Once ideas about how to run the economy are entrenched, it may take generations to dislodge them. Something big usually has to happen to tip politics in another direction. Something like Covid-19. In 2020, when the pandemic struck and economies around the world went into lockdown, policymakers effectively shorted the business cycle without thinking twice.
The Great Recession that followed the 2008 crash had already sparked reflection. But the overall approach came out relatively intact. Basically, this approach prioritized reducing inflation and managing the pace of economic growth by adjusting the cost of private borrowing rather than spending public money.
The pandemic has put these conventions aside around the world. In the new economy, fiscal policy has taken over from monetary policy. Governments channeled liquidity directly to households and businesses and ran record budget deficits. Central banks have played a secondary and supporting role: buying back public debt and other booming assets, keeping borrowing costs low, and insisting that now is not the time to squeeze in. ‘worry about inflation. While the flight of orthodoxy was most pronounced in the richest countries of the world, versions of this shift also occurred in emerging markets. Even institutions like the IMF, which have long followed old rules of fiscal prudence, have preached the benefits of government stimulus.
In the United States, and to a lesser extent in other developed economies, the result has been a much faster recovery than after 2008. This success opens a new phase in the struggle for politics. Lessons have been learned on how to get out of a crisis. Now is the time to figure out how to handle the boom.
For centuries, theorists have looked at the recurring and inevitable fluctuations that make up the business cycle. According to traditional laws of the cycle, it would have taken years for households to recover from the sudden collapse in economic activity in 2020. Instead, the US government stepped in to protect them from its worst effects of a a way that hadn’t really been tried before: by replacing wages that millions of newly unemployed Americans no longer received from employers.
But the policies of the pandemic era were also shaped by the regret, which had accumulated over a decade, about the response to the last crisis of 2008. In retrospect, economists have come to view this response as unbalanced. and inadequate. Bank bailouts fixed the financial system, but little was done to help homeowners in debt, and household incomes may have fallen.
The new pandemic economy has also protected the financial system, but from the bottom up rather than the top down – a point repeatedly emphasized by Neel Kashkari, who helped lead the rescue as a US Treasury Department official in 2008 and who is now the head of the Federal Reserve Bank of Minneapolis. As their jobs disappeared in the spring of 2020, Americans struggled to pay rent, pay mortgages, and cover car payments. Without the government’s efforts to replace lost income, the health crisis that had already triggered a jobs crisis would have turned into a financial crisis.
“How did the Americans pay all their bills? It’s because Congress has been so aggressive “with fiscal stimulus, Kashkari said in October on CNBC.
After an initial spike in spending, many countries quickly switched to budget limits in the years following 2008, driven by concerns about rising public debt – a trend that was most pronounced in Europe. In the United States, state and local government cuts have resulted in massive job losses. In both cases, relatively high unemployment and low growth rates persisted for much of the decade. In 2020, the austerity doctrine quickly receded around the world. Germany, where politicians and central bankers have long been obsessed with fiscal discipline, has abandoned a rule requiring balanced budgets and abandoned its opposition to joint borrowing with other eurozone countries. The depth of the Great Recession and the slow pace of the recovery put issues such as economic inequality and racial justice in the spotlight. Wealth and income gaps have widened since the 1980s as government intervention in the economy was supplanted by over-reliance on the free market.
Direct payments to low-income households could be a powerful new tool to protect people at the bottom of the economic ladder from the destruction of wealth that always accompanies downturns. Now that they’ve been used in one recession, it will be hard to say they shouldn’t be used in the next, according to JW Mason, associate professor at John Jay College of Criminal Justice.
“If you can replace 100% of the lost income in a crisis like this, why not replace 100% of the lost income of people in every cyclical downturn?” he says. “What’s the excuse for saying this because we have some kind of financial crisis that ordinary people should see their standard of living drop?” The importance of these transfer payments during the pandemic highlights another big change in the economy: the transfer of power from monetary policy to fiscal policy and the declining role of the central bank in fighting inflation. And while the new economy has the makings of an updated framework for dealing with recessions, it still has to tackle the potential problems posed by soaring growth.
Advocates believe inflationary pressures, the type that the 1980-2020 political paradigm was designed to contain, just aren’t going to happen anytime soon. If inflation risks materialize, there is a debate on how to manage them. Leaving the work to the Fed and a Volcker-type monetary policy would put people out of work, hitting the most vulnerable the most vulnerable. This would undermine the goal of achieving a more inclusive economy.