The laws of economic gravity

As the debate over the costs of Brexit continues to rage, it is worth taking a look at the different approaches which have been used to try and quantify the impacts. There are two main types of analysis: (i) gravity models and (ii) computable general equilibrium (CGE) models, both of which have strengths and weaknesses. Gravity models have long been used in the literature and are the economic analogue of Newton’s law of gravitation which states that the attractive force between two objects is the product of their mass proportional to the (squared) distance between them. In 1962, the economist Jan Tinbergen proposed that a similar model could be applied to international trade with the basic relationship shown below:

In other words, the trade flow (F) between two countries (i and j) depends positively on the respective size of the economies and inversely with the distance between them. In broad terms we can think of distance as a proxy for trade costs, which can have a significant impact on cross-border flows. If we take the logarithm of this equation we have a linear expression which can be estimated using standard regression techniques (in reality, the estimation methods are today quite complex but we will leave this aside). Over the years, the basic equation has been augmented with variables to take account of factors such as shared borders, common language, colonial links and whether they share some form of trade agreement (partly to explain why trade flows between countries such as the UK and US are so large), but the basic idea still holds: Large countries which are located relatively close to each other are likely to have significant trade flows. (Here for much more detail on gravity models, including a paper by Keith Head and Thierry Mayer covering all you ever wanted to know and much that you did not).

I looked at data for goods and services exports from the UK to 33 countries, representing 86% of total UK exports, over the period 1999 to 2016. If we fit a trend relationship between them, the slope of the line is negative – as theory predicts (see chart). But it is interesting that the line is less steep today than at the turn of the century. This reflects the notion often put forward by proponents of Brexit that rapidly growing markets such as China have become significantly more important for UK trade. Indeed UK exports to China rose from 0.3% of the total in 1999 to 3.1% by 2016. Over the past 20 years many commentators have suggested that distance is increasingly no barrier to trade, reflecting technological advances which have led to improved inventory management techniques and the like. But although the curve may have flattened, it is not flat, nor is it likely to be at any point in the foreseeable future. Rumours of the death of distance have been greatly exaggerated.

CGE models are much more computationally onerous but they do try to account for all the linkages between the various sectors of the economy to examine how a disturbance in one area feeds throughout the rest of the economy. They rest on the idea that there is a circular flow of income between sectors and also assume optimising behaviour by economic agents (subject to certain constraints). A CGE model of trade, looking at various sectors of the economy across a range of countries, involves a huge amount of data and one of the criticisms is that such models are often based on calibrations which may not necessarily be validated by the data (in contrast to gravity models which are estimated and therefore data coherent). But they are a useful way to understand how shocks percolate throughout the system and to that end are a valuable tool in trying to quantify Brexit shocks.

It is notable that the analysis of Gretton and Vines, which I cited in this post,  is based on a CGE model and as I noted, the welfare losses they report are significantly lower than other estimates I have seen. But the pro-Brexit group Economists for Free Trade, led by Patrick Minford, stretched the limits of CGE-based modelling too far in their latest paper by claiming that Brexit will actually lead to welfare gains. Their analysis is based on some highly dubious assumptions (which Chris Giles in the FT skewers here). I will return to the details of the Minford et al paper another time in order to look more closely at why this is a case of “garbage in-garbage out,” but aside from any issues regarding the basic assumptions, CGE analysis allows no role for economic gravitational effects. No serious analysis of trade can ignore this factor.

As the WTO put it, “the numbers that come out of [CGE] simulations should only be used to give a sense of the order of magnitude that a change in policy can mean for economic welfare or trade. But much more can be done to create confidence in the results.” This is not to say that gravity models are perfect either. But so long as the lines in our chart have a negative slope, we should never dismiss what they have to say.

I, Franz Kafka

For those of you looking for a feelgood film, the works of British filmmaker Ken Loach would not be high on anybody’s list. Loach is a renowned social commentator, whose political stance is avowedly socialist and who was described by the New York Times as having “the political outlook of a British Michael Moore.” Loach has been making films for more than 50 years and his 1966 television play Cathy Come Home was one of the most important British TV dramas of all time, offering a savage critique of the unemployment and homelessness problems facing those at the bottom end of the social strata. Such was its political impact that it prompted the foundation of Crisis, the charity for homeless people, in 1967.

