The 1990s and early 2000s witnessed a remarkable technological transformation in financial markets, ultimately leading to significant advancements in transparency and efficiency on a global scale. This era saw a shift towards electronic trading, with terms like “Quants” and “Algo trading” becoming increasingly prevalent. Today, it’s estimated that over 90% of global currency trading is executed by algorithms in some form or another.

Large financial institutions began hiring quantitative analysts, commonly with backgrounds in mathematics, computer science, or even physics. The purpose of these “quants” was and still is to develop systems capable of rapidly pricing financial assets, such as options. Alongside quants, algorithms emerged, enabling automatic or semi-automatic trading activities, such as buying or selling currency.

The result has been a significant reduction in market mispricings, making it increasingly challenging to exploit opportunities for buying low and selling high, as markets tend to already be efficient. This development has been facilitated by two key factors.

Firstly, the widespread availability of the internet means that pricing information for most financial assets is instantly accessible to anyone with an internet connection.

Secondly, the general globalization of capital movements has led to a significant convergence in prices across countries. With more liquid financial markets, even “small” financial markets are swiftly moving towards what are known as efficient markets, where opportunities for profit are scarce.

Similar trends are now increasingly evident in other markets, for example in the Danish retail sector. Danish supermarket chains report that pricing for common items like milk is nearly impossible to differentiate significantly from competitors. Price tests conducted by for example the Danish news site BT often reveal minimal differences between the prices of competing products.

Apps like “beepr” allow consumers in Denmark to track the prices of a wide range of groceries in real-time, prompting supermarkets to closely monitor their competitors’ pricing strategies. While price disparities still exist between supermarkets, there is a clear trend towards reducing these differences. Both consumers and supermarkets can now track price differentials at minimal costs, reflecting a process known as commoditization.

Commoditization refers to the standardization of goods across various sectors, resembling the pricing mechanisms observed in commodities or currencies. However, these changes also present challenges for sectors currently undergoing transformation. The same developments that accelerated in financial markets during the early 2000s are now unfolding in sectors like retail. It’s undeniable that Danish supermarket chains, in the coming years, will increasingly need to think and act like “quants.” It wouldn’t be surprising to see algorithmic pricing strategies emerge in the Danish retail sector, perhaps even for everyday items like milk.

Furthermore, this evolution is poised to be further propelled by artificial intelligence (AI). AI fundamentally functions as prediction engines, and with the cost of making predictions significantly reduced, we’ll witness a widespread adoption of AI in supermarkets. This adoption won’t be limited to logistics but will extend to navigating a grocery market increasingly resembling the foreign exchange market.

Ultimately, the primary beneficiaries of these developments will be consumers. As market standardization and algorithmic pricing become more prevalent, increased competition will drive prices down and lead to better-quality products. Hence, it’s high time for the traditional “merchant” to embrace the mindset of a quant and perhaps consider hiring mathematicians or physicists to implement algorithmic trading strategies, as this is how prices in supermarkets will be determined in the future.

* This article was first published in Danish on my Linkedin profile. See here.

Facebook has just reminded me of what I was doing on this day a year ago – I was giving a presentation at a seminar in Copenhagen organized by Danske Bank for some of the bank’s professional clients, as you can see in the picture below.

A lot has changed in the world since then, and looking back, things felt a lot more worrying at that time than they do now, especially because we had just experienced some banking turmoil in the USA.

What were my forecasts from exactly a year ago?

What you can see in the background behind my arm are two scenarios for the development of the American money supply (M2) – a “hawkish” scenario and a “dovish” scenario.

In the hawkish scenario, I assumed that the American money supply would stop falling and remain flat for about a year, after which it would gradually begin to rise.

If you look at the actual development of M2 in the USA over the past year, we have almost precisely been in this hawkish scenario.

So, I dug out my presentation and looked at the next slide after the one with the money supply. It’s also shown below. It shows two scenarios for inflation development.

The yellow line was the dovish scenario for monetary policy. The orange one was the hawkish scenario (the one that has almost played out).

I’ve added how inflation has actually developed. It’s the green line. And bingo – it lies almost perfectly on top of the orange line.

What does that tell us? Firstly, that we have been able to use the development of the money supply to predict the development of inflation quite well, but also that the talk we’ve heard recently among certain economists about inflation not coming down as quickly as expected in the USA is somewhat exaggerated. It’s almost gone exactly as expected (in the euro area, it has actually gone somewhat faster).

What I personally got wrong over the past few years was therefore not my forecast for inflation (I hit that almost spot-on) or growth (I didn’t have a forecast for a US recession), but instead, I got the interest rates wrong. It hasn’t come down nearly as fast as I expected.

And that explains a lot of the interest rate developments – because how can you be wrong about the interest rate when you hit the nail on the head with inflation and growth? The answer is that the natural interest rate has risen. But more on that another day.

Happy Easter.

PS If you wish to book me for a lecture or presentation on inflation, growth, interest rates, etc., please have a look a my agent YouandX here – the website is in Danish but I can also be booked for international speaking engagements through YouandX.

