Given all the uncertainty in the world economy today, we have been reminded that for all the authority economics commands, it is still a social science. Many major developments over the past year have departed from the consensus forecast, exposing the limitations of our understanding.
Most notably, many experts and forecasters predicted a recession in the United States this year. But not only have we avoided that (so far); the latest inflation figures have led many sell-side forecasters to write down the probability of a recession happening at all. Suddenly, financial markets are entertaining the idea that policymakers can indeed achieve a soft landing: inflation returns toward its target level (around 2%) without the need for a recession and a sharp increase in unemployment. Equity markets thus are rising, despite remarkably (and perhaps understandably) cautious investor sentiment.
The situation across the Atlantic is also overturning forecasts. Although the United Kingdom’s economy seems to be constantly beleaguered – with GDP growth remaining meager – it nonetheless has avoided a technical recession (defined as two consecutive quarters of negative growth). Will the next positive surprise be a sharp reduction in inflation? One issue that pessimists (including the Bank of England) focus on is wage inflation, which summons comparisons to the 1970s wage-price spiral. That episode inaugurated the long era of monetarist orthodoxy, which required that stringent anti-inflation measures take priority over most other economic-policy objectives.
Given the complexity of the UK’s macroeconomic situation, I am still waiting to see if the new optimism sticks. It is worth remembering that, before the pandemic and Russia’s war in Ukraine, the UK government was a vocal advocate of higher real (inflation-adjusted) wages. Now, its wish is being granted: labour representatives are determined to seek higher nominal wages in response to the sharp, unexpected increases in consumer prices. Policymakers thus should be praying for headline inflation to fall significantly, as that would allow them to claim credit for boosting real wages without the need for an increase in nominal pay.
Another irony, in the UK and some other countries, is the role of monetary growth as a leading indicator of inflationary pressure. Following the large monetary and fiscal stimulus packages rolled out during the pandemic, commentators who focus on the money supply predicted, accurately, that inflation would increase. But many of these commentators had been saying the same thing for the past decade, in response to central banks’ unconventional monetary policies. Their forecasts were wrong until COVID-19 arrived. If they are monetarist true believers, they should be advocating less monetary tightening now that growth in the money supply has slowed.
Between the slight weakening of commodity prices, slower monetary growth, the significant increases in interest rates, and the general stability of long-term inflation expectations, I see good reasons to side, cautiously, with the optimistic camp. But I would hasten to add that central bankers must remain vigilant in guarding against any return to the 1970s.
As always, much will depend on China. After the government abruptly ended its “zero-COVID” policy late last year, growth briefly shot up, and analysts rushed to revise their forecasts. But over the past three months, Chinese economic growth has been disappointing, forcing many to revise their forecasts once again.
Moreover, there is no sign of increased inflation in China, challenging the long-held assumption that China would eventually go from exporting deflation to exporting inflation. True, some might say that the redirection of business and investment away from China will be inflationary; but I have my doubts, considering that some of these moves will be to countries with even lower costs than China. In any case, Chinese policymakers clearly will need to address the weakening of growth and consumption, not to mention other major problems such as rising youth unemployment.
Looking ahead, a major variable to watch will be global commodity prices, which have undergone a surprising reversal since Russia’s full-scale invasion of Ukraine. But it is not clear why that happened or whether it is sustainable. My own hunch is that there have been larger-than-expected shifts toward efficient energy consumption and a wider adoption of alternatives than what was forecasted. But we will need more time and data to determine whether this is really the case.
For the past two decades, it has been fashionable among academic economists to assume that excess global savings have resulted in a lower natural rate of interest. While I respect many of those who held this view, I was never convinced by it, because I saw low interest rates as a consequence of persistently lower-than-expected inflation, which in turn justified accommodative monetary policies. Perhaps now reality is starting to catch up. If so, the long-term “new normal” would be much more normal indeed. Interest rates, finally, would remain above the actual or desired level of inflation.
Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK treasury minister, is a member of the Pan-European Commission on Health and Sustainable Development. Copyright: Project Syndicate, 2023, published here with permission.
