Christmas 2022 Newsletter

2022: A Roller Coaster of a year

Let’s start with the positives. The England Lionesses won the European football championship in front of a sold-out Wembley Stadium, bringing “football home”. It was also the year when the UK’s Space Man came second in the Eurovision Song Contest, with the result that Liverpool will host the event in 2023 on behalf of Ukraine. No more nil points from now on. And talking about space, NASA managed to deflect an asteroid from its trajectory so that humanity will not suffer the same fate as dinosaurs did a few hundred million years ago.

All that said, 2022 will enter the history books mainly for the wrong reasons. We had continued supply shortages caused by the Covid-19 pandemic (remember it?), had to get used to a war on our footstep in Europe and experienced soaring inflation leading to dramatic falls in living standards. On top of that we had record high temperatures and droughts, a meltdown in the UK gilts markets as a result of the “mini budget” and the third once in a hundred year economic shock in just over a decade. Most commentators also felt that COP27 had been a bit “meh”. At least the world – just about – reaffirmed its commitment to limiting global temperature increases to 1.5 degrees above pre-industrial levels.

A year of unprecedented macroeconomic challenges for economic policy makers

2022 presented unprecedented challenges for economic policy makers, especially those involved in big-picture macroeconomics. How do you respond to the third catastrophic economic event in just more than a decade, with the 2022 energy crisis and price shock following hot on the heels of the 2020-21 crisis caused by the Covid-19 pandemic and before that the 2007-09 global financial crisis?

The macroeconomic context is arguably more complex now than it was during the previous two crises, when economic stimulus in the form of big fiscal deficits and ultra-loose monetary policy saved the day. This time round macroeconomic policy makers are faced simultaneously with a sharp slowdown in economic activity – most likely resulting in recessions – and double-digit inflation rates not seen for more than a generation. While finance ministers want to provide fiscal support to the economy and help households deal with soaring energy costs, central bankers are raising interest rates to bring inflation back under control. This has the potential to go badly wrong. Macroeconomic policy coordination is clearly more important than ever.

The energy crisis versus climate change – an even bigger challenge

As big as these challenges are, they might turn out to be small relative to the challenge of mitigating climate change. The world community is nowhere close to reducing global carbon emissions consistent with the 2015 Paris Agreement to limit global warming to “well below” 2C above pre-industrial levels, never mind 1.5C. At least governments reaffirmed their commitment to these targets at COP27 though there was some pushback even on that.

The energy crisis has more or less done the job of carbon pricing schemes, with gas and electricity prices soaring towards levels required to encourage the energy transition. With this in mind and facing a cost-of-living crisis, what should policy makers have done?

As any microeconomist will tell you, subsidising retail energy prices – in some cases so much so that it might lead to an increase in energy consumption – would probably not be the optimal policy response. This is, however, what many policy makers aimed for.

An alternative policy response would have been to leave relative prices unchanged – high energy prices mainly reflect a sharp drop in energy supply after all – and provide direct budget support to households instead. Households would have had the financial means to deal with the significant increase in energy prices but would also have been incentivised to reduce energy consumption, consider renewable energy sources and use the additional money to buy something else – thereby supporting the economy.

And as we discussed in the Autumn 2022 newsletter, governments could also claw back excessive profits in the energy industry as these profits are the result of massive government intervention in markets. What else are unprecedented economic sanctions on one of your most critical energy suppliers after all? It is good to see that this is now happening in most countries.

EU countries are currently embarking on another interesting experiment to test some basic microeconomics. How big is the EU’s bargaining power as a buyer of natural gas in the global markets? We normally hear about abusive market power on the supply side – think OPEC – but price fixing on the demand side is rare. Could EU countries really impose a maximum price they are willing to pay for natural gas on the global markets? Some governments are concerned that supply might just go elsewhere, others believe that the EU has enough market power to dictate prices. We suppose there is only one way to find out…even though now might not be the best time to test some market concentration hypothesis.

Inflation – will it stay or will it go?

One of the biggest puzzles and challenges facing policy makers currently is what to do about inflation. We asked in the autumn newsletter how high can inflation go? …

It may not surprise you to know that economists themselves are not in agreement on what will happen with inflation. Some think that inflation is here to stay as imported inflation had entrenched itself as domestic inflation. The latest ONS wage statistics would support this. Others think that we might soon be back in a world of deflation as inflation drivers such as Covid-related supply bottlenecks and energy price spikes as a result of the war will soon fall out of the statistics.