The American inflationary pressure is falling rapidly.

When discussing inflation, there is often a debate about which price index is the correct one to follow. So I thought – why not use them all?

Thus, I have constructed what I have called an Inflation Pressure Index (IPI), in which I have examined a range of different measures of American inflation, both in a broad and more narrow sense.

I have therefore looked at a total of nine different indicators, ranging from the normal Consumer Price Index and the Federal Reserve’s preferred index (PCE) – and these indices excluding food and energy prices. In addition, I have looked at producer prices, housing prices, and oil prices – as well as wage and money supply growth.

I have de-trended each of these variables using an HP filter and observed how the median of these indices has developed. If the IPI is above 1, then it is an expression of accelerating inflationary pressure, and conversely, if it is below 1, then it is an expression of declining inflationary pressure.

And where is the IPI now?

We see that the IPI peaked in June 2022 – and since then, the index has been falling, and for nearly a year, the index has been below 1.

In other words, it is quite clear that the “inflation episode” from 2021-22 is now clearly behind us.

Therefore, the only thing now can justifying the Federal Reserve not lowering interest rates is if the natural interest rate has increased – something I certainly is not ruling out. But for now at least there is certainly no significant inflationary pressures in the US economy.

In my recent post “2024: The Productivity Boom is Coming” I delved into the fascinating trajectory of our current economic landscape, one that defies the gloomy expectations of a 1970s-style stagnation and instead hints at a revival reminiscent of the booming 1990s. This reflection stems from a detailed observation of recent trends and a hopeful outlook towards 2024.

A Surprising Twist in Productivity Growth

As I’ve monitored the economic indicators closely, the last three quarters of 2023 have presented an unexpected turn. The United States has witnessed an almost 4% annualized growth in productivity, a feat not seen since the dynamic era of the 1990s. This surge in productivity has sparked a debate: Are we on the cusp of a new era fueled by AI and breakthroughs in healthcare, or is this merely a temporary blip?

The Specter of the 70s Versus the Promise of the 90s

The fear of revisiting the economic turmoil of the 1970s — characterized by sluggish growth and spiraling inflation — loomed large in our collective consciousness. Yet, the recent data paints a different picture, one that mirrors the optimism and growth of the 1990s. This period of prosperity was marked by significant advances in technology and productivity, setting a precedent for what we might be entering once again.

In this context, the concept of the natural rate of interest, as introduced by the Swedish economist Knut Wicksell, gains renewed relevance. This rate, which balances price stability with economic equilibrium, seems to be adjusting to a new normal. Higher underlying growth suggests an increase in the natural rate, indicating that the economy can sustain growth without the immediate need for lower interest rates.

The Implications of Sustained Productivity

The prospect of sustained productivity growth brings with it a host of positive implications. It suggests a future where higher real wage increases do not necessarily lead to higher unemployment or inflation — a stark contrast to the traditional economic models. This potential shift could redefine our approach to economic policy and labor market dynamics.

Looking Forward with Optimism

As we stand on the threshold of 2024, the signs of a productivity boom are encouraging. Despite facing challenges such as the pandemic, geopolitical tensions, and inflationary pressures, innovation and technological progress continue to propel us forward. At least this is the case in the US – and less so in Europe.

This resilience and potential for growth evoke the spirit of the 1990s, offering a vision of an economy that is not only recovering but thriving.

In my ongoing journey to decipher the complexities of the global economy, I remain committed to providing insights that bridge the gap between historical economic cycles and the potential for future prosperity. The narrative of a return to the booming 90s, against all odds, underscores a message of hope and resilience in the face of uncertainty.

It is clear that with the opportunities created by artificial intelligence, the volume of content – articles, images, films, audio, etc. – on the internet generated by AI is exploding.

This gives rise to a paradox, namely that, for example, ChatGPT or Midjourney require content – text and images – to be trained on, and if more and more of the content in the world is created by AI, we end up with self-referencing AI, where we train future versions of ChatGPT on texts already written by previous versions of ChatGPT.

There is a parallel to this in economic theory, known as the Grossman-Stiglitz paradox.

In the article ‘On the Impossibility of Informationally Efficient Markets’ from the American Economic Review (1980), economists Sanford Grossman and Joseph Stiglitz challenge the Efficient Market Hypothesis (EMH), which essentially states that prices, for example, of stocks reflect all available information in the market, and therefore, one cannot ‘beat the market’.

It’s the ‘Wisdom of the crowds’. No one is wiser than the knowledge gathered in market prices.

But this creates a paradox, as highlighted by Grossman and Stiglitz because if the market is efficient – meaning that all available information is already reflected in the price, then there is no incentive to uncover information. In other words, you might as well give up trying to beat the market, but if everyone gives up trying to beat the market, then no new information is created.

And we actually see this in global financial markets. Increasingly, both professional and private investors realize that trying to beat the market is futile, and what we observe is that more and more investors become so-called passive investors – simply buying ‘the market’, for example, by purchasing an ETF on the entire US stock market rather than trying to ‘pick the winners’ and buy individual stocks.

