Many observers have noted that the financial situation facing the UK is different from that in Greece, Ireland, or Portugal. The rates of interest which the latter countries have had to offer in order to sell their Treasury bills illustrate this. While six month T bills can be sold by the UK at an interest rate of around 0.7%, Portugal has today auctioned off six month T bills at a mammoth 5.1%. This figure makes the terms of any prospective bail-out attractive to the Portuguese authorities, and such a bail-out is now surely inevitable.

The revisions made to the Office for Budgetary Responsibility's growth projections, released to coincide with today's Budget Statement, are in a downward direction, with 2011 growth now anticipated to be 1.7%. This still looks a touch optimistic.

The Chancellor of the Exchequer described his Budget as a Budget to fuel growth, but beneath the hype there does not appear to be much fuel in the tank. To some extent this is unsurprising as the Chancellor has already used the Comprehensive Spending Review to tie his own hands. Even so, further - and more accelerated - redistribution towards those on lower incomes would have done at least something to improve the multiplier effect of what measures are in place to support the economy. The £600 rise in the personal allowance on income taxation does not kick in until April of next year - too little and too late to help an economy that is shrinking now. And a shrinking economy makes it all the more difficult for the government to meet its targets with the public finances.

The Budget has been accompanied by something called a 'Plan for Growth'. This aims to increase the competitiveness of the tax system, to encourage the creation and development of businesses, to rebalance the economy through investment and export activity, and to provide a more educated workforce. The headline ambitions suggest that the government's aim is to produce a raft of microeconomic policies that could help improve competitiveness and hence provide the right context within which economic growth can take place. So far, so worthy.

When we turn to the detail of the Plan for Growth, remarkably little involves a financial commitment by the government. There is reference to an additional £100 million to repair potholes, and one or two other things. But the (uncosted) words 'encourage', 'support', and references to reducing 'burdens' occur frequently. In other words, it's a 'do it yourself' plan for growth - much as the expenditure cuts were a 'do it yourself' exercise (a huge proportion of these cuts being shifted onto local authorities). The plan - inasmuch as it is a plan rather than a hope - is for a Thatcherian resurgence in enterpreneurship. We should wish for this to be successful. Whether or not it will be so will depend in large measure on the detail of the microeconomic policies that are introduced. And for that, we'll have to wait and see.

This week's budget needs to include policies aimed at the promotion of growth. There is a wide range of options open to the government, but one that is in line with the policies of one of the coalition partners (the Liberal Democrats) would be to raise the personal allowance (or 'disregard') on income tax. For the coming year this is set to be £7475. A substantial increase in this would raise disposable incomes - especially those of the people on the lowest incomes. Since the latter group tend to spend the largest proportion of their incomes, the knock-on ('multiplier') effects of raising their disposable income is likely to be greater than that associated with raising the incomes of other workers.

Ultimately the Liberal Democrats want to raise the personal allowance to £10000. While their more hawkish partners in government are unlikely to want to go the whole hog at this stage, it is, of course, now that the stimulus is most needed. Tax revenues fall when the economy contracts, and - while borrowing fell over most of last year while the economy was starting to recover - the more recent stagnation is doing nothing to help the public finances. Moving most of the way to the £10000 target - in a budget containing other policies to encourage growth - would be prudent.

Consumer confidence has, according to the Nationwide's monthly survey, hit an all time low. What is particularly worrying about these figures is that consumer confidence has a track record as a very good leading indicator of the state of the economy. Confidence has clearly not been helped by the government's failure, thus far, to deliver any clear plan for growth. While the hope is often expressed that the private sector will expand to soak up the supply of labour that is shed by public organisations, this has, so far, been just that - a hope. The reality has been one of rising unemployment - with the number unemployed rising to 2.53 million in January, the highest figure for some 17 years. Meanwhile, the OECD has provided a downbeat assessment of the UK's growth prospects over the next 2 years. This anticipates growth of just 1.5 per cent this year. The OECD does deem fiscal consolidation to be 'necessary', but also describes the government's plans in this area as 'ambitious'.

