Will they, won't they?

The BoE’s Monetary Policy Committee meets next week to decide whether to cut interest rates. It is likely to be a close call. The markets currently assign a 50% probability to such an outcome (chart). Never before have we been so close to an MPC meeting with the markets so undecided, which would appear to put some questions against the policy of forward guidance by which outgoing Governor Mark Carney set so much store.

Turning first to the rate decision, I am, like the markets, unsure how the MPC will vote next Thursday. There are equally good arguments in favour of a rate cut and for rates on hold. The case for a cut is derived from dovish comments from MPC members in recent weeks and a raft of data showing that activity slowed sharply towards the end of last year. GDP in November contracted by 0.3% versus October, suggesting that Q4 GDP will struggle to register positive growth, whilst CPI inflation remains well below the 2% target with the 1.3% rate in November representing the slowest pace in three years. On the basis that if a rate cut is likely to happen at some point, now is as good a time as any.

Against that, survey data has shown a significant rebound in recent weeks with the CBI balance of industrial optimism rising from a recession-indicating -44 in October to a much more comfortable +23 in January. In addition, the flash PMI estimates on Friday showed a sharp rebound, particularly for services, with the index rising to 52.9, the highest since August. The calculation that the MPC must now make is whether this rebound is likely to translate into the hard data, or whether it represents a false dawn, in much the same way as the post EU-referendum weakness in the summer of 2016 did not herald an economic collapse. There is also a question of whether the MPC wants to bind the hands of incoming Governor Andrew Bailey who will take up the reins in March.

Whether the BoE should be cutting rates at all is another issue entirely. I have long argued that the era of low interest rates is having adverse effects on the economy, with my particular concern being the impact on savers, particularly those saving for pensions. But in his most recent speech, Carney argued “the vast majority of savers who might lose some interest income stand to gain from rising asset prices that result from monetary policy stimulus.” That does not wash I’m afraid. Most households’ wealth is held in the form of housing, and unless you can somehow realise the wealth, whilst still maintaining a roof over your head it is not going to compensate for the income foregone in our pension pots. But it does illustrate the relaxed view of many central bankers, particularly in the Anglo Saxon world, towards low interest rates. It is not necessarily a good indicator of where Carney’s sympathies will lie next week but it is evident that he is not averse to taking rates lower if necessary.

I will provide a more comprehensive retrospective of Carney’s tenure another time but whilst he has generally done a good job as Governor there are some areas where his policy prescriptions have proved more controversial than anticipated. Recall that seven years ago, when Carney was about to be installed as BoE Governor, he extolled the virtues of forward guidance as a way of reducing the kind of uncertainty that markets are experiencing today. It is designed to supplement policy options when interest rates are at the lower bound and I discussed some of the pros and cons in this post. But it is ironic that ahead of Carney’s final MPC meeting the BoE’s communications remain as opaque as ever. In my view, this raises the question as to whether the policy itself is flawed or whether it is the BoE’s execution which is the problem.

In a paper published by the BoE in 2017 the authors noted that there are two sources of uncertainty associated with forward guidance. “First, uncertainty stemming from the fact that forward guidance announcements are incomplete descriptions of state-contingent policy behavior”. Secondly, “forward guidance promises may be imperfectly credible ... There is a well-known time-inconsistency problem associated with such promises. Namely, that the central bank has an incentive, once the recovery has taken hold, to renege and tighten policy earlier than originally promised.” This in turn leads “to uncertainty about future policy and an associated reduction in the effect of the forward-guidance announcement on interest-rate expectations.”

Clearly there is no question of the BoE raising rates earlier than anticipated. Quite the opposite in fact. But arguably, the forward guidance policy is an “incomplete description of state-contingent policy behaviour.” Part of the problem stems from the fact that there are nine MPC members, each of whom may have a different view of the current state of the economy, with the result that the state-contingent policy response is likely to differ in each case. We have heard from a number of MPC members since the turn of the year. Carney suggested that “much hinges on the speed with which domestic confidence returns.” On the basis of recent evidence that is an argument to maintain policy on hold. But his colleague Gertjan Vlieghe noted that he would need to see “an imminent and significant improvement in the UK data to justify waiting a little bit longer” – a view shared by another MPC member Silvana Tenreyro. But the big question is whether the recent set of data constitutes such an improvement?