This has become possible because it has become much cheaper to buy such ETFs relative to so-called actively managed investment funds.

And perhaps even more strikingly, more and more of the world is becoming efficient. For example, I have worked quite a bit on pricing soccer players, and I initially had an idea that there was money to be made if one simply used the right quantitative methods – à la Moneyball – to find soccer players in the global market who were ‘cheap’. But the truth is that it is much harder than one might think.

Today, it is much harder to find a 16-year-old boy from Northern Norway who turns out to be a global superstar that no one else has discovered. The reason is that the price of uncovering this information has collapsed.

Today, there is information available about soccer players and soccer matches all over the world. We can watch their matches on YouTube or see results and statistics for even the most peripheral leagues in the world. And it also means that the prices of soccer players will converge towards being efficiently priced.

The Role of the Entrepreneur

But despite this, the world has not come to a standstill. Even though markets – even for soccer players – have become more efficient, there are still many actors who try to beat the market every day.

These actors can be referred to as entrepreneurs.

In economic theory, the entrepreneur has two roles.

The first is the equilibrium-seeking entrepreneur, as described by the British-American economist Israel Kirzner. This type of entrepreneur identifies mispricing in the market – something that is too cheap or too expensive (‘Buy cheap, sell dear’).

This Kirznerian entrepreneur can easily be imagined as a robot that constantly scans the market for mispricing using algorithms – and it could easily be AI.

Such algorithms have been known in financial markets for at least 30 years, and a large part of trading in global financial markets today is done by such robots.

And such robots are now spreading to more and more areas on the internet. It is obvious that more and more news reporting will be created by AI. There will be things that can be done cheaper and faster with AI than what humans can do today.

But traditional economic theory, including Kirzner’s, is often static. It operates in a given world, but the real world is constantly changing. There is innovation. We come up with new things.

Algorithms have not replaced innovation. This leads us to another economist, Joseph Schumpeter, who spoke of “Creative Destruction.” And the creative element is the interesting part. The entrepreneur as ‘Gyro Gearloose’ – as the inventor or innovator.

The Gyro Gearloose-entrepreneur is not the one who buys and sells existing goods and services, but the one who invents new products and solutions.

The parallel to AI and content production is clear. The human contribution to content creation is precisely to be creative. To create something new. To get ideas.

AI cannot (yet?) replace this creativity. And for the world not to stagnate, human creative contributions are needed.

We need to embrace AI to fulfill the role of Kirzner’s entrepreneurs. This has already happened in financial markets, and it will happen increasingly in other areas. But at the same time, we need to embrace human creativity, the creative.

Many of the successful people I have met are often dreamers who are not limited by conventional notions. Although many of them realize that they are subject to the same conditions as everyone else, some of their ideas turn out to be groundbreaking.

These people are Schumpeter’s creative entrepreneurs. They are necessary in an AI age. Kirzner’s mechanical entrepreneurs are increasingly being replaced by algorithms and AI.

Finally, I must say that I have had the idea for this article for quite some time, and this morning I thought I would have ChatGPT write it.

Despite feeding ChatGPT with all sorts of inputs – and old articles that I and others have written – ChatGPT was unable to create a readable text on the subject.

Therefore, if we really want to ignite the AI revolution, we need to add human creativity.

And yes, ChatGPT helped me with the proofreading of this article (in fact it mostly translated it from an article I wrote in Danish and came up with the headline), and then you can see if the drawing created based on the text with Dall-E in ChatGPT is funny enough.

Lars Christensen lacsen@gmail.com, + 52 50 25 06. See more about how to book me for a presentation or lecture on the economics of AI here.

We hear it all the time – are we heading for a recession (a hard landing) or a soft landing in the US economy?

The question, of course, is what a soft landing is. A way to answer this question is to determine whether the Federal Reserve conducts monetary policy in such a way that it does not create monetary imbalances that spill over into the real economy and create accelerating inflation or a general glut (a recession).

And the market monetarist answer to this challenge is that the Fed should conduct monetary policy in a predictable and transparent way to ensure a steady growth rate in nominal spending, often measured as the growth rate of nominal GDP.

Market monetarists like Scott Sumner and myself have further argued that the Fed and other central banks should not target present or, even worse, lagging NGDP, but rather future NGDP. However, contrary to inflation – where we can find market expectations for future inflation – there do not exist NGDP futures from which we can make forecasts about future NGDP growth.

Consequently, market monetarists argue that more traditional measures of the monetary policy stance, like money supply growth (relative to the growth of money demand) and interest rates (relative to the natural interest rates), should be supplemented with reading the markets and combining signals from exchange rates, commodity prices, stock prices, and bond yields to assess whether nominal spending is stable or accelerating/decelerating.

However, such indicators, while useful in the conduct of monetary policy, are harder to comprehend for the wider public and are often hard for policymakers to communicate.

Therefore, I am today happy to announce that I might have found something that makes this task easier going forward.

