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Should equity markets be more volatile?

by Matthew Smith | 19 Apr 2017
There is a disconnect between the perception that the world has become more uncertain, and the behaviour of the equity markets, a leading global economist says.
 
“When Brexit came, we were ready to use these tools [created by theorists during the global financial crisis] and with them we predicted … there would be an enormous drop of investment [in financial markets], but we were wrong,” says Olivier Blanchard, a French economist who was the chief economist at the International Monetary Fund from 2008 to 2015.
 
Speaking during a lecture series recently for the London School of Economics, Blanchard, who is now a professor and a senior fellow at the Peterson Institute for International Economics, points out that financial market reactions to events of economic and political uncertainty are not following the script he and other macroeconomic theorists predicted they would.
 
There world is a much more uncertain place when you consider political uncertainty around the world, Blanchard notes, during a lecture for the LSE which can be viewed here.
 
However, for those who have been tracing the VIX volatility index — a measure of the implied volatility of stocks — market volatility is unexpectedly low, Blanchard notes.
 
“There is a complete disconnect between perception that the world has become more uncertain and the [behaviour of] markets,” Blanchard says, to a room full of wonky economics enthusiasts.

GFC in the rearview

While most macroeconomists might start a talk such as with the global financial crisis and then working forward from there, Blanchard notes that many of the legacies of the global financial crisis (GFC) are actually fading in terms of the influence they have today on current fiscal measures and monetary policy.
 
He says the high debt levels from the Euro crisis and in the US are not the dominant force that they once were, with few exceptions.
 
Meanwhile, Blanchard says, while productivity growth remains low, the slowdown in productivity started before the 2008/09 crisis.
 
“Fiscal consolidation stopped for example a year and a half ago in the US and in many other countries. This is no longer an impediment to the macro anymore,” Blanchard comments.
 
Fiscal consolidation is the policy aimed at reducing government deficits and debt accumulation.
 
Fiscal stimulus, such as the plan outlined by US President Donald Trump could have the desired effect of increasing consumer demand and help to grow the economy, Blanchard notes, but he also says its main effect will be an increase in uncertainty.

Will that uncertainty translate to uncertainty in financial markets?

It’s surprising the uncertainty hasn’t led to more volatile markets to date so it’s anyone’s guess what effect further uncertainty will have in the future.

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