Whilst Loach’s work may not be a barrel of laughs, it does shine an important light on areas of British society that may otherwise be overlooked by a wider audience. His 2016 Palme d’Or winner I Daniel Blake carries on this grand tradition, offering a gritty take on the Kafkaesque workings of the UK benefit system. The story centres on the eponymous Daniel Blake who has suffered a heart attack and whose doctor determines that he is medically unfit to return to work. However, his benefit claim is denied because the Work Capability Assessment, to which all claimants are subject, deems that he is not sufficiently incapacitated. The reason for that is that the criteria that claimants must pass in order to make a benefit claim did not cover his condition (see here for a list of requirements). As result, our hero is eligible only for a particular category of benefit which requires him to prove that he is looking for work, despite having been told by his doctor that he is medically unfit.

The point of Loach’s film is to demonstrate that the system is not fit for purpose and is designed to put obstacles in the way of claimants to dissuade them from proceeding further, which reduces the numbers and eases the state’s financial burden. This is not simply a piece of social drama: I have heard it time and time again from people involved in dealing with benefit cases. According to the House of Commons Work and Pensions Committee (WPC) “290,000 claimants … – 6% of all those assessed – only received the correct award after challenging DWP’s (Department for Work and Pensions) initial decision.” The DWP’s own statistics show that between October 2013 and March 2017 roughly half of those people initially claiming some form of long-term invalidity benefit either had their benefit withdrawn or were required to claim one which requires them to look for work whilst in receipt. The WPC highlighted “a deficit of confidence in the assessment processes. Central to the lack of trust are concerns about the ability of the Department’s contractors to conduct accurate assessments.” All in all, the WPC’s report was a damning indictment of a system which claimants increasingly distrust.

Although the WPC did not touch on the subject, there are many insiders who claim that there is pressure to impose quotas on the numbers eligible for benefits. The system of benefit assessment is in any case initially carried out by people who are not necessarily qualified to make the appropriate medical judgements, and in 2016 a United Nations report criticised the UK system for being “focused on a functional evaluation of skills and capabilities, and puts aside personal circumstances and needs, and barriers faced by persons with disabilities to return to employment.” 

Even though only 6% of cases are overturned, this still represents 290,000 claimants who are being denied the support to which they are entitled. As the Institute for Fiscal Studies put it, “this is arguably suggestive of a system that is not working well.” In an excellent article in the Financial Times in November, Sarah O’Connor highlighted that “while national policy has been focused on pushing people from incapacity into the labour market, it is not clear that every local labour market is willing or able to absorb them.” To put it another way, in areas where jobs are scarce, getting people off the incapacity register may fulfil one set of government targets but it does nothing to resolve the underlying problems.

This is unfortunately all very bleak and depressing and further undermines the public’s trust in government in general and the benefits system in particular. Whilst reform of the system is not per se a bad idea, the experience of the past eight years is that the government has failed to manage the process of welfare reform. Universal Credit, which was designed to replace a multitude of different benefits in a bid to reduce outlays, was unveiled in 2013 but is still nowhere near completion having initially expected to have been completed within a four year cycle. Moreover, in a report released last month the OBR questioned whether the savings promised by this reform will even be realised.

Quite why the reform of the benefit system has proven to be such a shambles is no mystery: It is too complex and insufficient resources have been committed to make it work. Meanwhile the most vulnerable members of society are bearing the brunt of the adjustment. For those of us who spend our time looking at the big fiscal picture, it is quite an eye-opener to look below the surface at how the system actually works. Whilst such methods have (arguably) been successful in helping to bring down the public deficit, the more we look at the social costs the less justified some of the actions appear to be. With the government now focusing all its policy efforts on Brexit, it is difficult to see any light at the end of this tunnel.