Next week's budget needs to provide what has heretofore been lacking - not just a hope, not just a promise, but robust government support for growth. And if that means trimming the ambition just a little, and losing face just a little, then so be it.

There are some very pertinent observations about the future development of macroeconomics in this talk by Olivier Blanchard.

His nine points are:

1. In the wake of the crisis, policy making has to change, in particular with less of a focus on a single policy goal.
2. The pendulum has swung, some at least, in the direction of a recognition of an enhanced role for the state in macroeconomic regulation.
3. We previously underestimated the impact on the macroeconomy of microeconomic distortions.
4. There exists a multiplicity of macroeconomic policy tools...
5. .... not all of which are fully understood.
6. Some of these tools are difficult to employ for reasons of political economy.
7. The future research agenda for macroeconomics, with solid microfoundations, is exciting.
8. There should exist a multiplicity of policy goals. But moving from a model of inflation targeting to one where multiple goals are targeted is difficult.
9. We should not hope for too much.

Recent developments in macroeconomics have focused on models based on dynamic stochastic general equilibrium (DSGE). These models are characterised by a set of macroeconomic relationships which are built up from consistent microeconomic foundations. Their microeconomic underpinnings are intended to finesse the criticism raised by Lucas that changes in policy beget changes in the behaviour of microeconomic agents thereby posing a challenge to economic forecasters. DSGE models come in a variety of flavours - there are classical models developed from the real business cycle literature and there are Keynesian models which build in price rigidity as an institutional feature. The models take the assumption of rational expectations as given. Large scale variants of these models are used as a tool for policy making and evaluation in central banks.

In recent work, Georg Weizsäcker has produced compelling evidence that - contrary to much of the economic orthodoxy of the last 40 years - people do not form their expectations rationally. It takes particularly strong evidence to disturb someone's expectation away from their prior beliefs. If the expectations formed by an agent are approximately correct, they will not adjust them rationally. Only if they are way out will they take new evidence on board.

Weizsäcker's findings should not be particularly surprising. They suggest that a way forward in modelling may be to adopt a nonlinear approach wherein the degree of rationality used in forming expectations varies inversely with the accuracy of those expectations. Given the evidence, it is clear that our models would benefit by admitting some sort of learning mechanism - something more refined than the assumption that we always achieve rationality.

Weizsäcker, G. (2010). Do We Follow Others when We Should? A Simple Test of Rational Expectations American Economic Review, 100 (5), 2340-2360 DOI: 10.1257/aer.100.5.2340

In recent work, Atish Ghosh, Enrique Mendoza and Jonathan Ostry have developed a means of evaluating the 'fiscal space' of an economy. This is a measure of the flexibiltity that the authorities have to engage in expansionary fiscal policies given the levels of national debt. The measure is calculated by reference to the maximum level of national debt that (given that interest payments need to be made on the debt) is sustainable at the economy's GDP. If the national debt were to rise above this point, then interest payments will serve to ensure that it would rise forever more, and so default would become inevitable.

The results are instructive. Unsurprisingly, Iceland, Greece and Portugal are amongst the countries with very little headroom. Italy and Japan are also in this group. Spain and Ireland (surprisingly, perhaps), are somewhat better placed. The UK is (perhaps also surprisingly) in a relatively comfortable zone, keeping company with countries such as France and Germany.

Results from the new panel dataset, Understanding Society, have been reported today, suggesting that people in the UK remained broadly optimistic at the height of the recession in 2009. At times like these, good news is always welcome. It is important, however, to note that this is a snapshot. Evidence from another source - the Nationwide survey of consumer confidence - confirms that confidence did indeed recover well during 2009. Indeed by the end of that year, confidence was not far below the levels realised in the summer of 2007, before the first signs of the credit crunch became fully apparent. However, since the end of 2009, confidence has plummeted once more and the Nationwide's index is currently close to the minimum value that it realised at the end of 2008.