A new weekly NGDP growth indicator

Earlier today, I was reminded of a weekly indicator of real GDP growth created by Daniel Lewis, an economist at the Federal Reserve Bank of New York, Karel Mertens, a senior economic policy advisor at the Federal Reserve Bank of Dallas, and James Stock, a Professor at Harvard University.

The index uses high-frequency data such as Redbook same-store sales, Rasmussen Consumer Index, new claims for unemployment insurance, continued claims for unemployment insurance, etc., as an indicator of real GDP growth.

I must admit that I had forgotten about the index and really didn’t think it was all that accurate. However, when I was reminded of the index today by a tweet by Bob Elliot (who, by the way, often comes close to arguing like a market monetarist) where he noted that the Lewis-Mertens-Stock indicator was actually signaling an acceleration in US real GDP growth I once again had a look at the indicator and I must say I was impressed how accurate it has continued to be.

This, combined with the fact that I love real-time and high-frequency indicators, made me think – why don’t we have a weekly NOMINAL GDP indicator?

So, I had to create one. At first, I thought I would use truflation.com’s daily CPI indicator for the US, but I don’t have access to that data for a longer period of time, and I would at the same time like to have a forward-looking element in my indicator, so I instead opted for using daily market expectations for US 5-year-5-year inflation.

I admit this can seem a bit odd with a rather unusual combination of present-time and foreward-looking indicators, but adding these two variables together historically tracks actual NGDP growth very well, as the graph below shows, and at the same time, it adds an element of both being forward-looking and high-frequency. Something that should be very useful for monetary policymakers.

Obviously, it would be preferable to have an annualised growth rate over, for example, three months (12 weeks) rather than a year-on-year growth rate, but for now, this will have to do.

Fed’s implied target for NGDP and the weekly NGDP indicator

The Fed officially targets 2% inflation (measured by the PCE deflator). If we assume that potential real GDP growth is also around 2%, then the Fed’s implied NGDP growth target should be 4% annual growth. Here we refrain from discussing that a level target rather than a growth target would be preferable.

However, if we look at the period from 2010 to early 2020, the weekly NGDP indicator averaged around 4.5% growth. However, during the same period, US PCE inflation was quite close to 2%.

Hence, it is probably fair to assume that as long as the weekly NGDP indicator is around 4-4.5%, the Fed will also over time deliver on its 2% inflation target. The graph below shows the development of the weekly NGDP indicator since mid-2022.

We see that early in the period (and before), NGDP growth clearly was too high to ensure 2% inflation, and monetary tightening, therefore, was clearly warranted. However, it is also clear that towards the end of 2022, NGDP growth slowed too much, and in this regard, it may be worth remembering that in early 2023, we saw considerable financial and banking distress in the US.

However, after the Fed in March 2023 started to soften its rhetoric, the NGDP indicator gradually started to improve. The Fed ended its hiking cycle in the late summer last year, and since then, the weekly NGDP indicator has been very close to the 2010-20 median growth rate of 4.5%.

Hence, for nearly half a year, the Fed has been able to ensure very stable NGDP growth (as during the 2010-19 period).

Effectively this means that monetary policy now is more or less perfectly balanced, so at the same time ensuring a growth rate of nominal spending that will ensure that US inflation returns to 2%, while at the same time avoiding a recession. This is the much-talked-about “soft landing”.

To cut or not to cut?

However, the challenge now is to ensure that this continues to be the main scenario going forward. Some Fed officials over the past week have tried to signal to investors that they are wrong in expecting at least 5-6 rate cuts of 25bp each during the eight FOMC meetings of 2024.

I believe these Fed officials are playing with fire. The fact is that monetary policy presently is nearly perfectly calibrated – it is neither too tight nor too easy. It is just right. And in this regard, it should be remembered that if the Fed delivers what the markets expect in terms of rate cuts, it is a neutral monetary policy – and not an easing of monetary policy.

Monetary policy is only eased if the Fed delivers more cuts than already priced by the markets. So, by trying to signal fewer rate cuts than priced by the market, Fed hawks effectively are trying to push NGDP growth below what is desirable, and if continued, are likely to cause the US economy to fall into recession.

That being said, it is also notable that in recent weeks US bond yields have increased a bit and so has the weekly NGDP (and real GDP) indicator.

This, to me, is an indication that monetary policy has not become too tight either. This is even causing me to rethink my otherwise held view that there was room for some downward pressure on US 10-year bond yields, and I must admit that I increasingly think that we have seen a slight upward move in long US productivity growth, which would cause the natural interest rate to increase a bit.

Furthermore, lower global demand for US bonds, caused particularly by reduced Chinese savings (a reduction in the FX reserve) combined with excessively easy fiscal policy in both Europe and the US, is likely also contributing to this. However, none of this is dramatic – at least not judging from our new weekly NGDP growth indicator.