Of course, the supreme irony is that a good number of those who appeared to be abandoned by this failed benefit system are likely to have been those who voted for Brexit on the basis that they had nothing to lose. If the leading lights in David Cameron’s government ever wonder why they lost the Brexit vote, they might reflect on their inability to deliver a benefit system which provides the support it promised.

Gimme some truth

In the week when the UK government kicked off a series of speeches to offer a vision of the post-Brexit relationship it wants with the EU, it was unfortunate that the first man up to the plate was Boris Johnson. His speech today was a rehash of the tired, content-free clichés that have characterised his approach to Brexit over the past two years. I found that the easiest way to parse the speech was to download it and annotate it in Word, which allows me to see at a glance those areas where I found disagreement. With 48 annotations in a 4,609 word speech (one every 96 words), I clearly found a lot to disagree with. Indeed, I was reminded of the lyrics of John Lennon’s Gimme Some Truth (showing my age): “I'm sick and tired of hearing things from/Uptight short sided narrow minded hypocritics/All I want is the truth, just give me some truth.”

It was full of the usual bromides about “taking back control” and “will of the people”, promising a bright new future so long as we partake in “our collective national job now to ensure” that Brexit will be a success. The irony seems to be lost on Johnson that the UK’s decision to retreat from the EU is not universally perceived as a decision to look outwards and embrace the world. There is also an inability to accept that going through with Brexit represents a rupture – both political and economic – and that we will not be able to have our cake and eat it, as Johnson has never once accepted. For example, “there is no sensible reason why we should not be able to retire to Spain.” Apart from the fact that it is facilitated by the freedom of movement enshrined in membership of the single market!

Another thing that stood out was the old trope that the EU is a supranational organisation intent on crushing the UK’s national identity. “If we are going to accept laws, then we need to know who is making them … and we need to be able to interrogate them in our own language.” But we do know – it is the EU Commission in tandem with the Council and Parliament – and the UK is right in the mix. Indeed the lingua franca of the EU is now effectively English. “And the trouble with the EU is that for all its idealism, and for all the good intentions of those who run the EU institutions, there is no demos  – or at least we have never felt part of such a demos  – however others in the EU may feel.” There are two distinct issues here. Admittedly the EU’s decision making powers are remote from many of its 500 million citizens but whilst the EU Commission proposes legislation, it is passed into law by the European Parliament, which is directly elected by EU voters. And whilst it may be true that the UK has never felt part of the wider EU community, we should bear in mind this was facilitated by the EU-bashing which was a staple part of Johnson’s former career as a Brussels-based journalist.

The economics of Brexit are of paramount interest to me, but Johnson managed to avoid giving any detail. Despite suggesting that “I want to show you today that Brexit need not be … an economic threat but a considerable opportunity” he totally failed to do so. He continued to claim that there will be a “Brexit bonus” which will allow increased spending on the NHS. Remember Johnson claimed in 2016, and again in 2017, that up to £350million per week would be available as part of the windfall gain. A £50bn exit bill is almost three years’ worth of Johnson-style spending. In reality, because Johnson used gross outlays rather than a net figure, the comparative static bonus is only £190m per week which implies that the Brexit bill is likely to swallow up the first five years of the “Brexit bonus.” And that is before any losses sustained as a result of the slower growth that is likely to result from leaving the single market and customs union.

As is common with the Leave argument, Johnson points out that “our exports to the EU have grown by only 10 per cent since 2010, while our sales to … to China [rose by] 60 per cent” – which still puts them below exports to Ireland. “It seems extraordinary that the UK should remain lashed to the minute prescriptions of a regional trade bloc comprising only 6 per cent of humanity.” Or to put it another way, a regional trade bloc comprising almost 50% of our exports. The Leavers completely ignore the impact of trade gravity effects – countries of similar incomes in close proximity tend to trade heavily with each other. This is not to say that the UK will stop trading with the EU, of course, but leaving the single market means it will not be able to do so on terms as favourable as today. As for the claim that “we can simplify planning, and speed up public procurement” this would be laughable were it not so serious following the collapse of Carillion.