The world moves fast. Understanding Society is set to be a fantastic source of data for researchers, but when analysing data we should pick horses for courses. Understanding Society is simply not up to date enough to provide useful information about consumer sentiment now.

In a post on this blog last June, I expressed concerns that the Office for Budgetary Responsibility was underestimating the magnitude of the output gap in the UK. This underestimation appears to be contagious. A member of the Bank of England's Monetary Policy Committee, Andrew Sentance, has argued in a speech that the output gap is low and that maintaining historically low interest rates is stimulating the economy beyond the point at which inflation can be held in check.

The notion that, with high and rising unemployment, the output gap is low seems to be difficult to defend. There are, to be sure, reasons why prices are rising. Oil and food prices have risen internationally for reasons that have been well documented (here and elsewhere) and which are likely to be transient. Tax hikes have also contributed.

The economy shrank in the last quarter. Fiscal policy is imposing a squeeze which will inevitably increase the challenges faced in the labour market. To move too early to accompany this with a monetary squeeze - and to do so on the basis of price statistics that are probably blipping - would be dangerous. Yes, we need to keep an eye on inflation, but, no, the price increases we have seen up to this point do not suggest that inflation is a significant threat.

Project Merlin - the initiative that has aimed at securing more bank lending to businesses by linking bankers' bonus payments to such lending - has finally, after much wrangling, delivered an agreement. The banks will raise their lending to a total of around £190 billion this year. Some 40% of this will go to small firms. The banks will also provide capital (some £200 million) for the Big Society Bank - which is intended to fund projects that are community based. There will be increased transparency in bankers' pay, but this falls short of the hope that bonuses would be contingent on banks meeting lending targets.

Lending will be monitored by the Bank of England which will provide regular reports - which presumably means naming and shaming banks that do not live up to their promises. Beyond this, it is not clear that Merlin has any teeth. Banks will lend, and they will do so at rates of interest that they themselves set. If businesses do not find these rates attractive, they will not look for loans.

In this context, it is a little disquieting to note the continued rise of LIBOR - which is now at 0.80%, some 30 points above the Bank of England's interest rate. There is still a lot of nervousness around the financial markets, and that means that lending is still not going to come cheap.

So the environment in which Merlin has been launched is not altogether promising. A little more prescription might not have gone amiss.

The big question to arise from yesterday's disappointing growth figures is: can it really all have been about the snow?

Occasionally over recent months, I have referred to a forecasting model that I like to use. If the slump in the last quarter of last year was indeed due to the exceptional weather, then this model should fail to predict it. Indeed my model fails to predict the final quarter slump. So snow may have played a part. (Bear in mind, though, that this is a loose test - not least because the data I use in this model are industrial production data, and we know that manufacturing did relatively well in the last quarter.)

Despite this, the model's forecasts are not all that encouraging. They are that production will show modest growth (at an annualised rate of less than 2%) up to the late summer - but then it starts to fall off.

Plenty of caveats attach to a simple model of this kind (a neural net with a hyperbolic tangent squasher, 24 months of input data, 2 hidden layers, where the data are the 12-month change in logged index of industrial production data), or indeed to any economic forecast. But, for a simple model, the track record of this forecaster is pretty good. Snow may have played its part in the last quarter of 2010, but the recovery is nonetheless far from secured.

It's a double dip. The 0.5% contraction in the economy over the last quarter of last year represents a truly awful outcome. The government has been quick to blame poor weather towards the end of December. But that is clutching at straws.

The figures are considerably worse than the expected increase in output of around 0.4%. It represents a dreadfully weak platform on which to build the government's austerity measures. It is time for a reassessment.

