Where is the economy heading in 2019? Changes in economic growth are much less volatile than the performance of stock markets. In order to forecast what will happen in an economy it is better to focus on the fundamentals, which is to say, examining causes rather than effects. In my forecast for 2018, I included as a factor of my optimism the increase in value of U.S. stocks during the first years of the presidency of Donald J. Trump. This year I include in my analysis the bumpy downward ride of stock prices in late December. In most of 2018, the wealth effect had a positive impact on consumption, which led to a third-quarter GDP growth of 4.2 percent, the largest we have seen in years.

Economist Judy Shelton, the U.S. director of the European Bank for Reconstruction and Development, recently remarked in a CNBC interview: “There is a real disconnect between the behavior of the financial markets and the underlying real economy which I think is in real good shape, especially in the United States.” The sharp decline and volatility of the U.S. stock market during the end of 2018 isn’t reflected by similar negative movements in the real economy. But the real economy will have to adjust to a scenario of higher interest rates, poor economic growth among the relevant U.S. trading partners and increased uncertainty about the future of U.S. economic policy.

Regarding the impact of the reaction of the stock market and the rise of interest rates, I again quote Judy Shelton, who summed it up well: “We are seeing the effects of reversing quantitative easing. We know that it was going to be a little bit tricky, we reap what we sow. And when you expand the money supply you are going to push up the market trying to create the illusion of wealth. It then goes the other way,” she added. “[I]t is very difficult to normalize when you have such a distorting effect on the economy.” Along the same lines, Daniel Lacalle, a noted Spanish economist, argues that “we are entering into a phase of getting out of the excess created by the Central Banks and looking back at fundamentals.”

When assessing an economy I pay attention to economic freedom. Freer economies tend to be more prosperous. Here the measurements differ somewhat. For the United States in 2018, the Heritage/Wall Street Journal Economic Freedom Index shows a level of economic freedom similar to 1998. Economic freedom edged upward until 2008, and then down until today. Next year’s index will likely show improvement in taxes and regulations but deterioration in government spending and trade. The Fraser Institute index, which is produced with a two-year lag (the 2018 index reflects the 2016 scores), shows the United States already improving under the last years of Obama and a Republican Congress.

The Heritage index shows the United States slightly behind Western Europe in the area of monetary freedom. The Fraser index, however, shows the United States with an almost perfect sound money score, 9.85, surpassed only by Switzerland and Denmark. This index, though, does not capture the negative effects of monetary manipulation in a free economy. To quote Dr. Shelton again: “This whole exercise in monetary expansion has elevated the role of government into the private sector. And I think even now, the fact that the market just hangs on the most subtle, nuanced statements from a central banker just tells you that we turned the handful of people who have some influence over interest rates into something like the Wizard of Oz, the great and powerful, and it distracts us that from the fact that the economy is so much more than that, the real economy is people working and it’s the creativity and there are so many good things that are helping the real economy like the lower taxes, the less regulations. We just need stable money and I think that free enterprise would just cultivate and unleash all of the entrepreneurial zeal that it is still out there. And we are already seeing it in the strong growth rate. We are easily distracted by the shenanigans in the financial markets.”

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