Obviously, we all know that Johnson plays fast and loose with the facts so we should not be surprised at many of his outrageous claims. At some point, however, he will have to be called to account. As Philip Collins noted in The Times last week, the likes of Johnson and  Jacob Rees-Mogg “will betray their Brexit fans” (here if you can get past the paywall). Collins notes that the economic evidence we have seen so far suggests that the less well-off regions of England are likely to suffer most. And the Mogg-Johnsons (as Collins dismissively calls the cadre of prominent Brexit-supporting politicians) have demonstrated little interest in “improving the lives of the working class.”

This is a problem because although Johnson repeats the claim that “people voted Leave ... because they wanted to take back control,” Collins rightly points out that a key reason was that it offered a chance for those believing themselves disenfranchised to stick two fingers up to the “elite.” This means that if Brexit does not deliver the improved well-being that these people were promised, and instead makes them even worse off, the backlash against the political class could be even more severe. None of this is new, of course, but then nothing in Johnson’s argument is new either and it is important to push back against his rosy view of Brexit for which he has so far offered no evidence. After two years, I am still waiting for him to offer a credible analysis of the benefits. And the silence is becoming deafening.

Still arguing over Brexit costs

A lot has been written recently about the costs that Brexit will impose on the UK economy. Unfortunately a lot of the discussion has been at cross purposes. Remainers claim that whatever form Brexit takes it will leave the economy worse off than it would otherwise be, whilst Leavers rubbish those claims and point to the fact that the economy has held up much better than suggested by the worst case outcomes of 2016. In fact both are true. If we assume that the UK economy grows at an average rate of 2% per year, which is true over the period 1990 to 2016, then last year’s 1.8% growth rate represents an underperformance. This is thrown into even starker relief by the fact that the likes of Germany, which in recent years has grown more slowly than the UK, did indeed grow more rapidly last year. But the UK’s performance was far from a disaster, and there was certainly no recession.

What happens thereafter will be determined by the nature of the trade relationship between the UK and EU27. The leaked Treasury analysis suggests that in the absence of a trade deal with the EU, output would be 8% below the pre-referendum baseline over a 15 year horizon. A free trade agreement with the EU would result in a 5% decline in output whilst the soft Brexit option (i.e. continued single market membership) would result in a 2% decline in GDP. A recent paper by David Vines and Paul Gretton (here) suggests that the impacts are much smaller. According to their estimates, the effects of exiting the Single Market & Customs Union would cost just 0.6% of GDP. The effect is small because tariff barriers are low, although in industries such as agriculture and autos the impacts are higher because tariffs are higher.

Vines and Gretton point out that the benefits of signing up to a free trade agreement are also small because of the difficulties of negotiating the agreement in the first place and the impact of rules of origin restrictions which will preclude many sectors from gaining much benefit. To the extent that the government wishes to sign a form of FTA with the EU27, it suggests that this will not deliver many of the benefits which its proponents hope. But Vines and Gretton argue that unilateral liberalisation by the UK would reduce these losses by much more than the effects of joining FTAs. For example, not levying tariffs on imports from the EU27, might raise GDP by as much as 0.2%. Removing tariffs on all imports from the EU could raise GDP by another 0.2 %. It is worth noting that this is the same approach advocated by Patrick Minford, but his analysis was heavily criticised for the heroic assumptions on which it was based.

Whilst I am persuaded of the view that the gains from FTAs are small, the losses reported from the Vines and Gretton paper do appear to be on the low side. There has already been a 0.25% hit to GDP even before the UK has left the EU, and leaving the Customs Union and Single Market is likely to impose much bigger costs than anything seen so far. In any case, much of international trade theory is rooted in a world of goods whereas the real damage to the UK will be caused by the hit to services, where non-tariff barriers are far more of an issue.

