Bogdan Căpraru, PhD., Professor of Finance and Banking
Economic uncertainty refers to the situation where future economic developments are difficult to predict because of high degree of risk or many unknown elements. This can be related to a variety of factors and tail events occurrence, including due to political instability, changes in government policies, geopolitical turmoil and/or geo-economic resets, natural disasters, pandemics, market fluctuations, etc. There has always been a greater or lesser degree of economic uncertainty. The question is whether things are “different” now? Are these uncertainties wider than before?
In the short term, we still have the effects of persistent inflation, which is still stubbornly refusing to come down to pre-energy crisis levels. Even if the decline is significant from the peak, the big battle will be in the final run up to the target set by the main central banks (2%), with pressures coming from the labour market (especially in the services sector) but also from continuing supply chain reshuffles and still high energy costs (even if they are lower than in 2022). The continuing war in Ukraine, the conflicts in the Gaza Strip, the Red Sea etc. are deepening geopolitical uncertainties, with an impact on supply chains and the cost of international transport. Uncertainty is also heightened by the unpredictability with which these conflicts arise and how new geo-economic relationships, new poles of economic power, re-shape themselves.
And let’s not forget that China’s economy is showing signs of fatigue and financial trouble. Economic growth in Europe, for its part, although on an upward trend in forecasts to 2024, is below potential (the winter European Commission forecast for 2024 was revised downwards comparative with autumn one). Germany’s economy also showed signs of fatigue last year, recording a GDP decline in 2023.
2023 and 2024 are election years for many European countries, including Romania. This will increase the degree of uncertainty, especially as populism and ideology begin to show their fangs more and more in the EU countries. Together they can form a very harmful cocktail for the functioning of society and the economy in the medium and long term, as Paul Collier points out in his book „The Future of Capitalism. Facing the new anxieties”. In the short term, election years bring a „relaxation” of public finances.
In the medium and long term, there is also cause for concern about the widening spectrum of economic uncertainty. The current geopolitical situation in terms of wars and conflicts may continue and even lead to and amplify new hotbeds of conflict. This year’s US Presidential elections will play a decisive role in this respect, especially with implications for the war in Ukraine (in terms of financial but also military support). Whatever the outcome, Europe will have to be prepared to combat any aggression by a military force, and this will increase the size of Member States’ defence expenditures with supplementary pressures on public budgets.
Even if inflation is on a downward trend, elevated risks could keep interest rates still high, and central banks might still be cautious in starting to cut benchmark interest rates (at least in terms of pace and frequency). Higher long-term interest rates for longer will fuel increased borrowing cost and higher public debt for all countries around the world. Considering the aforementioned trends on inflation, interest rates and economic growth, the “r-g” position (interest rate vs economic growth rate) might become unfavorable. These higher for longer interest rates will keep credit conditions for companies still tight, with implications on growth outlook, as well.
Unless action is taken to address public debt issues, we could see a „slow fiscal death” of some countries, as economist Arthur Laffer Jr. told CNBC. The European Union has already reacted! The European Central Bank (ECB) has a new specific instrument (Transmission Protection Instrument) that will ensure an optimal transmission of monetary policy, taking into account the state of public finances in general and public debt in particular. A new economic governance framework is also about to be adopted, with new fiscal rules, designed to put the public debt (as percent of GDP) on a downward trajectory, with a reform-oriented medium and long-term approach.
Another phenomenon that will have crucial implications for the world’s economies in the medium and long term is Artificial Intelligence (AI) and digitalization in a large extend. It is currently seen as an innovative phenomenon that would have a positive impact on processes and actions, increasing efficiency and decreasing human effort. On a broader level, the negative implications as source of uncertainty must also be seen: it is not yet regulated (On December 9 2023 EU Parliament reached a provisional agreement with the Council on the AI act, being the world’s first comprehensive AI law); the proliferation of „deep fakes”; higher public social spending on retraining and assistance for those whose jobs will be affected by AI etc. Still on the digitization, we are witnessing increasingly „cyber-attacks” and “dark side” of social media’s influence, especially through “fake news”, which have extremely negative implications for society and the economy.
The ageing population and the unsustainability of public pension systems add further elements of long-term uncertainty. The shrinking of the working population, including in line with a future in which AI will take its place, the attitude of the new generations towards intergenerational solidarity and the payment of taxes, will make things increasingly complicated in this respect.
Last but not least, we must emphasize the climate risks, which unfortunately in some parts of the world are completely ignored and, where there are already concerns, there is much room for improvement. Uncertainty comes not only from physical phenomena, the impact of natural disasters, etc., but also from the high costs involved in remedying and preventing such phenomena adverse impact, as well as those involved in the transition to a greener society and economy.
As we can see, the realities show that we are living in challenging times of „disruptions” in society, economy and geopolitics. Thus, economic uncertainties are “different” than in the last decades, they are spreading more and more in time and space and becoming more and more complex, with various causes and a longer-term perspective. The most important thing is to take account of them, to act in a proper way in treating them and to be pre-emptive.
Note. The views expressed are the personal views of the author and do not involve the institutions with which he is associated.
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