Figures released this week indicate an increase in the unemployment rate to 7.9% and an increase in the inflation rate to 3.7%. Both are a concern, and they bring to mind the 'stagflation' that was experienced in the 1970s.

Economics is often thought of as the 'dismal science' - when there is good news about unemployment, there is usually some bad news about inflation, and vice versa. When there is bad news about both, things get really dismal, and we really have to try hard to look for some good news. There may be some. Petrol prices have risen sharply; food prices have also increased. The price of oil does tend to fluctuate a lot (a fact not unrelated to the inelastic nature of both demand and supply in this market), and at close to $100 per barrel the price is now, if anything, above its steady state. The increase in the price of food has been driven largely by severe, but transient, weather events.

So where is the good news? As things stand, it looks as though inflation is blipping. It will rise further before falling - not least because of the effects of the January VAT increase. But as oil and food prices stabilise, the inflationary pressure should ease.

This does suppose that the inflation that we have experienced up to now will not feed through into wage increases. If it does, then stagflation indeed looms. The Bank of England's Monetary Policy Committee is sure to look closely at wage settlements over the coming months. If there were to be a general upward drift in wage settlements, then that would not be good news for inflation - wage hikes would feed through into further price hikes, and this would lead to wages and prices leapfrogging each other in an inflationary spiral. To avoid this, the Bank may need to raise the interest rate sooner rather than later - and that would further threaten the recovery. Let us hope that sense prevails.

LIBOR has been creeping up over the last quarter or so, and has now risen to 27 points above the Bank of England's rate. All is still not well in financial services.

The Conferderation of British Industry has lowered its growth forecast for the coming quarter; it now forecasts quarter-on-quarter growth of just 0.2 per cent over the period from January to March 2011. It does, however, still expect growth of 2 per cent over the coming year.

Meanwhile, the Nationwide consumer confidence index fell further in November, and is now close to the low point that it reached in January 2009. (The index stands at 45 in November; it was 43 in January of last year.)

I have, on a couple of occasions over the last few months, reported the predictions of a neural network forecasting model. Over the coming 18 months, that model is currently predicting modest growth for the UK, and suggests that the danger of a double-dip is receeding. It should, however, be borne in mind that this model is based on output data (monthly data on industrial production, to be precise); the model may not adequately allow for the threats to the economy that come from sluggish consumer spending, fragile overseas demand, and government austerity packages. Nonetheless, the model offers a little festive cheer.

The Institute for Fiscal Studies has reported on the government's proposals for student finance. Its findings cast some useful light on a debate that has been dominated by political spin. An important conclusion is that 'graduates from the poorest 30% of households would (under the government's proposals) pay back less than under Lord Browne's proposed system, but more than under the current system'. Many politicians would have you believe otherwise.

Browne's proposals, which involved a 'soft' cap on tuition fees at £6000, with universities being allowed to raise fees above that level while being subjected to a steeply rising tax, have been replaced by a 'two cap' system - where the cap is either £6000 or £9000 conditional on widening participation. Both Browne and government proposals involve a loan for tuition fees and maintenance that is repaid once the student graduates and is earning £21000 or more per year. Concessions made by the government include the annual uprating of this £21000 figure, and tuition fee discounts to students from the poorest families.

The media has portrayed this as a three-fold increase in tuition fees, indicating an expectation that many universities will pitch their fees at or near the higher cap. Indeed, it is quite possible that, by introducing the higher cap, the government will already have encouraged some institutions to set fees higher than they would otherwise have chosen. This would appear to be good for neither students not public finances, and appears to have been driven by a political need to retain a cap of some sort. Yet surely it is almost inevitable that the cap will go some day, and Browne's suggestion of protecting students and the taxpayer by imposing taxes on universities that charge high tuition fees was eminently sensible. In this respect, politics seems to have trumped common sense.