In the course of this week I have also had numerous conversations with senior civil servants, past and present, whose views on Brexit I was particularly interested to hear. There was universal agreement that the government appears to be oblivious to the damage that a hard Brexit will cause. One well-connected official was scathing about the government’s approach to the Brexit negotiations, and suggested that not only has it no clue about the magnitude of the task at hand but it has absolutely no appreciation whatsoever of the EU27’s position. The UK takes the view that regulatory equivalence will be enough to ensure that it will be able to sign an FTA with the EU. But as this individual pointed out, such equivalence is not merely a process whereby the UK voluntarily agrees to adhere to regulatory harmonisation. The EU27 sees equivalence as part of a regulatory architecture in which adherence and enforcement are monitored by institutions such as the ECJ from which the UK wants to break free.

The recent spat between the UK and EU27 negotiators in which the EU’s chief negotiator Michel Barnier suggested that “I don’t understand some of the positions of the UK” goes to the heart of the problem. Both Leavers and Remainers, and the UK and EU27, occupy different ends of the spectrum and either cannot, or will not, understand the other’s position. It is going to be hard to salvage a favourable deal from this sort of wreckage. Meanwhile, we are less than 14 months away from the UK’s departure from the EU. Something has to give.

A risky business

The recent equity sell-off has focused investors’ attention on measures of market volatility, which have been abnormally low for much of the last four years. I did point out last summer that implied equity and bond market had fallen to all-time lows, and that there was a risk of a nasty surprise if investors believed that central banks would no longer continue to provide the unlimited support that they had hitherto (here). In the event, equity market volatility measures fell even further, bottoming out in November, whilst both the Fed and Bank of England since have raised interest rates.

Naturally, this raises the question, why now? And the truth is we don’t know. Many ex-post rationalisations have been offered but I suspect that markets had simply been living off fresh air for too long. It is thus possible that someone, somewhere simply placed a sell order that was picked up by algorithmic trading systems and triggered a widespread bout of selling. But nobody was really surprised that markets did correct sharply downwards, even if the magnitude of the correction caught many people out. Indeed, I pointed out last summer that “if the Fed starts to run down its balance sheet and put some upward pressure on global bond yields, the equity world may look different.”

At this stage, I do not have enough evidence to change my year ahead prediction that equities will finish 2018 up by 5-10% on year-end 2017 levels. But that view looks a little more shaky than it did five weeks ago. Whilst much attention focused on the fact that the correction in the S&P500 on Monday was the largest single daily points decline on record, it is only the 39^th biggest percentage decline on daily data back to 1980 (although that puts it well inside the top 0.5%). Slightly more worrying is the fact that exactly 10 years previously, on 5th February 2008, the S&P500 fell by 3.2% on the day – at the time, the 30^th biggest daily fall since 1980. And we all know what happened later that year …

Recent trends in volatility raise a number of key questions. First, is volatility mean reverting? If so, neither the extremely low levels of 2017 nor the elevated levels of today will be sustained. Second, if market volatility measures do move back towards more “normal” levels, how quickly is this likely to occur? And third, is it possible that the trend volatility level has changed (i.e. that investors risk appetite has changed)?

With regard to the first question, the post-1990 evidence does suggest that equity volatility is mean-reverting although it can diverge from the mean for a considerable period of time. On average since 1990, each period of over- or undervaluation relative to the mean lasted for 17 months, which suggests that the period of adjustment is relatively slow. With regard to the second issue, in 88% of cases since 1990 the VIX was within one standard deviation of the mean (although on only 38% of occasions was it within half a standard deviation). One standard deviation represents a 7-point move in the VIX which is relatively tolerable. It is only when we see the kinds of spikes associated with the bursting of the tech bubble between 1999 and 2002, or the post-crisis period of 2008-09, would high equity volatility threaten to derail the markets.

However, there is a risk that an extended period of low volatility sows the seeds for a period of higher vol. Lower volatility during periods of economic upswing tends to result in higher risk taking and excessive leverage, with the result that even small price declines can force investors to dump asset holdings, depressing prices further and generating higher volatility. This triggers a second round of price declines and volatility spikes which could turn into a self-reinforcing spiral. But as it currently stands, despite the sharp spike in equity volatility in early February, the forward vol curve is pricing in a decline back to levels close to the long-run average over a five month horizon (chart). This downward sloping volatility curve is not indicative of a market which is expecting a significant change in risk conditions.

