and is a measure of the political ambition that underpins the Euro. It will involve a not insubstantial shift of political power from the weaker economies to the centre of Europe.

The numbers are big. They need to be in order to build a sufficiently secure tidal wall; this needs to resist the pressure of market forces that are speculating against the weaker economies by failing to buy their debt. The question remains: tidal wall or Cnut?

The economic scenario facing Greece is difficult. The country has accessed international support and its parliament has approved a tough set of austerity measures. These measures will not be easy to implement. The current government, or a different government, may be left with little option other than to withdraw from the euro. This would allow the new Greek currency to depreciate, improving competitiveness and disguising (through inflation due to higher import prices) the real impact of the austerity measures on the Greek population.

Portugal and Spain, and to a lesser extent Italy, have been identified as other Eurozone countries facing difficulties. It looks increasingly as though the Eurozone was never an optimal currency area. The northern countries might more reasonably have formed one such area while the southern countries formed another. Political aspiration ran ahead of economic reality.

In the UK, the decision to stay out of the euro was motivated by political considerations rather than economic analysis - a proper cost-benefit study was never conducted. That being so, the fact that we, unlike Greece, are not straitjacketed by the euro appears to be more a matter of good luck than good judgement.

An interesting contribution to the election debate has been published by Tullett Prebon. It argues for substantial cuts in public expenditure, making the following claim:

'When anyone calls for cuts in public spending, there are howls of protest, and grim warnings that slashing spending would inflict unacceptable damage on the public services that are required by a civilised society. This is bunkum. In 2009-10, the government spent £674bn. If this were reduced by £50bn, it would remain higher than the inflation-adjusted total for 2007-08, when the public services were hardly under-funded. Even a £100bn reduction would only take real spending back to the 2004-05 level.'

This is a pretty dramatic claim. But it is spurious. To make a sensible comparison, it is necessary to adjust the figures to allow for the fact that the three years were at different points in the business cycle. Spending was high in 2009-10 precisely because the economy was in deep recession. This meant that spending on things like benefits (unemployment benefit, income support etc.) was high. And spending on projects was brought forward in order to mitigate the worst effects of the recession. Comparing this spending with that which obtained in 2004-05 is frankly ridiculous.

This does not mean that there is no scope for efficiency savings - there always is. But the Tullett Prebon report does show just how careful one has to be in reading claims made during an election period. In some measure, recovery will automatically bring about a cut in public expenditures. And in some measure a reduction of the UK's structural budget deficit is necessary. But without waiting for the recovery to take place, a £50b or £100b cut in public expenditure would cause untold damage.