Depending on your view, the monetary policy response will be fundamentally different. We would argue that we just don’t know. But we should perhaps not forget that only a few years ago economists believed that deflation was the biggest threat to the global economy and that it takes a while – macroeconomic textbooks would tell you around 18 months – for monetary policy to have its full impact on the economy.

Incidentally, if you think you know the answer, HM Treasury is currently looking for a new external member to the Bank of England’s interest rate setting Monetary Policy Committee.

The (previous) Government’s growth agenda – capital markets say “no”…

2022 will certainly be remembered for Liz Truss’s flagship going for growth strategy… with the capital markets just saying “no”. With the orthodox capital markets concerned about the sustainability of the government’s spending and tax plans, UK government bond yields rose sharply (nearly leading to a meltdown in UK defined-benefit pension schemes) and Sterling nearly reached parity with the US dollar.

For economists this episode demonstrates what can happen when policy makers lose credibility in the capital markets, an experience normally reserved for politicians in emerging economies. This was a new experience for the current generation of politicians (though some might recall the 1976 IMF bailout or the 1992 Sterling crisis). You just cannot take credibility for granted. Rubbing salt into an open wound, the Bank of England followed up on the government’s growth strategy by suggesting that the UK was about to enter the longest recession in a century. Just days before the turmoil in the capital markets, we argued in our Autumn 2022 newsletter to “expect debt sustainability to play a greater role in the policy debate again in the future.” Who could have imagined that this issue would cost the prime minister her job so quickly?

Sport and video gaming – economics and finance in action

When you are tired of economics and the real world you can always watch some sport or play some video games. But money talks in sports and video gaming as well though. If you are (still) watching the FIFA world cup now taking place in Qatar or watching your favourite players such as Haaland in Manchester City or Messi & Co in Paris St Germain it is strange to think that they are mainly asset positions in diversified portfolios of major Sovereign Wealth Funds or other investors. And while we expected a major gender wage gap in professional football, we were surprised to read that Premier League players apparently earn in a fortnight what women earn in the Super League in a year – a factor of 25!

If you think football is about big money, just watch the growth in the video gaming industry. According to the Economist, Call of Duty: Modern Warfare II, the most popular game of 2022, made as much money in its first ten days as Top Gun: Maverick, the most popular film of the year, made in its first month. Global revenue of the games industry is about five times that of the film industry.

In early-2022 Microsoft, the producer of the popular Xbox console, agreed to take over Activision-Blizzard, the producer of Call of Duty, for $69bn in its biggest ever acquisition. We talked about it in the Autumn 2022 newsletter. Regulators, including the UK’s Competition and Markets Authority, have been scrutinising the proposed takeover. Following its very own call of duty, the Federal Trade Commission, the US competition regulator, is now seeking to block the acquisition. In previous newsletters we talked about the clash of Epic Games, the producer of Fortnite, and Apple over the charging structure on the Apple app store. In the end, Epic Games couldn’t convincingly prove that Apple was abusing its market power, so lost the argument for now.

You just cannot escape economics and finance…even in sport and gaming!

Economicsense begins delivering SPE Courses

Since January 2022, Economicsense has been delivering SPE Courses, the development training programme for the Society of Professional Economists. Courses delivered in 2022 included Introduction to Python for economists led by Paul Wohlfarth, Cost-Benefit Analysis with Applied Example led by Catherine Connolly and Macroeconomics Refresher and Update with Andy Ross. It was particularly good to run courses face to face again, alongside our popular online delivery.

Economicsense wishes you a Merry Christmas and all the best for 2023

Finally, to the most important part of this Christmas newsletter. We at economicsense wish you all a Merry Christmas and all the best for 2023. We wouldn’t dare to make predictions but expect 2023 to remain turbulent, so fasten your seatbelts.

We very much appreciate your custom, and we are always keen to hear from newsletter readers with any suggestions you might have. The 2023 events and courses programme is currently being put together and will be available in the forthcoming Winter 2022/23 newsletter.