In the wake of the coronavirus pandemic, the economy is entering a new era.
Dating back to the 1940s, macroeconomic theory focused on the government’s central role in fighting recessions and creating jobs by running a deficit.
Following the Great Depression, American economic policy was largely dictated by these ideas. But in the 1970s, this changed as high inflation and unemployment rose simultaneously, leading economists to decide that running a deficit may not be the best way to manage a recession.
In the 1980s, Paul Volcker, then chairman of the Federal Reserve, approached inflation by decreasing the supply of money, shifting the focus to low and stable inflation to improve economic conditions in the long run.
Most recently, a blend of these two approaches emerged, which enabled policy aimed at low and stable inflation with the ability to prioritize unemployment when necessary.
However, once again, it seems the current economic policy has reached its limit. Americans’ spending and saving patterns shifted following the economic recession of 2008, with great increases in saving matched by decreases in spending.
In the decade following the 2008 financial crisis, recovery was slow, and economic growth and distribution of wealth were highly debated topics. Recent years showed GDP growth benefitting low-paid workers. The latest recovery revealed that redistribution of power was key in managing the business cycle.
Then came 2020, and along with it, coronavirus. The pandemic disproportionately affected the demand-side of supply and demand, suggesting that inflation and interest rates may continue to fall as investment drops and saving increases.
Those affected by decreasing demand have been in industries such as hospitality, with “essential” workers facing increased exposure to the virus, all while white-collar workers are able to work from home.
As the virus has highlighted the inequalities of the business cycle, three schools of thought have emerged to get the economy back to full employment.
The first school of thought suggests greater courage. Those in favor of this approach claim that as long as central banks can print money and buy assets, they can boost economic growth and inflation. This means going to whatever lengths necessary to restore growth and reach target inflation rates.
In past years, this approach has been used and was often accompanied by successful increases in employment. More recently, though, central banks have leaned on governments to increase growth by using the federal budget. Many countries are taking the position that fiscal stimulus has a greater role to play than ever before.
This reliance on fiscal stimulus leads to the second school of thought: fiscal policy. Proponents of this approach support the central bank taking a back seat to fiscal policy as the government boosts spending and cuts taxes to minimize the effect of the private sector’s increase in saving. The two main tools are directly buying bonds or pegging longer-term interest rates near zero.
This plan increases the public debt-to-GDP ratios, but that is no longer a concern to most supporters of this plan, who now think that as long as inflation remains low, central banks are able to finance the government without concerns over generating high public debt.
The concept of running high public debt through fiscal policy coincides with the “modern money theory” (MMT). In MMT, a central argument is that countries who print their own currency should ignore their debt-to-GDP ratios because as long as interest rates are zero, there is no significant difference between financing through debt or money.
MMT and mainstream economists diverge from there. While MMT prioritizes a permanently pegged interest rate of zero, this second school of thought aims for long-term interest rates to rise once again so that monetary policy may regain traction.
The third school of thought takes the most radical approach, centered around negative interest rates. Concerns about the central bank financing the government suggest the greater the percentage of government debt created by the central bank, the greater short-term interest rates will fluctuate. Combined with future expenses and circumstances, the third approach advocates for taking interest rates negative, rather than creating debt to be paid when rates rise again.
One result of negative interest rates, especially the -3% that some economists propose, is a decrease in saving accompanied by a sweeping reform that drastically decreases the usage of cash.
While negative interest rates have the potential to dwindle banks’ profits, the increasingly cashless nature of the economy could support taking the interest rate negative.
Each of the three proposed approaches leaves policymakers weighing the risks of central bank intervention, increasing public debt, or radical change. Now, though, many economists argue there is a deeper problem at work, one that is only rectified through structural reform.
The argument is this: recent decades have brought higher inequality, higher debt-to-GDP ratios, and lower interest rates, all factors that reinforce the others. This increased inequality creates the need for additional stimulus, which in turn leaves economies in more debt.
One perspective on this trend is a divergence from standard macroeconomic theory and an increase in competitiveness in markets where big businesses face little competition.
Other approaches reject this idea and instead focuses on workers’ declining bargaining power. Here, improving labor unions and safety nets for workers would increase this power. Other proposed ideas are establishing a universal income, strengthening employment law, and regulating mergers and acquisitions.
Just six months ago, these issues were seemingly less pressing. But now, as 70% of Americans receiving unemployment payments earn more than they did while working, and tens of millions of Europeans receive their wages through government-funded furlough schemes, these questions are now at the forefront of economists’ minds.
The economy is facing challenges that present an opportunity to rethink labor markets, investment, and government financing. While policies may be disputed and solutions may seem far-fetched, the economy of pre-coronavirus is becoming a system of the past. The future, whatever that may be, is bringing change.
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