Monetary policy is difficult.
Economist Scott Sumner describes in his blog how the thinking of an intellectual giant like John Maynard Keynes evolved through three distinct phases in the 1920s and 30s. As the man himself is reputed to have said “When the facts change, I change my mind. What do you do?”. Sumner then argues that the thinking of the economics profession repeated pretty much the same pattern of evolution over the last decades of the twentieth century.
It makes a persuasive case for intellectual humility in general, and in monetary policy in particular. Even more so in unusual times. The forcefulness and fluency of experts can conceal the fact that they are testing new ideas when they make policy.
From this vantage point, the glass looks more than half full. We might even want to salute monetary policymakers – particularly in the US. They supplied enough liquidity during the financial crisis for adjustment without a prolonged slump and their unconventional tinkering looks to have kept the post-crisis recovery ticking over. And now with the second shock of Covid, we see a global recession which doesn’t really feel like a normal recession (and in which savings rates have risen extraordinarily).
From the perspective of minimising the impact of shocks on the voters in democratic countries it is perhaps unprecedented. Moreover, this cushioning might even provide a springboard for a strong renewal of economic growth next year. The world’s stockmarkets certainly seem to think so.
But bear in mind, we can’t be sure. And it might be worth worrying a little about underlying economic imbalances.
Global debt levels have risen dramatically – the Institute of International Finance expects them to reach 365% of the world’s GDP by the end of the year. This has been sustainable because of low interest rates, which are in part the result of a strong desire for liquidity.
And examples like Japan – with government debt near to 240% of GDP – suggest that a high debt can be successfully managed, albeit in that case with a stable economy and a large domestic savings base.
But it doesn’t look like there is much flexibility left to cope with future economic shocks. Voters expect government spending to rise to any challenge. Few governments have succeeded in raising taxes in recent years. Interest rates are already low enough to risk slowing down adjustment and encouraging poor investment.
It might be worth casting an eye back to the economic history of the 1970s, when the New Zealand economy was pummeled by one blow after another: the wool collapse, loss of the British market, oil shocks. The economy could not adjust, and the political system struggled alongside it.
So let’s hope for a sustained productivity-led global recovery, filling in the gap between taxes and spending, and eroding the debt. With governments using market forces to drive adjustment, weeding out poor jobs and replacing them with better ones, lest economic imbalances build up.
And also hope that there will be no more major economic shocks – like say a Chinese bond market collapse – because scratchy post-Covid voters seem unlikely to volunteer for hardship. Avoiding conspicuous failure since 2008 has been an achievement but it provides no guarantee of continuing success.