The universities, meanwhile, will suffer severe cuts to their teaching budgets from the coming tax year (which starts before the end of the current academic year), and will - if the legislation goes through - be able to charge higher tuition fees only from academic year 2012-13. They will face a more robust competitive environment, and will need to innovate rapidly - and constantly - if they are to prosper. These are interesting times indeed in higher education.

'Nudge' is the title of an influential book written a couple of years ago by Richard Thaler and Cass Sunstein. The thesis of the book is that small actions by government can be used to trigger large changes in behaviour amongst the population at large - government can 'nudge' people in a particular direction. The idea comes from the insights of behavioural economists who have combined research results from the disciplines of psychology and economics.

Nudge is now influential in policy circles. Indeed the new white paper on health policy, 'Healthy Lives, Healthy People', contains many ideas based on nudge. It talks of the need to harness 'the latest insights from behavioural science, and emphasises that 'top down inititiatives and lectures from central government about the risks are not the answer' to health issues.

Good. But let us hope that the solutions will be based on research, and that nudge is not used as an excuse for doing (and spending) too little when more needs to be done.

The Office for Budget Responsibility (OBR) has raised its forecast for growth in 2010 to 1.8%. This is in response to the higher than expected figure for third quarter growth. At the same time, the OBR's forecast for growth in 2011 has been cut - from 2.3% to 2.1% - following the VAT hike (from 17.5% to 20% in January of next year) and the planned cuts in government expenditure.

The outlook for the world economy remains very uncertain, with recent events surrounding the Irish economy merely serving to highlight the continued fragility of the financial sector. Weakness in the UK's main export markets continues to suggest that the risks remain on the downside. If the economy fares as well as the OBR expects in 2011, I would be pleasantly surprised; given the severity of the government's austerity measures, and the imposition of similar measures elsewhere, a growth rate of one point something seems to me to be more likely.

The government has launched an initiative to create an index of happiness. Prime Minister David Cameron has argued that purely economic measures of prosperity, such as Gross Domestic Product, provide too narrow a metric of our wellbeing. No doubt he is right.

Composite measures of wellbeing are not a new thing. The United Nations has calculated a Human Development Index which, since 1990, has evaluated wellbeing in terms of people's educational attainment, life expectancy and income. The UK comes 26th in this ranking.

But what about happiness? A lot of recent work on happiness uses standard survey questions such as this: 'All things considered, how satisfied are you with life as a whole these days?' Respondents give a response, usually on a 5 point scale. The results correlate strongly with more objective measures of average happiness across countries - like suicide rates, addiction rates and so on. So perhaps there is something in this idea of a happiness index.

We know that stable familes, good health, active leisure time, high levels of employment, a relatively equal distribution of income, freedom and democracy all positively influence happiness. If these insights lead to the adoption of policies that are family friendly, that are health enhancing, that encourage active leisure and so on, then that is all to the good.

So far, so good. But there is an inconvenient paradox lying in wait. Much of the work that has been done on happiness indicates that happiness has not risen over time - even though we are now much richer than we were in the past. However, we also know that our happiness is determined largely by a comparison of our own income with that of other people. So if we see other countries getting richer while our own does not, we become less happy.

Like it or not, the question of economic prosperity will always come to the surface.

There is the deficit, and there is the debt. The deficit is a flow (like water flowing into a bath) - and it only make sense to talk of a flow as a measure of volume per period. The deficit tells us how much is being added to the debt per year. The debt, on the other hand, is a stock (like the amount of water that is actually in the bath). We pay interest on the national debt, and if the national debt rises too high we squander too much of our resource on these interest payments.

Clearly the flow and the stock are related. Keep the tap on too long and the tub overflows. The deficit does need to be reduced. But this chart, published by the Financial Times, is useful in putting things in context.

Relative to many other countries, the UK started out from a good place. Its policy response to the recession was aggressive (and, given the economy's reliance on financial services, it needed to be). We are left with a high deficit that needs to be cut. But the national debt remains in a place which gives the government some discretion (not much, but some) about how fast it should go in making the cuts.