As for the third question of whether there has been a shift in the trend level of the VIX, and therefore a shift in investor risk tolerance, the jury is still out. We will probably only know after a prolonged period of tighter monetary policy. The most four dangerous words in finance are “this time it’s different.” Any data series which shows strong mean-reverting trends should be treated as such until we have overwhelming evidence to the contrary.

All in all, I am inclined to treat the current trends in markets as some of the air coming out of the bubble rather than as the beginning of a more prolonged sell-off. As many people have pointed out, the fundamental factors which drove markets higher in the first place – strengthening growth and the impact of US tax cuts on corporate earnings – remain in play. But the spike in volatility acts as a reminder that markets are like wild animals: they can act unpredictably and you can never tame them, so you have to act cautiously to avoid getting your face ripped off.

In defence of economic forecasts

It is becoming rather tiresome to hear the constant carping about the value of economic forecasts, particularly when the critics are responding to forecasts that do not accord with their pre-conceived views. Ed Conway weighed into the debate in The Times yesterday (here if you can get past the paywall), with his claim that “the job of a city economist is not to make accurate forecasts; they’re basically there to market their firms.” As a city economist who has spent a lot of time working with various models generating forecasts to meet client demand, I can say with total confidence that Conway is dead wrong. It’s a bit like saying that we should ignore the views of most economic columnists whose raison d’être is to offer clickbait for the masses.

But the most annoying comments of the week came from Eurosceptic MP Steve Baker who proceeded to denigrate the Treasury’s analysis of the negative economic consequences of Brexit. He noted in the House of Commons that “I’m not able to name an accurate forecast, and I think they are always wrong.” The second most annoying comments, and probably more serious set of allegations, came from Jacob Rees-Mogg who accused Charles Grant, the director of the Centre for European Reform, of suggesting that Treasury officials “had deliberately developed a model to show that all options other than staying in the customs union were bad, and that officials intended to use this to influence policy” (here). Grant denied any such implication and Baker was forced to apologise for providing support to what is an outrageous slur on the impartiality of the civil service.

What all this does illustrate, however, is that factual analysis is being drowned out by an agenda in which ideology trumps evidence. With regard to Baker’s claims that forecasts are “always wrong” it is worth digging a little deeper. No economic forecaster will be 100% right 100% of the time – we are trying to predict the unknowable – but there are acceptable margins of error. HM Treasury surveys a large number of forecasters in its monthly comparison of economic projections, which is a pretty good place to gather some evidence. Our starting point is the one-year ahead forecast for UK GDP growth, using the January estimate for the year in question (at this point, we do not have the full numbers for the previous year).

I took the data over the past five years, for which 34 institutions have generated forecasts in each year. The average error over the full five year period, using the current GDP vintage as a benchmark, is 0.63 percentage points. This is not fantastic, though if we strip out 2013, the figure falls to 0.51 pp.  For the record – and probably more by luck than judgement – the errors in my own forecasts were 0.48 pp over the full five year sample and 0.33 pp over 2014-17, so slightly better than the average. But there is a major caveat. GDP data tend to be heavily revised, due to changes in methodology and the addition of data which were not available initially. Thus, the data vintage on which the forecasts were prepared turns out to be rather different to the latest version. Accordingly, if we measure the GDP projection against the initial growth estimate, the margins of error are smaller (0.5 pp over the period 2013-17 and 0.4 pp over 2014-17).

Without wishing to overblow my own trumpet (but what the hell, no-one else will), my own GDP forecasts proved to be the most accurate over the last five years when measured against the initial growth estimate, with an average error of just 0.16pp over the past four years. More seriously, perhaps, the major international bodies such as the IMF and European Commission tend to score relatively poorly, lying in the bottom third of the rankings. These are the very institutions which tend to grab the headlines whenever they release new forecasts. A bit more discernment on the part of the financial journalist community might not go amiss when it comes to assessing forecasting records.