A way forward for the Fed

In conclusion, at least for now, it seems like Jay Powell and the Federal Reserve have managed to ensure a soft landing by ensuring stable nominal spending growth around 4-4.5%, and that this is consistent with the Fed’s 2% inflation target.

Therefore, the Fed could do a lot to actually embrace a high frequency indicator of nominal spending growth like the one I have suggested and announce that it will track it closely to ensure 4-4.5% growth in nominal spending.

It could continue to use interest rates as its primary policy instrument, but the Fed needs to communicate in terms of a further interest rate path relative to market pricing. This would presently imply that the Fed openly should say that “our indicators for nominal spending continue to develop in a way consistent with our 2% inflation target, and we therefore plan to deliver rate cuts in line with present market pricing”.

Furthermore, if for example the weekly NGDP indicator moves up and above 5%, it certainly would be justified by the Fed to signal that it will deliver fewer rate hikes than the markets are presently pricing – and vice versa if the indicator moves down towards and below 4%.

If the Fed operated in such a way, the Fed basically would not have to do much more than publish a weekly quasi-forward-looking NGDP growth indicator and set interest rates according to market expectations.

Monetary policy then would become fully rule-based, and there would be little need for any other communication from the Fed or any in-house/FOMC forecasting. The market would then take care of most of the lifting in monetary policy.

But I am probably dreaming…

PS if the Fed keeps NGDP growth close to 4-4.5% and the we at the same time see an acceleration in productivity, which I think is likely (see my post on this topic here) then inflation might drop below 2%. That should just be welcomed as long as it reflects higher productivity growth and this own its own is an argument why the Fed should target NGDP growth rather than inflation.

PPS the second graph above was created using ChatGPT 4.0 (Data Analyst) as is the cartoon below. AI is changing the world – and making economic analysis easier and even more fun.

Why hasn’t American growth slowed down more when interest rates have been jacked up?

The graph below, which I have created with a little help from data from the Federal Reserve St. Louis’ FRED database, and which I have processed through ChatGPT 4.0, illustrates what has happened.

In 2020-21, the USA implemented massive monetary and fiscal policy easing. Basically, the American government sent money directly to every citizen. These funds were financed by the government issuing treasury bonds, which the Federal Reserve purchased with newly printed American dollars.

This money circulated in the American economy. The money supply consists of two parts: physical notes and coins in circulation and deposits in banks. The graph below shows the total deposits in the banks – adjusted for inflation.

We see that bank deposits grew rapidly in 2020-21, but thereafter the bank deposits have fallen significantly, and we are now approaching the red line, which marks the trend before the major monetary policy easings.

It should be noted in this context that it is natural for deposits to grow in an economy that is growing underneath – but not as rapidly as in 2020-21.

It was precisely the strong monetary policy expansion that caused the bank deposits to grow so significantly in 2020-21.

But from 2021, two things happened. Firstly, inflation began to rise sharply already from 2021. With higher inflation, the purchasing power of bank deposits is eroded. This is the first factor that caused the growth in bank deposits to decline during 2021.

The second thing that happened was that the Federal Reserve began to tighten monetary policy during 2021 – and this really caused a drop in bank deposits.

But we have not yet fallen below the red line – and we can actually see signs of a “soft landing,” that is, a decrease in the rate at which bank deposits are falling. This is due to a combination of slightly increasing (nominal) bank deposits and a continuing decline in American inflation.

However, we can also see why it looks ominous. If the green line really falls below the red line (with all the uncertainty about how we measure this), then we must expect that we also hit the growth wall, and that we get an American recession. But it is not necessarily given yet.

……….

Do you want to book me for a lecture or a presentation so have a look here.

When I was a younger economist, I harboured more apprehensions about the world approaching its demise – or at least the global economy. Yet, paradoxically, as I’ve aged, my perspective has shifted to increasingly acknowledge the gradual improvement of our world over time.

This blog post is a testament to that sentiment, underlining the need to harbour not just optimism but profound optimism about future growth.

Indeed, like many, I am acutely aware of the current global challenges – the draconian regulatory overreach, widespread lockdowns, school closures, and massive inflationary monetary policies, coupled with evidently unsustainable fiscal policies. These phenomena have been prevalent in both Europe and North America, painting a somewhat grim picture of our present circumstances.

Additionally, I have long maintained a sceptical view of China’s economic trajectory, predicting a significant deceleration in its growth. Back in 2014, on this very blog, I expressed doubts about China’s potential to become the world’s largest economy, citing numerous indicators pointing towards a stagnation in growth.

Time has proven these predictions accurate, and the trend seems set to continue unless there is a radical shift in the Communist Party’s approach towards market reforms, democracy, human rights, private property, and free enterprise. Despite the passage of time, my optimism on this front remains reserved.

Equally concerning is the threat from Putin’s Russia and Europe’s heavy reliance on Russian oil and gas, not to mention the increasing trends towards de-globalisation and the sharp escalation in geopolitical risks. In many respects, the current global landscape mirrors the challenges of the 1970s, characterised by geopolitical tensions, economic stagnation, and high, unstable inflation.