The problem markets have is that they understand the publicly communicated positions of MPC members but they have been left in the dark regarding their reaction to the most recent data. This is a result of the BoE policy which imposes a communication blackout in the 8-9 days leading up to the interest rate announcement. Whilst this policy has been imposed with the best of intentions, it does highlight one of the unsatisfactory elements of forward guidance by preventing communication when it is most needed.

As former Fed Chairman Alan Greenspan said before a Senate committee in 1987, “If I seem unduly clear to you, you must have misunderstood what I said.” More than 30 years later, and after all the efforts by central bankers to improve the way they communicate with markets, it appears that some things never change.

More sabre rattling

In recent weeks I have posed a number of economic questions of Brexit. My issues are never addressed head-on. Instead, the usual response is for supporters of the policy to meet my question with another question which is irrelevant to the issue at hand. I probably shouldn’t be surprised: This has been the modus operandi of Leavers throughout the past four years who have never been able to successfully answer any questions on the economic benefits of Brexit. But we cannot run away from the issues forever, and the latest salvo from Chancellor Sajid Javid in an interview with the FT suggesting there will be no post-Brexit regulatory alignment with the EU raises questions that need to be answered.

To quote directly, “there will not be alignment, we will not be a ruletaker, we will not be in the single market and we will not be in the customs union - and we will do this by the end of the year.” He justifies this stance by arguing that companies have had three years to prepare for a new economic relationship. But they haven’t really. Theresa May’s administration was concerned to minimise trade frictions with the EU and it has never been clear what regulatory arrangement the government was aiming for. It is even less clear today. The fact that the government has postponed EU exit three times in the last ten months means the business community is increasingly unsure which deadlines it has to meet, which has added to the confusion. Following the government’s cancellation of regular meetings with industry groups there appears to be a widening gulf between the needs of business and the government. No wonder that business investment has barely risen in the past three years.

Digging deeper only reveals the flaws in Javid’s thinking. His suggestion that “Japan sells cars to the EU but they don’t follow EU rules” is to ignore the fact that Japan has invested heavily in the UK precisely in order to have production facilities which allow it to comply with EU regulations. His hope to boost annual GDP growth to “between 2.7% and 2.8%” a year also sounds like a big stretch when you consider that the slowdown in population growth appears to have reduced the potential growth rate to something closer to 1.5%. His belief that “Once we’ve got this agreement in place with our European friends, we will continue to be one of the most successful economies on Earth,” was pure hubris. How an economy which neither grows particularly quickly nor has exceptionally high incomes per head, let alone one with a debt-to-GDP ratio close to 90%, can be considered “one of the most successful economies on Earth” strains credulity. The economic situation is not terrible but his is not a description of the UK economy I recognise.

As I can attest from my own experience, just because Javid has worked in a trading environment does not mean he necessarily knows anything about economics and I have no idea whether the man entrusted to looking after the nation’s finances believes this nonsense. I rather suspect he does not, as this gem taken from his Brexit referendum literature in 2016 confirms (see graphic above). Consequently, his comments can simply be seen as a bargaining ploy to get the EU to take seriously the UK’s threat to walk away with no deal at the end of 2020. However, I maintain that such an approach is counterproductive. Nobody doubts that a no-deal Brexit will cause some hardship for the EU but it will only have a problem with one trading partner whilst the UK will have a problem with 27. This type of posturing was tiresome three years ago – today it appears deluded.

There is a clear sense that the government is trying to reboot the economic model, in much the same way as the Thatcher government did 40 years ago. The difference is that the economic failures of the 1970s justified trying out new policies. By the early 1980s, the old industries on which the UK had depended for the better part of a century were no longer globally competitive. One of the ways the UK moved forward was to focus on new sectors, particularly in services, and new markets, particularly the nascent EU single market. The case for such a radical economic change is absent today (though you can argue about the need for political change). If the UK is, as Javid believes, “one of the most successful economies on Earth” what is the argument for such a radical structural change?

