Guest Contribution: “Six right predictions in 2018”

Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers.

I realize that compiling a list of one’s own past forecasts is self-indulgent. But perhaps there are readers who will indulge me too, as I run through six predictions that – it seems to me – were mostly proven right this past year.

  1. Volatility, as measured by the VIX, had been too low and would rise.
  2. The stock market was too high and would fall.
  3. Trump would switch from attacking the Fed for low interest rates, as he had during 2010-2016, to attacking it for raising interest rates.
  4. Prices of oil, minerals, and other commodities would fall.
  5. The December 2017 tax cuts would raise the US budget deficit and national debt (contrary to partisan predictions that they would pay for themselves);
  6. and in turn would raise the trade and current account deficits (contrary to Trump’s trade promises). In other words, the twin deficits would return. They have.

Some of these may seem obvious, at least in retrospect. But prediction in real time is even harder in the Trump age than under normal conditions.

Here are the citations for the six predictions.

  1. Volatility, as measured by the VIX would rise.

On Jan. 14, 2018, shortly before the VIX rocketed upward [from 11 to 30 and higher], Gavyn Davies wrote in the Financial Times (“Ultra low market volatility – friend or foe?” ), “A pre-eminent question for 2018 is whether these low volatility levels are reflecting excessive complacency…among investors. … [Some] ‘contrarian’ investors suggest that over-extended asset prices are ignoring the state of economic or geopolitical “fundamentals”. Jeffrey Frankel states the pessimistic case very well here.”

That article linked to a Sept. 25, 2017, Project Syndicate column (“Why Financial Markets Underestimate Risk”), in which I had written: “During most of 2017, the Chicago Board Options Exchange Volatility Index (VIX) has been at the lowest levels of the last decade. It recently dipped below 9 … Investors, it seems, are once again failing to appreciate just how risky the world is.” The title of my full blogpost was blunter: “The VIX is too low!”

  1. The stock market would fall.

I specifically ventured medium-term predictions on the direction of the stock market (largely based on historically high cyclically adjusted P/E ratios) — for example, in Barron’s on February 24, 2018: “a good reason to sell is that stock prices are too high from a longer-term perspective.” I then defended this position when questioned by the legendary John Bogle.

Indeed the S&P is down 15% since February.

  1. Trump would switch to attacking the Fed for raising interest rates.

It was easy to predict that Trump and the Republicans, upon attaining the White House, would shift from attacking fiscal expansion to supporting it. But at first not everyone predicted the analogous switch in position on monetary policy. I wrote in The Guardian (November 11, 2016: “… Trump, who attacked the US Federal Reserve’s easy monetary policy during his campaign, will quickly reverse that position and press the Fed not to raise interest rates.” It seems obvious now.

(Before and After. On September 29, 2011, citizen Donald Trump tweeted: “The Fed’s reckless policies of low interest and flooding the market with dollars needs to be stopped or we will face record inflation.” Unemployment then was still 9.0%. On July 19, 2018, President Trump said: “I am not happy about [interest-rate increases]”. And on October 11: “the Fed is out of control.” The unemployment rate had by then fallen to 3.7 %.)

  1. Prices of oil, minerals, and other commodities would fall.

Building on lectures on August 15 (at UCo, Denver) and August 23 (at the USGS), I wrote on August 25, 2018:

“One might hazard the prediction that… real commodity prices will decline… The current US combination of loose fiscal policy (tax cuts and increased federal spending) and normalization of monetary policy (more increases in short-term interest rates from the Fed) suggests that real interest rates and the value of the dollar may go up. This monetary-fiscal mix is reminiscent of the Volcker-Reagan policy combination in 1984. The overshooting theory predicts that, as a result, real commodity prices are headed down.”

Indeed, the WTI oil price has fallen 42% since that date. Agricultural prices and other non-energy prices also fell in the second half of the year.

  1. The December 2017 tax cuts would raise the budget deficits and national debt

In an article in The Hill (“To understand the tax reform bill, use good old math and history,” Dec. 10, 2017), I wrote, “The partisan tax cuts that the Republicans are about to pass this year will raise the budget deficit, and trade deficit, as the 1981 and 2001 tax cuts did.”

On Feb. 25, 2017, the fact-checking service PolitiFact had called President Trump on a brag, Why Donald Trump’s tweet about national debt decrease in his first month is highly misleading: “The media has not reported that the National Debt in my first month went down by $12 billion vs a $200 billion increase in Obama first mo.,” Trump posted on Twitter Feb. 25, 2017… “I wonder what he thinks he did to bring this about,” said Harvard University government professor Jeffrey Frankel…”This one-month number is trivial in the long-run trend. The national debt will rise this year, and in future years. It will rise at a sharply accelerated rate if Trump carries out even half of his campaign promises for specific tax cuts (and specific spending increases). Will he be willing to be judged by the debt numbers in the future?”

