At the best of times, economic forecasting is more art than science — but, as geopolitical risk soars, the task is looking tougher than ever, says Desjardins Group.
In a new report, economists at Desjardins note that recent events — from recent U.S. military intervention in Venezuela to its latest sabre-rattling at Greenland — signals a shift in some of the fundamental assumptions underlying economic forecasting.
“For several decades, macroeconomic analysis operated within an implicit framework of relative geopolitical stability. There was consensus around a seemingly solid foundation built on the rule of law, independent monetary policy and strong institutions,” it said.
Now however, an international order based on respect for the rule of law is under threat — and, as a result, the framework underpinning economic forecasting, “is now in question,” it said.
The implications of this shift “may be more sweeping than immediate market reactions suggest,” the report warned.
“It is rational for markets not to overreact if the intervention remains limited in scope and expectations around key variables such as growth, profits and monetary policy remain largely anchored. But the frame of reference used by economic agents is shifting,” it noted.
“In this increasingly turbulent environment, investment is becoming more sensitive to political risk, value chains are becoming more vulnerable to disruption and risk premiums are becoming more volatile,” it added.
Against this backdrop, “there’s reason to be somewhat humble about the frontiers of economic forecasting as we begin the new year,” the report concluded. “Economics is still a powerful explanatory tool, but it must now be considered alongside dynamics once relegated to the history books.”