Over the last four years, many Brexit supporters have consistently failed to acknowledge the importance of regulatory harmonisation for trade. Industries with cross-border supply chains, for example, do not have to worry whether their products meet local requirements if they are sanctioned for use within the single market. Industries such as pharmaceuticals have to meet stringent requirements before their product is certified for use by the general public. Having the same set of rules across different markets makes it easier to sell across borders, and ultimately reduces costs from which the consumer benefits. Regulatory harmonisation is even more important in service industries where it is so much easier to impose little obstacles that can derail trade. Sajid Javid might believe the UK is no longer going to be a rule taker in international trade rules but he is wrong. Trade rules are what underpin the system and if you want access to the Chinese, Indian or American market you have to abide by the rules in those markets.

I have been upfront about my concerns regarding leaving the EU over the years. Even though I was on the wrong side of the Brexit decision, I can live with the referendum result so long as the economic disruption can be minimised. But I remain opposed to the decision to leave the single market, not only because it was not on the ballot paper in June 2016 but primarily because it threatens to impose higher costs which will lead to a reduction in economic welfare. The Brits do have legitimate concerns about the extent to which the UK may be forced to adhere to future changes to EU law on issues such as the environment, and I will deal with this problem in a subsequent post. Indeed, this may be one of the motivating factors behind Javid’s comments. Nonetheless, for too long politicians have been allowed to get away with economically illiterate arguments to support their political case. This is another such example, and there is a serious risk that one day the EU will call the UK’s bluff.

Monetary policy at the limit

As the global economy recovered in the wake of the 2008-09 bust, many economists noted that central banks would have to raise interest rates as a precautionary measure in order to give monetary policy some headroom when the next downturn struck. That downturn appears to be here and central banks do not have much conventional ammunition left in their locker, even though markets are increasingly pricing a BoE rate cut this month having dismissed such a prospect at the start of last week (chart). Central bankers continue to sound confident about their ability to cope. Is this simply a case of them trying to underpin market sentiment or are there grounds for confidence?

A speech last week by outgoing BoE Governor Mark Carney was a case in point. In summary, Carney emphasised that further asset purchases and additional forward guidance mean that central banks have more scope than is commonly supposed. But the speech had a valedictory air about it, highlighting the successes of the BoE’s monetary policy during Carney’s near-seven years in office without touching on the downsides, and we have to look through some of the spin in order to assess whether some of the policy prescriptions still stand up. That said, central banks have had more policy successes than failures over the past decade so we should cut them some slack. After all, if the likes of the ECB had not done “whatever it takes” to hold the euro zone together in 2012, the economic history of the past decade could have been very different (and not in a good  way).

Turning first to the issue of forward guidance, this was one of Carney’s big ideas when taking office in 2013 through which the BoE would indicate how it would set monetary policy contingent on economic conditions. Despite the Governor’s claims for its success today, the reality in 2013-14 was very different. Recall that the BoE made it clear it would not raise interest rates so long as the unemployment rate remained above 7%. In the event unemployment fell much more quickly than anticipated, yet rates were kept on hold. Clearly, a commitment not to raise rates so long as unemployment is above a threshold level is not the same as a commitment to raise them when it falls below it. But there was a significant degree of confusion surrounding the policy and it is more than a stretch to claim, as Carney does now, that “people understood the conditionality of guidance.”

One of my retrospective criticisms of the BoE’s forward guidance policy is that it quickly abandoned the published unemployment rate as a target variable in favour of the output gap, giving rise to the suspicion (whether justified or not) that it no longer suited the BoE’s purposes. As I noted in written evidence to a parliamentary committee in 2017, “since the measure of spare capacity was determined by the BoE, this meant that outside observers became increasingly reliant on the information feed from the MPC to determine the future policy stance. The clarity of rule-based forward guidance policy was lost.”

Is there a future for forward guidance? Despite my reservations about the way in which it has been implemented in the past, I believe it does have a role to play – although maybe a less important one than Carney believes. In my view, forward guidance has a much more prosaic role. By communicating its objectives to as wide an audience as possible on a regular basis, it should be possible to remind people of the things that the central bank focuses on and thereby encourage the public to observe a particular set of variables, thereby giving it a better idea of how the central bank is likely to react. I am not sure that the message is getting through, however. Despite numerous BoE communications regarding the current below-target rate of inflation, the most recent Bank of England/TNS Inflation Attitudes Survey, conducted in November, suggested respondents believed the current rate of inflation was 2.9% (it was actually 1.4%) and the 12-month ahead forecast was for a rate of 3.1% (the BoE expects it to be significantly below 2%).

