You might be forgiven for thinking that running an economy is easy. Much market commentary often suggests that it is blindingly obvious what should and shouldn’t be done.
Like football fans berating managers and players from stands it is tempting to think we could do a better job. The benefit of hindsight tells us that QE, low interest rates, and austerity were obviously going to fail. Today it can seem equally obvious that fiscal stimulus and policy to boost productivity are what are needed.
So how should investors respond when policy makers appear to be doing what we think is right? Even the mere mention of fiscal stimulus from Donald Trump seems to have played some role in the price action of assets since the US election result.
Today in the UK, the new Chancellor Philip Hammond delivered his first “Autumn Statement” and unsurprisingly, productivity and fiscal policy featured heavily.
The Chancellor made much of the UK’s record on productivity, which like much of the developed world has been one of long term structural decline in the rate of growth.
In particular, Hammond spoke of the “productivity gap” between the UK and other nations, describing it as follows:
“It takes a UK worker five days to produce what a German can in four.”
It is no surprise that this analysis is overly simplistic. The UK’s Institute of Fiscal Studies wrote about the apparent productivity gap in 1998 and explained how measures can be confused by various forces. Today, the global debate around productivity is even more intense. In short, economists and policy makers need to be very careful about interpreting productivity numbers between countries and over time.
This has a huge bearing on the appropriate policy response. In 2010 a McKinsey report argued that “it is no surprise that top down…assessments…have often proved inconclusive and that government intervention in markets has tended to be hit or miss.” Instead it is crucial to recognise that different policies are more or less effective in different sectors.
An IMF study into fiscal policy came up with similar conclusions. The “hows” (and “whens”) of policy matter, and the lags involved before any meaningful impact on the economy are significant.
This may seem obvious, but very little debate appears to acknowledge these complexities. Many continue to think in “one size fits all” terms, often allowing their own ideologies to override pragmatism and attention to detail. Investors should be extremely wary of trading on policy maker rhetoric and think very carefully about trading on announcements.