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National output, unemployment and inflation — these numbers are on the news almost every night but why are they watched? Policy-makers watch these figures to see when to introduce measures to stabilize the economy like changing interest rates. , has spent much of his career studying how changes in the economy impact stock and bond prices — providing information to help policy-makers and investors make better choices in volatile times.

How does the economy look compared to situations in the past and what will this potentially mean for companies raising funds and retirement investments? David spoke with UToday to provide some insights about where our economy is right now, why — and how this might impact the choices you may want to make.

Times of economic uncertainty

Q: What is macro-economic uncertainty?

A: Broadly speaking, it is the degree of the difficulty that people in the economy have about predicting the growth rates of macroeconomic aggregates such as GDP, investment, hiring, or credit growth over the next year or so.

Q: Would you consider Canada to be in a period of high macroeconomic uncertainty?

A: Most definitely so, and not just Canada, but probably the entire world.

Q: How long has Canada been in a period of economic uncertainty? What factors have created this situation?

A: Without doubt, the pandemic has been a huge factor. Coming into 2020, the U.S. and Canadian economies looked quite strong and stable and in one of the longest last periods of economic expansion, which began all the way back in 2009. However, the lockdowns slowed things down. The jobless rate surged, and consumer expenditures plunged to unprecedented levels. The central banks responded to this crisis by increasing credit to all and particularly lower-income households, and things returned to some degree of normalcy.

A major factor in managing the lockdowns was the increase in usage of stay-at-home technologies, which permitted lots of regular activity to resume with much less physical presence of people at the traditional workplace. Indeed in 2020, the technology sector did really well, as people purchased their products to increase their productivity while working from home.

However, macroeconomic uncertainty started increasing again in 2021. There were three major factors that I see: First, due to recurrent lockdowns at factories, ports and other transportation facilities, important supply chains did not function as efficiently as we are used to, and this created shortages of different goods in several countries.

Data from the Federal Reserve Board in the U.S. showed that the number of unfilled orders for goods increased dramatically in 2021, which shows that production could not keep pace with demand. In such an environment, economies experience supply-side inflation, that is, the prices of goods increases due to the lack of adequate supply.

Second, the massive amount of credit created since 2020 (building on a huge amount already in place from the stimulus efforts of the central banks since 2009) further increased inflationary pressure due to the standard narrative of "too much money chasing too few goods.’’

Finally, the Russian invasion of Ukraine has increased the shortages of food grains and oil, and further increased inflationary pressures. In some of my research, I have shown that during periods of high inflation, the stability of economic growth declines, that is, macroeconomic uncertainty increases, and this is what we are witnessing again.

Q: Have we seen times like this before?

A: A period of low growth and high inflation has been called "stagflation’’ by macroeconomists. The last time the major economies of the world experienced stagflation was in late 1970s and early 1980s. Since, then, inflation was tamed due to a combination of strong economic growth and conservative policy by central banks.

In the 2000s, we saw two recessions before 2020. In 2008-2009, economic growth rates were very poor; however, inflation was very low and there was the risk of price declines (deflation), which also leads to growth uncertainty. So, the times were different in the past two recessions and the polices that the central banks could take were different from what we are experiencing currently.

Q: We are feeling the effects of a pandemic and now a war between Russia and Ukraine. How do these situations contribute to economic uncertainty?

A: Russia was the third-largest producer of crude oil in 2021, and the second-largest exporter. It also supplies a large amount of the natural gas to European countries. In addition, Russia was the largest exporter for wheat, while Ukraine was the fifth largest. With the trade sanctions imposed on Russia, the risk of shortages of these commodities, as well as some others (such as metals) has increased dramatically. We have seen a surge in the price of oil since late 2021, and more so after the invasion. These price pressures have only increased the inflationary pressure and increase the uncertainty of economic growth in the next year.

Impacts on markets, companies and investments

Q: When there is economic uncertainty, how does this affect markets?

A: There is indeed a strong relationship between macroeconomic uncertainty and financial market volatility. Most episodes of uncertainty are associated with bad times, although there have been a few episodes of good uncertainty, such as in the late 1990s, when there was uncertainty that the internet would increase economic growth rate for the foreseeable future. 

Q: What does this mean in a broader context? For people’s retirement funds? For companies raising funds in markets? For an economy?

A: The higher financial market volatility means that people find financial markets riskier, and hence they demand a larger reward (risk-premium) for holding the financial assets. This increase in the risk premium affects the rate at which people discount future cash flows, and hence lowers financial asset prices, something we have seen recently.

It also means that firms in the economy must pay higher rates for borrowing or offer larger proportions of their shares to buyers for the same amount of financing. This discourages business investment and hiring, and then has additional rounds of effects with lower profits for firms, and incomes for households, which makes the latter more risk-averse and demand an even larger risk-premium. The vicious spiral can continue until better news arrives. 

Q: People cannot help but feel uncertain when so many events are happening both globally and locally. Do you have any advice for investors who are feeling uncertain? Are there potential opportunities to explore when people are feeling uncertain?

A: For people who have lost jobs, the first thing is survival in the short run, without depleting their savings and retirement plans in a major way. Historical data shows that the returns for investing are the highest in bad times, although there is the problem of calling the bottom — things could be getting worse, so the risk is the highest as well. So, for such people, having their savings in safe assets might be the only feasible strategy. For investors with sufficient liquidity (available cash and income), investing in risky asses is indeed more rewarding, although they might have to wait for a few years to realize the gain.