Carney also made the case for additional QE. On the basis of his calculations, further asset purchases of around £120bn (0.5% of GDP) is equivalent to 100 bps of interest rate cuts. Adding in the near 75 bps of conventional rate reductions, which would take Bank Rate to near zero, and the (unspecified) impact of forward guidance he reckons the BoE would be able to deliver monetary easing equivalent to 250 bps of rate cuts, which just happens to be the average in pre-2008 monetary easing cycles. However, it is what he did not say that is telling. It may be possible to deliver a one-off monetary boost of the magnitude that Carney suggests, though that is questionable since it is acknowledged that the marginal impact of QE diminishes as central banks buy more assets. But it is not possible to deliver it on a repeated basis without taking away some of the initial stimulus when the economic picture improves (which is, of course, what European central banks have not done in the past decade).

Another issue that Carney did not address are the long-term consequences of lower for longer. Savers have foregone a significant amount of interest income over the past decade. The response to that is savers should have taken cash out of the bank and bunged it into equities, but that does not seem to be a prudent policy which central bankers should endorse. Indeed, Carney argued that “the vast majority of savers who might lose some interest income from lower policy rates stand to gain from increases in asset prices that result from monetary policy stimulus.” But that is not very helpful when the asset in question happens to be your home as it is not so easy to realise the capital gain (unless you plan to significantly downsize). As for pensions, central bankers are aware that keeping rates low has a major impact on future pension returns but they do not talk about it much in public. However, annuity rates continue to fall which means that the future value of our pension pots is a lot less than it used to be. I thus continue to believe that the long-term consequences of a prolonged low interest rate policy will only be felt in the very long-term, by which time it will be too late to do anything about it, and today’s generation of central bankers will be long gone.

For all central bankers continue to tell us that they have more ammunition in the face of a downturn, the ECB under Christine Lagarde is no longer as gung-ho about a lax monetary stance as it was under Mario Draghi, since it realises that negative rates have significant side effects. Although the likes of Carney and Draghi can, with some justification, argue that their loose policy prescriptions were the right choice at the time the real problem is that rates remained low for much longer than was necessary on the basis of prevailing economic conditions. The problems associated with this are becoming increasingly evident and sooner or later I fear we will all pay a price.

No permanent friends, only permanent interests

We do not hear as much these days about the prospect of the UK falling back on WTO rules in the event that a trade deal with the EU cannot be concluded. This is partly because such an outcome is unlikely to happen in the near-term since the UK will enter into a transition agreement with the EU from February. But it also probably reflects the fact that the WTO has been severely damaged by the actions of Donald Trump which in turn has reduced its usefulness as a body overseeing international trade rules.

The problem is that Trump has consistently blocked appointments to the WTO’s Appellate Body – the high court of international trade – as the terms of sitting judges expire. The Appellate Body (AB) was established in 1995 and is comprised of seven judges who rule on trade disputes between WTO member countries. Each judge is appointed for a four year term, which can be renewed only once, and the Body requires a quorum of three in order that its rulings are accepted as valid. Following Trump’s tactic of blocking the reappointment of existing members, the AB was reduced to the minimum number of three in 2019 and with the terms of two of them expiring in December, it can no longer command a quorum. In theory, the AB can continue to hear pending appeals because members are able to rule on existing cases even after their mandate expires, but it is no longer able to hear new cases. As a consequence, a country which loses a dispute can file an appeal knowing that it will not be heard, and as a result can continue to act as before.

How have we got into this position? Quite simply, the Trump administration believes that the WTO is biased against the US. It is true that compared to the pre-1995 period the US is less able to throw its considerable weight around on international trade issues. Under the old GATT system, there was no settlement mechanism in place to hold countries to account for trade violations and in the 1980s and early-1990s the US exploited this to introduce a series of unilateral tariffs, ostensibly to force countries to open up their domestic markets. This policy, dubbed “aggressive unilateralism” by US-based trade economist Jagdish Bhagwati, served only to anger major trading blocs such as the EU and in any case its rate of success was limited. To assuage these concerns, the Uruguay Round of GATT began in 1986 which eventually led to the formation of the WTO in 1995, including the Appellate Body.

