Uncertainty is the main certainty
The economic outlook for 2020 is characterized by more uncertainty and risks than we have seen in the past. Whether it is global trade, Brexit, Hong Kong, or even more structural changes like disruptive new technology, ageing or climate change, times are turbulent and there is a lack of clarity. And 2020 does not appear to bring much relief, given the coronavirus outbreak and the US-Iran confrontation.
Many people are concerned that uncertainty has reached unprecedented
levels in recent years. However, feelings of uncertainty are as old as
mankind and therefore we can question whether indeed uncertainty is
peaking. In practice, it’s not easy to measure the state of
uncertainty objectively. Often, one has to rely on indices that gauge
the frequency of usage of particular words related to uncertainty. The
figure below illustrates three of them, each with a global
First, the Economic Policy Uncertainty Index, developed by three
American economists (Scott Baker, Nicholas Bloom and Steven Davis),
tracks the number of press articles that use buzzwords related to
economic and political uncertainty. Additionally, it measures the
number of tax laws set to expire and the spectrum of disagreement
among economists: the more dissent, the higher the index. It’s now
hovering around its highest level since the first calculation in 1997.
Drivers of policy uncertainty are associated, amongst others, with
monetary policy, increased regulation and protectionism, and the
challenges stemming from new technology, ageing and climate
Second, the Geopolitical Risk Index, constructed by Dario Caldara and Matteo Iacoviello at the US Federal Reserve Board, counts the occurrence of words related to geopolitical tensions in leading national and international newspapers. The index spiked during the Gulf War, after 9/11, during the 2003 Iraq invasion, during the 2014 Russia-Ukraine crisis and after the Paris terrorist attacks. More recently, a heightened level of geopolitical risk was seen since the start of the Trump presidency, amongst others linked to trade tensions under his reign. On top of that, other factors like the uncertain Brexit outcome, instability in the Middle East and the turmoil in Hong Kong are also increasing geopolitical risk.
Finally, the IMF’s Trade Uncertainty Index is a third metric of
prevailing global uncertainty, linked specifically to trade. The index
goes back to the mid 1990s and is based on the number of times the
word uncertainty is mentioned in the Economist Intelligence Unit
Country Reports in proximity to a word related to trade. The index
shows trade uncertainty in the past year has risen sharply, mainly due
to the US-China trade war escalation, after having been stable at low
levels for about 20 years.
In general, all uncertainty indicators are currently at very high
levels. An important side note is that one can only compare historical
data as far as the history of the data reaches. In the past, there
were periods during which uncertainty was likely even higher (e.g.
during the World Wars or the oil crises in the 1970s). Nevertheless,
the past two decades are the most relevant to compare current
uncertainty levels with.
Enemy of the business cycle
History has shown that heightened uncertainty has the potential to
negatively impact economic growth. This has also been the case over
the past year. Corporate sentiment indicators have been declining
globally, for a large part reflecting the uncertainty caused by trade
disputes and political uncertainties such as Brexit. Amidst high
uncertainty, there have been regular spikes in risk aversion on
financial markets, causing increased flows to so-called safe havens
and lower long-term bond yields. The resulting caution in central
banks’ policy stances, contributed to lower bond yields.
2020 is not likely to bring (much) relief. Negotiations on the EU-UK
trade relations are likely to be difficult. And despite the likely
pause in the US-China trade war, trade protectionism will remain in
place. Together with continued geopolitical uncertainty and
unpredictable policy making becoming the new normal, this implies
uncertainty undoubtedly is here to stay.