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A Humbling Economy for Economists

Many major macroeconomic developments over the past year have departed from the consensus forecast, exposing the limitations of economists and financial analysts' understanding. Although there is still a great deal of uncertainty in the global economy, key indicators now support a more cautiously optimistic outlook.

LONDON – Given all the uncertainty in the world economy today, we have been reminded that for all the authority economics commands, it is still a social science. Many major developments over the past year have departed from the consensus forecast, exposing the limitations of our understanding.

Most notably, many experts and forecasters predicted a recession in the United States this year. But not only have we avoided that (so far); the latest inflation figures have led many sell-side forecasters to write down the probability of a recession happening at all. Suddenly, financial markets are entertaining the idea that policymakers can indeed achieve a soft landing: inflation returns toward its target level (around 2%) without the need for a recession and a sharp increase in unemployment. Equity markets thus are rising, despite remarkably (and perhaps understandably) cautious investor sentiment.

The situation across the Atlantic is also overturning forecasts. Although the United Kingdom’s economy seems to be constantly beleaguered – with GDP growth remaining meager – it nonetheless has avoided a technical recession (defined as two consecutive quarters of negative growth). Will the next positive surprise be a sharp reduction in inflation? One issue that pessimists (including the Bank of England) focus on is wage inflation, which summons comparisons to the 1970s wage-price spiral. That episode inaugurated the long era of monetarist orthodoxy, which required that stringent anti-inflation measures take priority over most other economic-policy objectives.

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