On a global basis, the WTO has been a great success in as much it has reduced the extent to which trade disputes spiral out of control. But it does constrain the US to work within the rules. However, the US wins around 85% of the cases that it brings before the AB – hardly evidence of bias against it. As long ago as 2007, the US Council on Foreign Relations suggested that “the dispute settlement system reflects a delicate balance between toughness and respect for sovereignty; rather than criticizing the result, U.S. policymakers and legislators should invest more energy in defending it.” Furthermore, the dispute settlement mechanism “curbs the protectionist instincts of U.S. trade policymakers and so underpins prosperity” by acting as a counterweight to the intense domestic lobbying by politically influential, but inefficient, domestic industries.

Ironically, the US is today reported to have reached out to Japan and the EU for support to introduce tougher WTO regulations on government subsidies in a bid to further increase the pressure on China, where the US believes state support is distorting competition. To the extent that this may be a way to bring the US back into the WTO fold, it has found support from the EU. But it comes just a day before the US and China are supposed to sign their phase one trade agreement, in which China will agree to buy at least $200 bn of US exports over the next two years whilst the US will commit to rolling back some of the tariffs it has levied on China (though by no means all).

One of the concerns ahead of the publication of the deal is the extent to which the phase one agreement will fall foul of WTO rules. If, for example, it requires China to import a specified amount of US produce, this would amount to managed trade and thus violate WTO rules. There is also a concern that China may simply import less from other WTO members whilst raising its imports from the US. All this goes to reinforce the views expressed by nineteenth century British prime minister Lord Palmerston that “nations have no permanent friends or allies, they only have permanent interests.” China is very much in the sights of the US but the EU fears that it, too, could fall foul of the Trump administration’s trade policy. Meanwhile, China may well be prepared to acquiesce to US demands for now but at the expense of trade with other nations. And who is going to do anything about it? Not the WTO, which has been hobbled by the US!

At the current juncture, it does look as though we are going back to an era of power politics on trade issues, with the US and China increasingly operating in their own interests. I did point out last August that this was not the right time for the UK to go it alone on trade policy and I maintain – as I have done for the last three years – that the decision to leave the European single market is a dumb and short-sighted policy. As I noted in my last post, it is imperative that the UK strikes the best possible trade deal with the EU for it cannot rely on the kindness of strangers in what looks to be an increasingly hostile trade environment.

End the politics, bring on the economics

It is a sad indictment of our times that the passage of the Withdrawal Agreement Bill through the UK parliament was relegated to the inside pages of the newspapers by the manufactured furore of Harry and Meghan’s “withdrawal” from the Royal Family. Having spent the last twelve months trying to get the WAB across the line, MPs yesterday voted by 330 to 231 to pass the legislation that will enable the UK to leave the EU on 31 January. Whilst it has yet to be ratified by the Lords, this is merely a formality. Transition phase, here we come. 

A year ago things were very different. Having ended 2018 with the government being held in contempt of parliament and surviving a Conservative leadership challenge, Theresa May began 2019 with the most heavy defeat ever inflicted on a sitting government as her Brexit deal was rejected by MPs. She then had to face down a parliamentary vote of confidence. And it never got better for her, as her battered credibility meant that she could never deliver what she promised. Having sown the seeds of her own demise, May was eventually replaced by Boris Johnson who promised to “get Brexit done” and won an overwhelming election victory as a result. How did he do it? Quite simply, he took a direct approach and the defeats he suffered along the way, on issues such as proroguing parliament, eventually played to his advantage because they demonstrated that he was prepared to do whatever it took to fulfil the wishes of the electorate (as I noted here). 

