INTRODUCTION

Uncertainty is everywhere, but especially when it comes to the economy. Concerned that the weather might disrupt weekend plans? There’s an app for that. But there’s no app for the uncertainty that really counts. Is my job secure? Will I earn more next year? Can I afford to purchase a home? Will I ever be able to afford one? Is now the right time to buy? Is the money I have set aside for a down payment growing? Is the stock market about to collapse? What will the interest rate be when I renew my mortgage? Should I renew for a short or long term? How long will I live—will I have enough savings for my retirement? And why is the price of gasoline so high this week, by the way? These questions pertain to important personal life decisions that have long-term consequences. We all live in the economy.

These everyday questions are difficult enough for individuals, but they are even harder for companies, which have more factors in play. Indeed, the quality of their decisions will determine not only their future but also whether you do still have a job tomorrow. To maintain a viable business that offers secure employment and ongoing profitability, companies must make forecasts about future economic trends such as sales, prices, interest rates, and exchange rates. They translate those estimates into a business plan that covers hiring, orders for raw materials, equipment purchases, expansion plans, and so on. They also must develop a corresponding financial plan, supported by a bank and perhaps public equity or bond markets.

In short, employers and employees face the same economic uncertainties together. Economic growth versus recession, the rate of inflation, the level of interest rates, the exchange rate, the stock market, job creation or cutbacks, salary levels, the state of the housing market, prospects for government spending and taxes, and so on—it matters to us all. From the street level, some macroeconomic concepts may seem abstract, but they are ingredients in all of our major economic decisions: whether to work and where, where to live and how, what to buy and when, when to borrow and how much, when to hire and when to fire, and when to take a chance and expand the business. Economics is the air we all breathe and the water we all swim in.

You don’t need an economist to tell you that economic instability has risen in recent years. That means it is becoming a lot harder to make plans for the future. The question often posed is whether things will ever return to normal. The book-long answer to that question is that “normal” is not what most of us think it is. The short answer is we should expect even more volatility in the years ahead, not less.

A future with greater economic volatility means that things could turn out either worse or better than we expect and that the range of possible outcomes will expand. We all instinctively loathe uncertainty, even when we understand that it is two-sided, meaning that it can bring not just bad luck but sometimes good. Uncertainty is stressful. We make fresh economic decisions every day based on our expectations about the future. And the wrong decision is only going to get easier to make.

When economic uncertainty increases, so do the risks associated with making the wrong decision. The forces acting on the economy will produce more frequent and larger fluctuations in employment, inflation, house prices, interest rates, and stock markets in the future. For example, when buying a house, we will need to consider that the risk of losing our job, and therefore possibly losing the house, will be greater than it has been in the past.

In short, the more uncertain our future becomes, the more risk we take on when we make everyday decisions. How do people make decisions in the face of uncertainty? We base our decisions on our own average past experience, expecting the future to follow course. In other words, if things seem unusual right now, most of us expect that things will return to normal. But how confident can we be of that? The more uncertain we are, the more stressful that decision becomes. We may seek advice from family, friends, or experts to relieve the stress of the unknown.

Experts are a special breed. They don’t form expectations like the rest of us do; they make forecasts based on a much wider information base, including an understanding of economics, reams of data, and computer-driven models to predict outcomes. They spend all day trying to understand these things, while the rest of us do our regular jobs and try to understand the world on evenings and weekends. We read newspapers, books, search the web, or watch business news shows to access a wide array of experts to help us understand how the world works. There are many experts on the economy, and even more opinions than there are experts. There is too much information available to us on the economy, much of it loud, excessively confident, and contradictory besides. Experts aren’t always right. And there are things experts just can’t know.

During my time as governor of the Bank of Canada, I made a habit of being honest about uncertainty in our economic outlook. This is especially important after the economy is hit by a significant disturbance, as economic models can easily lead us astray. A good example was the Global Financial Crisis of 2008 and the Great Recession that followed. Canadian exports fell dramatically and the situation was made even more difficult by a rising Canadian dollar, which eventually broke above parity in 2011, forcing many Canadian export companies out of business. As the dollar moved steadily lower in the next few years, economists expected Canadian exports to recover. This forecast was wrong because so many of the export companies no longer existed. Economists’ models were simply not equipped to account for company destruction on such a scale. This experience illustrated perfectly that economic forecasts should always be interpreted as the midpoint of a range of possible outcomes—sometimes a wide range of possible outcomes. A forecast is only an expert’s guess, usually supported by models based on historical data. Economists are a lot like scientists in that we take in a lot of information and come up with an hypothesis for how the economy works. But while a scientist can test an hypothesis in the lab, economists and central bankers can only develop models based on past behaviour. As a consequence, those models work best when the future resembles the past.