All forecasters know that they are taking a leap into the dark when making economic projections, and I have always subscribed to the view that the only thing we know with certainty is that any given economic forecast is likely to be wrong. But suppose we took the Baker view that forecasts are a waste of time because they are always wrong. The logical conclusion is that we simply should not bother. So what, then, is the basis for planning, whether it be governments or companies looking to set budgets for the year ahead? There would, after all, be no consensus benchmark against which to make an assessment. Quite clearly, there is a need for some basis for planning, so if economic forecasts did not exist it is almost certain that a market would be created to provide them.

As for the Treasury forecasts regarding the impact of Brexit on the UK (here) , it may indeed turn out that the economy grows more slowly than in the years preceding the referendum, in which case the view will be vindicated. There is, of course, a chance they will be wrong. But right now, we do not know for sure (although the UK did underperform in 2017). Accordingly, the likes of Baker and Rees-Mogg have no basis for suggesting that the forecasts are wrong, still less that the Treasury is fiddling the figures. I take it as a sign they are worried the forecasts are likely to prove correct that they have been forced to come out swinging.

Janet Yellen: A job well done

Today’s FOMC meeting was effectively the last act of Chair Janet Yellen, whose four-year term expires on 3 February. It is unusual for a one-term Chair not to be offered another term: Her tenure marks the shortest since G. William Miller’s ill-fated 17 month spell in 1978-79 and is indeed the second shortest since 1934 (beating the curtailed chairmanship of Thomas McCabe by a mere 14 days). The Fed Chair is in the gift of the President, so he is quite within his rights not to renew Yellen’s term. Nonetheless, I cannot help thinking that the Administration may be missing out by not giving her another four years.

Compared to her two immediate predecessors, Yellen came across as relatively unflashy and low key. She never sought the limelight in the same way as Alan Greenspan, and as good an academic economist as she is, Yellen never seemed to exude the same star quality as Ben Bernanke (maybe that’s an unfair characterisation but it is purely a personal impression). Yet in her understated way, Yellen has moved the dial further forward as the Fed seeks to move away from the crisis measures of 2008-09. In many respects, Bernanke’s inheritance was the result of years of loose monetary policy and a relaxed attitude to markets under Greenspan. Accordingly, much of his eight years were spent trying to prevent the economic and financial system from collapsing and Bernanke scored high marks for recognising the symptoms of the Great Depression and introducing a massive monetary expansion to combat it.

When Yellen took over in 2014 the economy was on a solid footing but monetary policy was still jammed in high gear, with interest rates at zero and the central bank balance sheet all but maxed out. The decision to start raising interest rates in late-2015 – the first increase in almost nine years – passed off without incident and an additional four increases, each of 25 bps, have not done any damage to the economy or to markets. Yellen also presided over the decision to start running down the Fed’s balance sheet although it will be up to her successor (Jay Powell) to fully implement it.

On the whole, it is likely that Yellen will be judged as a safe pair of hands who navigated the Fed through some difficult waters. It appears that her only failing was to be a Democrat at a time when an avowedly Republican Congress was in place. Whilst it was conservative lawmakers’ distrust of the Fed’s QE policy, fully supported at the time by Yellen, which counted against her, it is ironic that she has overseen the start of balance sheet unwinding – a process which has never been tested in the modern era.

As of next week, Jay Powell will be occupying the big chair and although he is widely seen as the continuity candidate, he may have his work cut out. For one thing, the US expansion is already long in the tooth, and assuming nothing goes wrong beforehand, May will mark the second longest expansion in recorded history. Quite how the Fed will respond if the economy starts to wobble may be an issue for the latter months of 2018. Then there is the question of how the Fed deals with any market wobble. For the last nine years, markets have generally only gone in one direction – upwards – but with valuations looking stretched it may not be too long before the bubble of optimism starts to deflate.

In the past, Greenspan and Bernanke were not averse to nudging monetary policy to help markets along. Whether Powell will act in the same way remains to be seen. But Janet Yellen will not be around for these issues to blot her copybook, which is a pity because the true test of how good central bankers are at their job is determined by their reaction to adversity. So we will never know how good she could have been, but as it is, Yellen can reflect on a job well done over the last four years.