Are we headed towards a revolution in economic policy-making?

The fallout from the 2008 global financial crisis refuses to go away and now leading economists may be looking to upend traditional neoliberal economic policy.

The 2008 global financial crisis was one of the biggest economic shocks the world has witnessed since the Great Depression. It has been over a decade now, and most might have even forgotten about it. However, those who pay close attention would know that several economies have not yet been able to recover. Growth rates in advanced economies are still low, and the business environment remains fragile.

Now, the main discussion in policy circles is whether a genuine normalisation is even possible. In that regard, recent trends in policy-making, especially in central banking, have reached a new milestone and are creating the case for a new paradigm in economic policy. A heated debate is underway, and according to many, we are at the brink of a revolution in the way we perceive policy-making.

In recent months, central banks in major economies including the EU, the US, and Japan, have reduced interest rates to boost economic growth. Interest rates had already been quite low since the 2008 financial crisis, and now, all these economies have near-zero or even negative real interest rates, which economists once believed impossible. A negative real interest rate basically means that, when inflation is accounted for, the bank is paying a premium to the borrowers.

We have never seen anything like this before. Of course, central banks have a mandate to keep employment low and growth steady. Typically, they accomplish that by reducing interest rates when economic growth slows, and unemployment starts to rise and then raise them again when the ship steadies. By doing that, they incentivise consumers and investors to borrow at a lower price in recessionary periods and control inflation and debt in boom periods.

When the crisis hit in 2008, central banks followed precisely this pattern. They sharply lowered their real interest rates to support growth and investment. Except, at that time, interest rates dropped to lows that were never seen before. What is truly unique in this scenario is that central banks have not been able to reverse this process since. Instead, abnormally low interest rates persisted way longer than was forecast. Interest rates in Europe first hit the zero mark in 2012, and then turned negative in 2014. Most recently, the European Central Bank (ECB) pushed its rate further below zero to record low levels of -0.5 percent. In his last announcement, former ECB President Mario Draghi said governments should take more initiative to overcome growth fragility. The new ECB President Christine Lagarde echoed that in her first message.

In the US, The Federal Reserve System started to increase interest rates in 2017 in an attempt to normalise monetary policy. It announced that it would target a range between 3-3.5 percent by late 2019 if the trend in growth can be sustained. However, by March 2019, the Fed announced that it would reduce interest rates again. Since then, interest rates are back to the 2-2.5 percent range. So, once again, monetary normalisation has hit a snag. The situation is not much different in other major economies. Interest rates in the UK have already been at historic lows since the crisis. Japan has been in this situation for a very, very long time. That’s why the current process in other economies is referred to as the ‘Japanization’ of the world economy.

When you keep interest rates too low for too long, indebtedness rises too much. Then, in a recession, everything may turn upside down and lead to a deeper crisis than it would otherwise. Now, no one knows what the central banks will do when the next recession hits. And, there are warnings of a synchronised global recession already. Now, former American Secretary of the Treasury and Harvard professor Larry Summers says it is time to admit the impotence of central banks, and it is time to turn to governments to correct the situation. According to Summers, policy-making should turn back to pre-1980s’ Keynesianism; namely, the government should start spending again to boost economic growth. This is quite simply a call for a revolution in policy-making

Similarly, Anatole Kaletsky called for the death of the monetary policy. For so long, he says, central banking played a role in stabilising business cycles, but that has reached its limits. He notes, despite all their attempts, central banks are unable to influence business environments. Kaletsky also points at Kristalina Georgieva, the IMF’s new managing director, who said in her keynote speech during the IMF’s annual meeting that fiscal policy should play a more central role in policy-making. Specifically, Georgieva said, “Now is the time for countries with room in their budgets to deploy or get ready to deploy fiscal firepower.”

Former World Bank Chief Economist and Nobel Laureate Joseph Stiglitz claims that the neoliberal era is over, and a new paradigm in policy-making is emerging, while Harvard economists Dani Rodrik suggests that standard mainstream economics literature does not suffice to explain, let alone solve, the current problems of the world economy and calls for a radical change. He claims that, given the current state of the global economy, there is a strong case for ‘a bold Economics”.

What lies at the centre of all these analyses is the admission of the deadlock the global economy finds itself in now and calls for a revolution in policy-making. We are yet to see what this will entail as the ideological battle unfolds. What we are sure of is that the global financial crisis of 2008 was a watershed moment, and the neoliberal policy tools that economic administrations are accustomed to, are not functioning anymore. Naturally, policy-makers and economists are in pursuit of a new framework in economic policy-making. This is a revolution in the making.

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