But whilst Johnson has won the political battles hands down, the economics poses much more difficult challenges – a view which has always been at the heart of my opposition to Brexit. The visit to London of the new European Commission President, Ursula von der Leyen, acted as a reminder that this is a process which will be driven by the EU, and the UK has flexibility only in as much as it can choose its degree of compliance with the EU’s demands. Von der Leyen reminded her audience that there are trade-offs – something that British politicians have failed to be honest about over the past four years – and the more the UK wishes to deviate from the rules governing the single market, the less access it will have. She also expressed her doubts that the UK will be able to negotiate a full future-relationship deal and have it ratified by the end of this year (it is, in her words, “basically impossible”). But how do we square this with the Johnson government’s stated intention not to extend the transition period beyond end-2020? 

One way is that the UK simply does not attempt to replicate the full and comprehensive relationship with the EU that it has now. Under these circumstances the UK will aim for a lowest common denominator trade deal which will allow Johnson to claim that he has fulfilled his mandate to take the UK out of the EU without extending the transition period. It is pretty likely that this will focus only on goods trade, which has been the focus of the government’s attention up to now, whilst services continue to be ignored. On the assumption that some form of trade deal is agreed, at issue is the extent to which the UK is prepared to abide by EU standards. The greater the degree of divergence, the higher will be the barriers to EU trade which will make UK manufacturing even more uncompetitive vis-à-vis other EU economies.

This, of course, is the economic calculation. The political calculation is that voters do indeed want to “get Brexit done” and Johnson’s behaviour so far suggests he will do whatever it takes to deliver this, even if there is collateral damage along the way. Indeed, it has been reported from inside government that this approach is expected to play well with those traditional Labour voters who lent their support to the Conservatives at last month’s election.

But this does not mean it is economically sensible. Whilst it is unreasonable to expect most Brexit supporters to understand the economics – this is after all a matter of the heart for many – there remains a wilful misunderstanding of trade issues amongst the better educated supporters of this policy. I was told just recently that Brexit will allow the UK to unshackle itself from a moribund EU. This is a good thing, I was told, because the share of the EU in world GDP continues to fall so it makes sense to leave and strike trade deals with faster growing regions. I intend to look at the UK’s external trade position in more detail another time, but let’s deal with these points which I thought we had put to rest years ago (clearly not).

It is true that the EU’s share of world GDP has fallen – on my estimates using data in real terms, which allows us to abstract from exchange rate swings, I reckon that the EU’s share (ex UK) has fallen from about 23% in 1980 to around 14% today. But the US share has also fallen, from 19% to 15% over the same period and the share of what I call “consuming countries” (Europe, North America and Australasia) has declined from 45% to 30%. What does this tell us? Simply that if one country grows more slowly than another, its share of GDP must decline as a matter of simple arithmetic. Moreover, the fastest growing economies have been enabled in their quest for growth because they are exporting countries. The UK might have a chance of boosting exports if growth in these countries is based on domestic demand, but it isn’t. The flip side of this is that the UK’s  imports from the world's fastest growing economies have been growing more rapidly than exports. As a result the UK’s trade deficit with China has increased more rapidly than that with the EU over the past 20 years (by a factor of 10 versus 8 for the EU).

We also have to account for pesky details such as incomes per capita. All of the world’s most rapidly growing economies have incomes per head which are lower than the EU. Chinese GDP per head, for example, is around a quarter of the EU average in USD terms (chart). And we can forget about the artificial construct of PPP comparisons – it is the absolute level of income which will determine whether China can afford to buy what the rich world wants to export to it (at a price that makes it worthwhile for European economies). And China is a lot further away, implying higher transport costs. It is for this reason that the analysis of trade issues based on gravity models continues to support the view that economies that are situated close to each other and which have similar levels of income tend to trade more with each other. 

Anyone believing that leaving the European single market will allow the UK to tap into more rapidly growing export markets is wrong. Doubtless there will be those who will tell me that that the Brexit issue is settled and we should all get behind making it a success. But the best way to make it an economic success is not to rush into making a shoddy trade deal by adhering to an artificial deadline to satisfy political ends. Unlike last year, when there appeared to be some grown-ups in government able to understand these issues, I fear they are fewer and further between today. But that’s what we voted for, right?