However, just as the 1970s gave way to the 1980s, marked by significant supply-side reforms in both the US and Europe, and the adoption of more rule-based fiscal and monetary policies, there is potential for a similar transformation in our current era. These reformative trends, which continued into the 1990s, further accelerated economic growth, suggesting a potential pathway out of our current predicaments…

…and into a future marked by renewed economic vitality and technological progress. It’s essential to recognise that despite the apparent parallels with the past, the world of today is fundamentally different, particularly in terms of technological advancements and global interconnectedness.

I am reminded of my youth in the 1990s

In 1995, I obtained my Economics degree from the University of Copenhagen, shortly after the end of the Cold War.

This period heralded a significant opening of the global economy, with the benefits of a rule-based economic policy, low inflation, and healthy public finances becoming increasingly evident in the latter half of the 1990s and the early 2000s. These developments were not only authentic but also marked a gradual yet transformative shift in the global economic landscape.

The rise of the internet and mobile telephony during this period also represented true technological milestones. Initially, I, like many economists, was slow to recognise the full potential of these advancements and in that sense, I probably was not much different from Paul Krugman, who famously said, “By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.”

Economists often view technology as a ‘residual’ – a component of growth unexplained by increased labour or capital. However, its critical role in driving growth is far more significant than traditional metrics might suggest.

Despite the challenges of recent years, including the 2008 financial crisis and its aftermath, the drastic responses to the pandemic in 2020-21, and the geopolitical tensions arising from Russia’s actions and China’s authoritarian shift, there is, therefore, reason for optimism.

The year 2023 has witnessed two notable technological breakthroughs: Novo Nordisk’s weight-loss medication and OpenAI’s ChatGPT.

These innovations have the potential to drive significant societal and economic benefits, mirroring the transformative impact of the internet and mobile technology in previous decades. In fact, they might even represent bigger, positive, and long-lasting supply shocks to the global economy.

These developments underscore the importance of technology in overcoming regulatory and economic challenges.

AI will be everywhere in 2024

AI offers the promise of significant productivity enhancements across various sectors, including finance, law, and healthcare. By embracing these technologies, we can potentially address some of the most pressing issues of our time, such as healthcare efficiency and financial regulatory compliance.

As we approach 2024, it’s clear that we are at the cusp of a new era, one that is likely to be characterized by significant productivity boosts from both medical and technological advancements. This potential for growth and improvement, despite the current geopolitical and economic challenges, provides a strong basis for optimism.

Just to give an obvious example of where AI will be making a huge difference – banking. Today, probably 10-15% of all those employed in the European banking sector work with compliance, dealing with anti-money laundering and ensuring banks uphold the enormous amount of financial regulation that has been implemented globally since 2008.

I think it is very likely that the implementation of AI in the banking sector (and the wider financial sector) will significantly reduce the effective burden of this regulation, and I would not be surprised if within the next 1-3 years, we see many banks improve productivity by 10-20%.

We are likely to see this type of productivity gains in other sectors as well. For example, I find it hard to think of any law firm in the US or Europe that will not, within the next year, implement AI as a completely integrated part of their daily work.

Similarly, we are already seeing examples of AI effectively conducting diagnostics on patients better than many doctors in various fields, and going forward, AI has the potential to completely transform global healthcare systems. Perhaps we can finally make a real leap towards prevention rather than treatment of illness.

So AI on its own offers an enormous potential for boosting productivity growth in nearly all sectors of the economy. But that is not the only innovation that is presently boosting global growth.

Novo Nordisk: Boosting the World’s Weightiest Economy

The Danish pharmaceutical company Novo Nordisk – now Europe’s largest company measured by stock market capitalization – has significantly impacted the Danish economy and is set to continue doing so. Its influence, however extends beyond Denmark, particularly through its diabetes and weight-loss medications, Ozempic and Wegovy, with potential significant impact on the global economy, especially the American economy.

Obesity, particularly severe obesity, involves enormous healthcare costs. In the United States, the rate of obesity has increased markedly since the 1980s. Now, approximately 40% of the population is obese, leading to stagnation in average life expectancy and making obesity-related diseases like diabetes and heart disease among the leading causes of death.

A Danish study from 2021 showed that healthcare costs for obese individuals are double those for individuals of normal weight, significantly contributing to the national healthcare burden in Denmark. The reduction of severe obesity through medications like Ozempic and Wegovy could provide a substantial economic boost.

Obese individuals are also less productive, more likely to be unemployed, and earn lower wages. This translates into substantial economic impacts, such as higher rates of work absenteeism among severely obese workers compared to their normal-weight counterparts.

A reduction in obesity in the U.S. could lead to an improvement in the economy. Halving the number of obese individuals could result in a 2% increase in overall wages and a significant rise in GDP if we assume as numerous studies shows that obese women have salaries 10% lower than normal weight women (corrected to age, education and experience).

While the widespread adoption of weight-loss medication in the U.S. is uncertain, especially considering its cost, the potential impact on the U.S. economy is substantial.

