By Iakov Frizis, Economist, CASE
Browsing through headlines of economic newspapers one gets the feeling that uncertainty will be the buzzword of 2017. The term was used 123 times in the minutes of the Bank of England’s Monetary Policy Committee; the Deutsche Welle described the US President elect’s absence from the 2017 Davos meeting as The Great Uncertainty; while Harvard Kennedy School Professor Carmen Reinhart recently described economic uncertainty as the biggest challenge that policy makers will have to confront in 2017.
Policy uncertainty is growing in prominence among academics and researchers, as it is shown to be associated with significant macroeconomic implications. Baker, Bloom and Davis demonstrate that a decline in economic agents’ capacity to use past information as an accurate indicator for future outcomes tends to lead to increases in stock price volatility as well as overall declines in investment, output and employment.
In December 2016, the ECB added to global uncertainty with its surprise decision to scale back asset purchases from EUR80bn to EUR60bn. By going against the previous objective of inflation targeting, the Bank has introduced significant uncertainty in how future guidance should be interpreted.
Across the Atlantic, potential upcoming changes to the US policy-platform is also increasing uncertainty, as mixed signals are making markets increasingly nervous over financial market volatility. On the one hand, prospects of pro-growth fiscal policy is positively viewed, while on the other hand, fears associated with potential disruption of cross border supply chains due to protectionist backlash are creeping in.
On a global scale, as stressed by CASE experts, the recent resurgence of economic uncertainty relates to issues such as the Trump presidency, the rise of populism in Europe, mixed monetary policy guidance by the ECB and discussions surrounding Brexit. These events, have substantiated the rise of global economic policy uncertainty to the highest level since the beginning of the 21st century.
The persistence of these types of events creates the potential for increased demand for safe assets, which will further dampen the current recovery path set out by the EU and the US. In order to avoid this, it is of the essence for policy to become more transparent, articulating with consistency forward guidance. If the current slow recovery across the EU has taught us anything, it is that uncertainty can create quagmires in an already sluggish investment environment, which bears a high cost on potential economic growth.