New year, new concerns

We have barely started the year and already a number of issues have surfaced which are likely to impact on the global macro picture. In the first instance, the decision by Donald Trump to order a missile strike that killed Iranian general Qassem Suleimani threatens further destabilisation in an already febrile Middle East. Markets reacted negatively, as is often the way with such events, and although nobody knows for sure what the longer term implications will be, this sort of provocative action has the potential to generate a spiral that nobody can control. At a time when the global economy has already lost momentum, a spike in uncertainty does not bode well for markets, although as I noted a few days ago, markets have developed a habit of defying bad news. 

Nonetheless, equity markets would appear to be due a correction. After a massive rally in 2019 driven by Fed rate cuts, I cannot see this being repeated in 2020. To a large extent, the rally of 2019 felt a bit like the late cycle surge of 1999 when markets were driven by irrational exuberance. With the economy in the industrialised world likely to shift down a gear, and Chinese growth at its slowest since the late-1980s, the fundamentals underpinning the markets appear less favourable. There again, equities remain the asset class of choice so unless we experience some form of major random shock, it might be too pessimistic to expect a bearish correction (in the sense of a decline of 20% or more) but upside is far more limited than a year ago. 

A second issue is climate change, which is rising up the list of things that policy makers should be paying more attention to (although in fairness, European policy makers have done more than most). The pictures splashed across our TV screens showing the extent of the bush fires in Australia are a measure of how the climate appears to be changing, and such issues are likely of be one of the key economic issues of the next decade. As long ago as 2006 the Stern Review set out the economic implications of climate change, pointing out that business as usual practices will lead to increasingly higher economic costs. The report highlighted that although the costs of climate mitigating investment are high, the costs of doing nothing are potentially even greater. When Australia’s prime minister, Scott Morrison, argues that there is no proven link between the bushfires and climate change,  it is clear that politicians have not heeded the message of the Stern Review even after 14 years. And when Donald Trump sees fit to withdraw the US from the Paris Agreement on climate change it is obvious we have a problem. Undoubtedly, we are going to hear a lot more from Greta Thunberg this year and in years to come. 

Central banks have started to make lots of noise about climate issues with Christine Lagarde suggesting it should be a “mission critical” priority for the ECB. Although climate change does not pose an immediate risk to the financial system, there are concerns that rising payouts as a result of climate-related issues could pose solvency problems for insurance companies, or that loans secured against property at risk of flooding could increase the burden of banks’ bad debts. There are those who criticise the actions of central banks’ intervention in this area, arguing that if they get involved in climate issues what is to stop them widening their remit into other areas? Whilst there is some truth in the argument, it is merely another example where central banks are providing a lead on policy issues where governments are unwilling or unable to step up to the plate. 

Above all, politics will remain one of the dominant themes of the year, indeed decade. The big event of 2020 will be the US presidential election. A few months ago I would have said that the odds were in Donald Trump’s favour as he seeks re-election. I am less sure today. A lot will depend on how impeachment proceedings go; how the rest of the world reacts to the US intervention in the Middle East and who Trump’s Democratic opponent is. One thing is highly likely, however: It will be an even nastier campaign than in 2016.

Closer to home, 2020 will be the year that the UK finally leaves the EU – almost four years after the narrow vote in favour of doing so. The Conservatives’ huge parliamentary majority should prevent a repeat of the fractious discourse that characterised 2019 but many battles lie ahead. I still maintain that the economic risks associated with Brexit outweigh any possible economic benefits (which continue to elude me) but the real cost burden will only become evident in the longer term. I suspect that as the year wears on, Boris Johnson’s government will begin to find how difficult it is to deliver the benefits he has long promised. 

One of the issues which will continue to dominate the agenda in 2020 will be that of fake news. Political discourse has blurred the boundaries between fact and fiction and this will be writ large throughout the presidential election campaign. We increasingly appear to live in a series of parallel realities, with the political dimension ever more separated from the rest of the real world. A return to evidence based policy making is not something that I expect to see this year. But without it, I fear the errors that have characterised recent years will continue to mount up. If economics stands for anything it is to aid policy decisions based on the evidence before us. Many of the political debates which invoke economic arguments, notably Brexit but also the US policy on trade, are based on a fundamental misunderstanding of the evidence. Whilst they have not yet significantly impacted on the lives of voters in Europe and the US, sooner or later there will be an economic reckoning. This may not become evident in 2020 but as they fail to deliver the promised benefits the pendulum will start to swing slowly back.