From a financial market perspective, increased American economic growth could be reflected in various sectors, particularly healthcare. However, industries like fast food might experience a downturn, as observed in the recent decline in American food and beverage stock prices, coinciding with the rise in Novo Nordisk’s stock.

The potential macroeconomic effects of Novo Nordisk’s medications are significant, not just for healthcare but for consumer spending patterns as well. A shift in spending away from food could redirect funds towards other sectors, potentially balancing the cost of the medication.

In conclusion, Novo Nordisk’s innovations in diabetes and weight-loss medications hold the potential to significantly influence not just the Danish but the global economy, particularly the U.S. Their potential to reshape consumer behaviors and the broader economic landscape is a development worth close attention from both economists and financial market analysts. This underscores the broader theme of our discussion: the transformative power of technology and medical advancements in shaping our economic future.

How it looks in an AS/AD-model

Hence, we have two major positive supply side shocks playing out at the moment and we should expect them to play for some time to come.

We can illustrate that in a traditional AS/AD model (but in growth rates rather than in levels). In the model, we assume that the impact of anti-obesity medicine and AI will have longer-lasting effects on productivity growth and will play out for some time, which we illustrate in the model as a positive shock to the long-run aggregate supply curve (LRAS).

In this model, the vertical axis represents inflation rates, and the horizontal axis shows real GDP growth rates. The initial long-run aggregate supply curve (LRAS) is at point A, where inflation is at p0 and real GDP growth is at y0.

The positive supply shock from the effects on the labor market and the reduced healthcare costs pushes the LRAS curve from LRAS₀ to LRAS₁, which in turn pushes down inflation to p₁ and pushes real GDP growth up to y₁ (point B). This is essentially a simplified version of the real business cycle model where growth is driven by productivity gains and shocks rather than by aggregate demand shocks.

The important thing to notice here is that we are seeing both growth re-accelerate and inflation continuing to decline. If this scenario plays out, I would certainly not be surprised to see US inflation inch down toward 1% and real GDP averaging 3% or more throughout 2024.

This certainly looks like a bit of a goldilocks scenario, but nonetheless, I think that it is a probable scenario for the next 1-2 years. However, it is also a scenario that could challenge the Federal Reserve in the sense that inflation in this scenario will drop below and remain below 2% without any signs of a slowdown in US growth. In fact, we will likely see the opposite.

And this is in many ways what the markets are telling us at the moment with both market inflation expectations inching down and the US stock market continuing to move higher. There can be a number of reasons for this, but it is normally so that when inflation expectations decline the absence of financial market volatility then it is normally good news – news of a positive supply shock.

It should also be noted that while for example the fall of communism starting in 1989 and opening of the global economy was a quite gradual process that last at least 20 years. On the other hand he impact of Wegovy is happening right now and I personally doubt that obesity will be a major global health problem in 10 years and we can only imagine the impact of AI, but it is happening right now and similarly I think we will see the impact on productivity of implement of AI in for example he banking sector very, very fast.

If anything – and I rarely try to second-guess the markets – the markets are not optimistic enough about growth. That being said we are here talking about macroeconomics – not necessarily where markets are headed from here, but I must admit that I am significantly more optimistic about 2024 than I was about 2023 so enjoy the coming productivity boom and happy new year!

Lars Chrisensen

lacsen@gmail.com (contact for media requests and advisory work)

+45 52 50 25 06

For speaking engagements and workshops contact my speaker agent Youandx here.

In an unprecedented move that echoes through the financial world, China has tightened its grip on economic discourse, effectively outlawing negative narratives surrounding its economy. This development came to light in reports circulated by Bloomberg among others on Friday.

According to a memo from the Chinese Ministry of State Security:

“To maintain economic security, we must unswervingly adhere to the socialist economic system… Currently, the economic field has increasingly become an important battleground for competition among major powers, and the international environment is becoming more complex, serious, and uncertain. To promote economic recovery, we must overcome internal difficulties and face external challenges. For example, various ‘clichés’ that intend to sing about the decline of China’s economy continue to appear, which are fundamentally an attempt to use false narratives to build ‘discourse traps’ and ‘cognitive traps’ about ‘China’s decline’ to attack the socialist system with Chinese characteristics.”

In essence, this is a direct command to cease the publication of any pessimistic stories about the Chinese economy, or risk arrest.

This directive also signifies a not insignificant danger for economists and economic journalists in China. How can international banks, for example, those in Shanghai, write commentaries on economic indicators if the figures are not as expected?

For instance, according to November’s consumer price data, China is experiencing deflation—a far cry from good news. To avoid punitive measures, one must either ignore the figure, misrepresent it, or assert that what is bad is, in fact, good.

Having dealt with emerging market economies for over two decades, skepticism towards the accuracy of published data is normal, but I’ve always believed that the discussions around these figures among local Chinese economists were somewhat valid, even if the actual numbers were not always trustworthy.

China’s trajectory towards the suppression of speech and information freedom increasingly mirrors that of North Korea, and it also distinctly suggests that those of us who have been (very) skeptical of China’s economic progress were correct.

