Once ideas about how to manage the economy become entrenched, it can take generations to dislodge them. Something big usually has to happen to jolt policy onto a different track. Something like Covid-19.
In 2020, when the pandemic hit and economies around the world went into lockdown, policymakers effectively short-circuited the business cycle without thinking twice. In the U.S. in particular, a blitz of public spending pulled the economy out of the deepest slump on record—faster than almost anyone expected—and put it on the verge of a boom. The result could be a tectonic transformation of economic theory and practice.
The Great Recession that followed the crash of 2008 had already triggered a rethink. But the overall approach—the framework in place since President Ronald Reagan and Federal Reserve Chair Paul Volcker steered U.S. economic policy in the 1980s—emerged relatively intact. Roughly speaking, that approach placed a priority on curbing inflation and managing the pace of economic growth by adjusting the cost of private borrowing rather than by spending public money.
The pandemic cast those conventions aside around the world. In the new economics, fiscal policy took over from monetary policy. Governments channeled cash directly to households and businesses and ran up record budget deficits. Central banks played a secondary and supportive role— buying up the ballooning government debt and other assets, keeping borrowing costs low, and insisting that this was no time to worry about inflation. Policymakers also started looking beyond aggregate metrics to data that show how income and jobs are distributed and who needs the most help.
While the flight from orthodoxy was most pronounced in the world’s richest countries, versions of this shift played out in emerging markets, too. Even institutions like the International Monetary Fund, longtime enforcers of the old rules of fiscal prudence, preached the benefits of government stimulus.
In the U.S., and to a lesser extent in other developed economies, the result has been a much faster recovery than after 2008. That success is opening a new phase in the fight over policy. Lessons have been learned about how to get out of a downturn. Now it’s time to figure out how to manage the boom.
FOR CENTURIES, theorists have pondered the recurring and inevitable swings that make up the business cycle. They’ve looked for causes in mass psychology, institutional complexity, and even weather patterns. According to the traditional laws of the cycle, it should’ve taken years for households to claw their way back from 2020’s sudden collapse in economic activity.
Instead, the U.S. government stepped in to insulate them from its worst effects in a way that hadn’t really been tried before: by replacing the wages that millions of newly out-of-work Americans were no longer receiving from employers. In the aggregate, benefit checks made up for all the lost paychecks and then some—even though creaky
Regime changes the policymakers who govern interest rates in developed economies ran out of room to make cuts, fiscal rescues in those economies grew larger.
Average central bank rate in developed economies average budget balance as a share of GDP in developed economies systems for delivering unemployment insurance or one-time stimulus payments meant that many people missed out.
The scale of this innovation is apparent in what Jan Hatzius, chief economist at Goldman Sachs Group Inc., has called “the most amazing statistic of this entire period.” In the second quarter of 2020, a time when economic activity— measured by the conventional gauge of gross domestic product—was shrinking at the fastest pace on record, U.S. household income actually went up.
U.S. politicians moved rapidly because they could see the calamity that would result if they didn’t. But pandemic-era policies were also shaped by regrets, which had been building for a decade, over the response to the last crisis in 2008. In hindsight, economists have come to regard that response as lopsided and inadequate. Bank bailouts fixed the financial system, but little was done to help debt-burdened homeowners, and household incomes were allowed to fall.
The new pandemic economics also shielded the financial system, but from the bottom up instead of the top down—a point repeatedly made by Neel Kashkari, who helped lead the rescue as a U.S. Department of the Treasury official in 2008 and who’s now head of the Federal Reserve Bank of Minneapolis. As their jobs vanished in the spring of 2020, Americans struggled to make 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 morphed into a financial crisis.
“How have Americans been able to pay all their bills? It’s because Congress has been so aggressive” with fiscal stimulus, Kashkari said in October on CNBC. “If they don’t continue that, these losses roll up into the banking sector, and nobody knows how big those losses will ultimately be.”
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