Of course, we are now looking at trillion-dollar budget deficits and acceleration in the national debt (from $19.8 trillion to $21.5 trillion, so far), even relative to GDP. But perhaps comparing one’s predictions to the frequently inaccurate claims of the President is too low a bar.

  1. The tax cut and budget deficit will in turn raise the trade and current account deficits.

A New York Times article, “Trump Tax Cuts Likely to Increase Trade Deficit” (Nov. 17, 2017) quoted a confident forecast: “There may not be much that macroeconomists can predict with accuracy, but a large tax cut will lead to a budget deficit, which will lead to a trade deficit,” said Jeffrey Frankel, a professor of economics at Harvard.

Similarly, my January 15, 2018 column in Project Syndicate, and The Guardian was titled “Making America’s Trade Deficits Great Again,” and was subtitled ”Republican tax cut will widen the trade and current-account deficits, the opposite of what was promised.”

“Simply put, the Republicans’ tax law – which emphasizes big cuts, especially for corporations and the highest-income earners – is virtually certain to widen the budget deficit and, in turn, increase the current-account deficit. Trump’s legislative victory implies the return of the infamous twin deficits that followed George W Bush’s tax cuts of 2001 and 2003, and Ronald Reagan’s cuts of 1981-1983.”

I also explained in a short video why the twin deficits would return.

Needless to say, I didn’t get everything right this past year. Much of what Trump says and does I find it impossible to predict.

This post written by Jeffrey Frankel.

6 thoughts on “Guest Contribution: “Six right predictions in 2018”

  1. baffling

    jeff, do you believe the vix is still an accurate indicator of volatility, with numbers comparable to a decade ago? i have questioned whether this is really true, but don’t have a good answer. i guess i am still vague about how the vix is calculated. it seems to me the balance of investors and behavior has changed quite dramatically in the past decade. we have very large institutional investors, perhaps more hedge funds, rather large passive vehicles such as etf and index funds. and we have a proliferation of high frequency traders. does this change in stock purchasing behavior versus options buyers have an impact on the level of the vix? it’s changes are still significant, but perhaps the critical levels have changed? could this be why we had such low vix numbers in an era when perhaps there should have been more worry and volatility in the market? anyways, happy new year to menzie, jim and jeff! thanks for keeping this blog honest and insightful in spite of us commentators.

  2. Barkley Rosser

    Congratulations to Jeffrey Frankel for making six accurate predictions. I did not independently make any of those, but when I saw them made thought they looked reasonable and likely. Anyway, it is not that often anybody gets six out of six predictions right in a year, unless he is not reporting some others he made that did not pan out.

    I did not make any predictions, but one area where Trump went further than even I thought he would has been on his trade war. Yes, he has cut some half-baked deals, but I guess I did not foresee him keeping steel and aluminum tariffs in place on Canada and Mex8ico after negotiating his NAFTA 2.0, although, frankly, I did not predict he would actually do that, so maybe I am contradicting myself. I also thought maybe the “adults in the room” would keep him from withdrawing from the Iran nuclear deal, but he fired some of them and did it.

    Something that has surprised me is how effective his single-handed economic sanctions on Iran have been, even as our treaty partners in Europe and elsewhere have opposed his move. Private companies have knuckled under and withdrawn from Iran, such as France’s Total, even as their governments oppose his sanctions. Of course, his move has led to no policy changes in Iran, although in the case of them continuing to abide by the JCPOA, that is a good thing, so Trump has gotten away with this nonsense without triggering Iran to return to highly enriching uranium again.

    1. Barkley Rosser

      BTW, the one of these I was the least sure of was the stock market one. I expected an end to the bull market of 2017, but I also expected a lot of volatility, which has happened, with tt unclear where the market would be at the end of the year. Indeed, as of a couple of months ago the market did hit an all time high, only to drop sharply since, so a bit arbitrary that one, other than the forecast ofgreater volatility and an end to the genreal bull market.

  3. pgl

    I enjoyed the last two especially:

    “The December 2017 tax cuts would raise the US budget deficit and national debt (contrary to partisan predictions that they would pay for themselves);
    and in turn would raise the trade and current account deficits (contrary to Trump’s trade promises). In other words, the twin deficits would return. They have.”

    Given Trump’s economic team consists of Kudlow, Moore, and that DOW 36000 fellow, I bet they are still expecting the 1981 tax cuts to lead to soaring tax revenues and a current account surplus!

    1. noneconomist

      I’m shocked–shocked, I tell you!–that the tax cuts have not already built a Treasury surplus. I hope the new congressional Democrats are happy with the coming trillion dollar deficit their election will create.
      Must say. I’m almost as shocked–shocked, I tell you!– about the failure of the tax cuts to reduce the deficit as I am knowing that Alabama will play Clemson for the national championship. Seriously, who saw that coming?

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