As an independent economic advisor, I’ve advised economic-political decision-makers in countries where the press is anything but free. My experience tells me that in such countries, even the powers that be have no real idea of the state of the economy due to the lack of public debate.

This is the path China is rapidly heading down, and it will only worsen the quality of its economic policy.

Therefore, my clear advice to Western companies and investors is this – exit China sooner rather than later.

I regularly hold lectures on China’s economic crisis. If your company wishes to engage with the crisis, I am also available to facilitate internal workshops on the subject. See more information here or drop me a mail (lacsen@gmail.com).

Appendix: Embracing AI in Economic Discourse

I have been using Midjourney to create AI-generated images and illustrations, often with a humorous touch, for my writings and lectures.

While that has been reasonably successful, Midjourney’s interface is not conducive to creativity and back-and-forth interaction with the AI.

However, with the integration of DALL-E into ChatGPT 4.0, the ability to create illustrations has significantly improved.

This morning, I wrote a brief article on Chinese censorship of poor economic data and needed a humorous illustration to accompany it.

So I requested assistance from ChatGPT/DALL-E. Given that the AI could read my article, it produced a draft for a humorous illustration based on it. Below are some examples of what the AI generated.

I find the results quite impressive and funny. However, notice that there are spelling errors, a problem also known from Midjourney (where it is somewhat worse), but I consider these teething issues. Very soon (within a few months), this problem will be resolved—at least judging by the speed of development we’ve seen so far.

Afraid of losing your job to AI? Don’t be – it’s time to embrace technology. It’s fun and enables you to produce a far superior product. Personally, I believe it greatly rewards creativity.

But first, take a look at DALL-E’s quite brilliant humorous illustrations of Chinese censorship. We conquer censorship by confronting it – and laughing at it.

In the ever-evolving dance of monetary policy, the Federal Reserve’s latest meeting has struck a new chord, setting in motion a fascinating interplay of market forces and policy expectations. As an economist deeply engaged in the intricate mechanics of monetary and market dynamics, I find this unfolding scenario a compelling narrative, rich in lessons and insights.

The Fed’s Recent Stance: A Prelude to Change

On December 13, 2023, the Federal Reserve, amidst signs of slowing economic activity and persistent inflation concerns, maintained its federal funds rate. The decision, layered with the Fed’s unwavering commitment to a 2 percent inflation target, reveals a complex picture of resilience and caution in the face of evolving economic indicators.

Scott Sumner’s Perspective: A Friend’s Insight on Monetary Leads

My friend and fellow market monetarist economist Scott Sumner offers a riveting counterpoint to Milton Friedman’s view of monetary policy’s “long and variable lags.” Sumner advocates for the concept of “long and variable LEADS,” a theory exemplified in the recent market reactions.

The mere anticipation of future policy shifts, as suggested by the Fed, has already sparked significant movements in bond yields and stock markets, even before any tangible policy changes.

A Vibrant Analysis: VAR and the Market’s Symphony

To delve deeper into these dynamics, I turned to a VAR (Vector Autoregression) regression analysis. This technique, executed with the assistance of ChatGPT 4.0 and its integrated Python modules, shines a light on the intricate dance between stock prices, housing market trends (using the Case-Shiller index), and nominal GDP.

Let’s take a moment to visualize this intricate dance. The graph below is a representation of the analysis, shows a gradual ascent in housing prices following a positive jolt in stock prices. This upward trajectory sustains above the baseline trend for approximately seven quarters, echoing Friedman’s narrative of a lagged response. Meanwhile, the housing market’s delayed reaction to the financial sector’s immediate moves provides a fascinating spectacle of economic interplay.

The Ripple Effects: From Financial Markets to Real Economy

This narrative of leads and lags in monetary policy is not just an academic curiosity; it paints a vivid picture of the ripple effects across different economic sectors. Financial markets, quick to respond to the Fed’s signals, contrast with the more measured pace of the housing market and broader economic indicators like GDP and inflation.

A Call for Clarity: The Case for Rules in Monetary Policy

This intricate ballet of immediate market reactions and delayed economic responses underlines the wisdom in Friedman’s call for rules-based monetary policy. The lingering effects of 2022’s monetary tightening are intertwined with anticipations of future easing, illustrating the delicate balance central banks must navigate.

In Conclusion: The Art and Science of Monetary Analysis

In essence, the recent FOMC meeting and the ensuing market dynamics offer a rich tapestry of insights into the multifaceted impact of monetary policy. The interplay of immediate and delayed responses, as seen in financial and housing markets, provides a deeper understanding of the timing and scale of policy effects. As we continue to explore these complex rhythms, tools like VAR regression, augmented by AI innovations like ChatGPT, become indispensable in deciphering the nuanced dance of monetary policy.

Acknowledgements

A hat tip to ChatGPT 4.0, a pivotal partner in this analytical journey, underscoring the burgeoning role of AI in the realm of economic research and exploration.