by John Wyn-Evans
All the economists in the world were unable precisely to predict the Great Financial Crisis of 2007-09, as famously commented on by The Queen.
And many of those who claimed to have done so had been notoriously bearish for ages – like cults who claim that “The End of the World is Nigh”, they had been dismissed as pessimists and crackpots.
Even former Federal Reserve chairman Alan Greenspan recently (sort of) admitted that he hadn’t properly understood what was going on, especially in the interaction between the “real” economy and financial markets.
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Policy has to be based on something, and economic data is the best source.
This can be derived either from real output and prices, or from sentiment surveys, which tend to be more timely and predictive.
Over the years different series have taken on more importance, but they end up influencing one major element of central bank decision-making – monetary policy.
This used to be mostly about managing inflation cycles.
If there was too much heat in the economy, it was relatively easy to nudge up rates and reduce consumption by forcing more income to be diverted to debt service.
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The tourniquet was eased as inflation subsided.
This process was gradually subverted by several instances of (mainly) the Fed saving the world (well, financial markets) from impending melt-down, leading to unsustainable levels of debt being accumulated.
We are now trying to negotiate a path out of a situation where monetary policy will have to be tightened, but only if growth is sustainable.
What are the key numbers?
Given that both the Fed and the Bank of England have cited unemployment data, that has to be top of the list.
The Fed says 6.5 per cent is the point at which to re-evaluate its quantitative easing policy, and the Bank of England says seven per cent.
But it’s also clear that these numbers are not set in stone, and underlying consumer prices will be taken into account: so second on the list is inflation. If it’s not rising (especially if below two per cent), then the brakes are likely to be left off for longer.
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Inflation data also must not be too weak. The risk of deflation is once again being highlighted, especially in Europe.
This is the tightrope upon which central bankers are teetering.
- John Wyn-Evans is head of investment strategy at Investec Wealth & Investment