Economic shifts and shocks can trigger changes in the tools that economists are willing to recommend, and policymakers are prepared to deploy. Such tendencies are further intensified in the heat of a crisis, when policymakers tend to become even more open to experimentation.
The 2007–08 global financial crisis (GFC), for example, triggered large adjustments to fiscal and monetary policy settings. In the case of fiscal policy, many of the changes proved short-lived. There was a period when leading economies went “all in” on expansionary fiscal policy. But that “Keynesian moment” only lasted about a year and was followed by a swing to austerity. In contrast, GFC-accelerated adjustments to monetary policy proved longer-lasting. Many of the world’s leading central banks pursued large-scale quantitative easing (QE) during the crisis and its aftermath, while a smaller number experimented with negative interest rates. QE is now a standard item in the central banking toolkit while negative interest rates, although still controversial, have also joined the monetary policy arsenal.
Prompted not just by the GFC, but also by longer running trends in the global economy — quiescent inflation in much of the developed world, declining real interest rates, lacklustre productivity performances, subdued wage growth, a growing focus on inequality, shrinking competition, rising industrial concentration and a pattern of sustained regional economic divergence — the rethinking of pre-GFC policy assumptions has covered a range of issues. This includes the case for a broader and more aggressive range of fiscal and monetary policy options alongside heated debates about the pros and cons of modern monetary theory (MMT), universal basic income (UBI), government employment guarantee (EG) programs, and ambitious public sector investment plans.
The huge economic shock triggered by COVID-19 has sparked another round of policy experimentation that is giving new impetus to many of these debates. And much like the GFC, the coronavirus crisis looks like it will encourage another wave of policy change.
In the case of monetary policy, many central banks have either doubled down on previous commitments to QE or its variants, or introduced such measures for the first time, such as the RBA’s adoption of yield curve control. Several, including the Reserve Bank of New Zealand, have said they are contemplating joining the negative interest rate policy club.
Other measures are more radical still. In April, the Bank of England agreed to a UK Treasury request to directly finance the British government’s spending needs by extending its Ways and Means financing facility on a “temporary’ and short-term” basis. Closer to home, Bank Indonesia has started buying Indonesian government bonds directly from the government to finance that country’s deficit.
“In the case of monetary policy, many central banks have either doubled down on previous commitments to quantitative easing... or introduced such measures for the
The US Federal Reserve — the closest we currently come to a world central bank — dramatically increased the scale of bond purchases under its own QE program while significantly widening the range of assets it’s prepared to buy. The Fed also announced the results of a two-year review of its policy framework, promising a shift to a “flexible form of average inflation targeting” — meaning it will now allow inflation to run “moderately above” its old target of two per cent for an unspecified period to make up for those times when inflation has fallen below target.
The Fed will also run the economy “hotter for longer” to drive down unemployment, treating a tight labour market more as a key policy objective than as a potential risk to meeting its inflation target.
On the fiscal front
The pandemic crisis has triggered an enormous expansion in government spending, deficits and public debt. In its midyear economic update, the IMF estimated that announced fiscal measures in response to COVID-19 were approaching US$11 trillion worldwide — of which about half reflected actual spending commitments or foregone revenue, with the balance covering loans, guarantees and equity injections. The “world” fiscal deficit is expected to rise by about 10 percentage points of GDP this year, while global public debt is forecast to jump to an all-time record high of more than 100 per cent of GDP.
“It is striking how the emerging new orthodoxy resembles some of the key messages of modern monetary theory, making it easier and cheaper for governments to finance bigger budget deficits.”
Governments’ fiscal responses to the pandemic have included substantial direct support for jobs. According to the RBA, wage subsidy schemes have supported about 60 per cent of the labour force in New Zealand, 15 to 45 per cent in the large Eurozone economies, and 20 to 30 per cent in Canada and the UK. In Australia, JobKeeper has provided support for about 30 per cent of the pre-COVID private sector labour force. Policymakers have also deployed direct payments to households. The first US relief package included payments of US$1200 for most adults and US$500 per child, for example, while Canberra made two lump sum payments of $750 each to more than five million eligible Australians.
And both countries have increased the generosity of benefits — Washington added an additional US$600/week to unemployment benefits, while Canberra introduced the Coronavirus Supplement to Jobseeker payments, for example. Some governments are boosting public investment spending to support a hoped-for recovery phase, with targets including infrastructure, environmental initiatives and education and training programs.
Economic policies that just a short time ago were struggling to gain traction no longer appear quite so outlandish. The huge increase in employment support by governments, for example, has some echoes of proposals for EGs. Likewise, higher levels of benefits and the embrace of direct payments call to mind — albeit in a modest way — UBI proposals or suggestions for the direct distribution of helicopter money to households. Similarly, if you review contemporary central bank policy settings, it is striking how the emerging new orthodoxy resembles some of the key messages of MMT — making it easier and cheaper for governments to finance bigger budget deficits and by rebalancing the focus of policy towards employment by accepting more expansionary policy settings for longer.
An alternative perspective on this same, shifting landscape might focus on the huge swing in public sector finances and consequent rise in government debt to a record share of world output and the potential implications for taxation, financial repression or even inflation. One way or another, COVID-19 seems likely to revolutionise economic policy.