This book was written in the wake of the COVID-19 pandemic, a case study in extreme economic uncertainty. From my vantage point, the situation looked and felt like chaos. For several weeks in spring 2020, my life consisted of an erratic and relentless sequence of virtual meetings, at all hours of the day, all taken from my rarely used home office using an internet connection of questionable reliability. Financial market programs and monetary policy tools were deployed on the fly, with most of us guided by instincts rather than actual data.

Whenever something extreme happens to the economy like that, economists are immediately called upon to opine on what it may mean for the future. Personally, I had very little confidence in our ability to predict how the pandemic would affect the global economy, and yet, as usual, confident forecasts about the future were not in short supply. The vast majority were predicting a major economic convulsion, one that would last for a long time. I was skeptical. Perhaps it was my sunny disposition rising to the surface, but I had the sense that economies would show some resilience. The situation reminded me of September 11, 2001, and the confident pronouncements in the wake of that event, some that very day.

“People will never travel again,” said some economists. “The global economy will see a deep and prolonged recession,” said many. I was chief economist at Export Development Canada (EDC) at the time, and I still remember wrestling with forecast uncertainty then. As it turned out, we realized that uncertainty itself was the most useful insight. We called our forecast update “The New Age of Uncertainty,” to acknowledge that the future may never be as certain as it had seemed in the past. I carried a copy of John Kenneth Galbraith’s 1977 book The Age of Uncertainty with me as a prop for the next few weeks as I delivered some twenty public speeches setting out our thinking on the future. We did not call for a global recession but said that increased uncertainty would throw sand in the wheels of international business. Business risk would be higher in a world in which the risk of terrorism was ever-present, and companies would adapt. For the record, the world economy did not experience a recession after 9/11; it picked up speed.

Galbraith’s book was written during 1973 to 1977, a time of great uncertainty for the economics profession as the concept of “normal” was being upended. The arrival of the baby boom generation in the global workforce was disrupting labour markets. The price of oil sky-rocketed in the wake of the Arab oil embargo, creating convulsions in oil-importing countries. The international monetary system in place since the end of World War II—under which most national currencies were fixed against the U.S. dollar, which was locked to a fixed price of gold—broke down, and exchange-rate volatility erupted. These were gigantic shocks to the world economy and represented a fundamental shift in what previously had been regarded as “normal.” What emerged was a combination of rising inflation and rising unemployment, an outcome the economic models of that era had never predicted. Clearly, something had gone wrong.

Over the next decade, those models were given a complete rethink. A new generation of models was emerging while I was in graduate school in the late 1970s. This was Galbraith’s point: economics had always progressed from one big new idea to another, to another, and each time the new idea’s proponents delivered it with absolute but unjustified conviction.

This critique of economists did not originate with Galbraith. He quoted none other than John Maynard Keynes himself, from the very last paragraph of his 1936 book The General Theory of Employment, Interest and Money:

. . . the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.

When the world changes, economic theory must change with it. Economists who fail to adapt will be wrong, and so will everyone who follows them.

While history may not always repeat itself, it often rhymes, as famously pointed out by Mark Twain. As financial markets calmed in the late spring of 2020, I found myself thinking again about economic forecasts made at important turning points in the past and how wrong they had turned out to be. Not just in the decimal points but even in direction. The only reasonable interpretation of such forecast errors is that these major events had altered our economic foundations. Our theories had lost their power to predict the future.

Economists all carry in their minds a foundation for the economy, a conceptual set of elements and relationships between them that will be constant through time. The economy is always being disturbed by one event or another, so it is rarely observed in an unchanged setting, but this foundation is the place to which the economy will gravitate after a disturbance. Economists refer to this as a long-term equilibrium or steady state. Economic models are based on this foundational structure and attempt to explain the fluctuations around that steady state that the economy experiences. And the model is used to forecast how the economy will return to that steady state from today’s starting point. Given the magnitude of the COVID-19 shock, I wondered what constants in the economy we could rely upon to act as an anchor for the future, a resting position to which we would return, once the pandemic was behind us.

I soon realized that there may be very few such constants in our economy today. I had been thinking about the destabilizing effects of long-term forces acting on the economy since 2019. That year, I had the honour of outlining my early thoughts on the subject in the marquee lecture at the Spruce Meadows Changing Fortunes Round Table, an annual high-level international gathering of business leaders and policymakers, begun by the late Ron Southern over twenty years ago and continued by the Southern family. As I prepared for that lecture, I came to understand that several of our key economic foundations are not constants—they are actually in motion—and their force would shape our future. This book grew out of that Spruce Meadows lecture.