11 Comments
The rest of your quoted paragraph is perhaps much more important:
Interest rates, finally, would remain above the actual or desired level of inflation.
And for NZ if CPI is 6.6%, or wherever it is, then today we should have an OCR of +7.5%, and at some stage that margin will arrive and be maintained. The risk we run is letting CPI get away to, say, 10% and the OCR has to then leap ahead of that to stop CPI going to +12%
For the past two decades, it has been fashionable among academic economists to assume that excess global savings have resulted in a lower natural rate of interest. While I respect many of those who held this view, I was never convinced by it, because I saw low interest rates as a consequence of persistently lower-than-expected inflation, which in turn justified accommodative monetary policies.
[The natural rate] is never high or low in itself, but only in relation to the profit which people can make with the money in their hands, and this, of course, varies. In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low, and expected to remain low.
When nominal profits are expected to be robust, holders of money must be compensated for lending it out by higher interest rates. Thus, the same holds for inflationary circumstances, where nominal profits follow the rate of consumer prices. During the Great Inflation, interest rates weren’t low at all, they were through the roof well into double digits and higher by 1980. At the opposite end in the Great Depression, interest rates were low and stayed there because, as Wicksell wrote, the rate of profit was low and was expected to be low well into the future. High quality borrowers were given as much money as they could want while the rest of the economy was deprived of funds; liquidity and safety being the only preferences in what sounds entirely familiar. Link
From 2009:
Sorry Ma’am — we just didn’t see it coming
A British newspaper reported Sunday that a group of eminent economists have apologized to Queen Elizabeth II for failing to predict the financial crisis.
The Observer newspaper reported that a letter has been sent to the queen after she demanded, during a visit to the London School of Economics last November, to know why nobody had anticipated the credit crunch.
According to the newspaper, the letter says that “financial wizards” who believed that their plans to manage risky debts and protect the financial system were infallible but were guilty of “wishful thinking combined with hubris.”
NZs failed and still failing "Economists" are even worse.
They have/will lead many into financial disaster/mortgagee sales and bankruptcy, during the last/next few years!
The "Independant Economists" are the worst and the first, most obvious lie is in their Title. From there, the fish rots from the Head.
No. And neither is it a category of the Nobel Prize.
"Peter Nobel, a great-grandnephew of Ludvig Nobel accuses the awarding institution of misusing his family's name, and states that no member of the Nobel family has ever had the intention of establishing a prize in economics"
This is an interesting topic for many reasons. Some of it relates to the biased data assembled by biased the agencies in many nations, including our own, along with the [poor] quality of the data modelling, which is then revised & then quietly revised again in hindsight [which still offers the best views] etc. In fact quality pops up a lot in economics, or the lack of it, or the out of date nature of it.
The CPI model for example is not a real representation of most peoples daily lives. You might say there are hundreds of different versions of those & you are right. That's the problem.
This is after the global politicians skewed it in the first place, in law, or whatever passes for law these days, by eliminating some key metrics, such as mortgage payments.
Every which way you look at economics, every model, every interpretation, every angle, every economist, every comparison, every season, every cycle, they are always changing things, always shifting things, always revising their stories, their narratives, including updating their reasons for existing & doing so... when it's quite obviously a shambles in all directions. Including from the big banks. It certainly is not a science & should always be taken with a pinch of salt upon reading.
As such, we have taken to assembling our own version of economics for our own businesses & family & industry & region & national viewpoint & even international interests, which from experience have taught us are unique to us, & is confirmed when meeting with other like-minded & similarly positioned people/businesses to ours on a regular basis.
However, I'm fairly sure we are not unique in doing this, although as a small business it can often get harder to gather the relevant details/data especially when in isolation which includes the covid calamity, from which we are still getting over, some might suggest hungover, & which looking forward from where we sit, are layers upon layers, upon layers, upon layers.... of debt, most of which, once again from where we sit, can never, nor will ever be repaid. We might be wrong, & often are, but I sense the worst 12 months is still ahead of us, for we can see no leadership, anywhere & of any note, that is likely to lead us through is without further pain.
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