The Covid trauma has changed economics, maybe forever
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.
The Great Recession that followed the crash of 2008 had already triggered a rethink. But the overall approach 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. 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 IMF, longtime enforcers of the old rules of fiscal prudence, preached the benefits of government stimulus.
In the US, 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. 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 US 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.
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 US 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.
After an initial burst of spending, many countries quickly pivoted to reining in their budgets in the years after 2008, driven by concerns about rising public debt—a trend that was most pronounced in Europe. In the US, state and local government cutbacks resulted in mass job losses. In both cases, relatively high unemployment and low growth rates persisted for much of the decade. In 2020 the doctrine of austerity went into rapid retreat all over the world. Germany, where politicians and central bankers have long been obsessed with fiscal discipline, scrapped a rule requiring balanced budgets and dropped its opposition to joint borrowing with other euro-area countries. The depth of the Great Recession and the slow recovery put issues such as economic inequality and racial justice in the spotlight. Wealth and income gaps have been widening since the 1980s as government intervention in the economy was supplanted by an overreliance on the free market. Direct payments to lowincome households could be a powerful new tool to protect people at the bottom of the economic ladder from the wealth destruction that always accompanies downturns. Now that they’ve been used in one recession, it will be hard to argue that they shouldn’t be used in the next one, according to J W Mason, an associate professor at the John Jay College of Criminal Justice. “If you can replace 100 per cent of the lost income in a crisis like this, why don’t we replace 100 per cent of people’s lost income in every cyclical downturn?” he says. “What is the excuse for saying that because we have some sort of financial crisis that ordinary people should see a fall in their living standards?” The prominence of such transfer payments during the pandemic highlights another big shift in economics: the handover of power from monetary to fiscal policy and the receding role of the inflation-fighting central bank. And while the new economics has the makings of an updated framework to deal with recessions, it has yet to grapple with the potential problems posed by surging growth. Adherents believe that inflationary pressures, the kind that the policy paradigm from 1980 to 2020 was designed to contain, simply aren’t going to arise anytime soon. If inflation risks do materialise, there’s a debate about how they should be managed. Leaving the job to the Fed and a Volcker-style monetary policy would throw people out of work, hitting the most vulnerable the hardest. That would undermine the goal of achieving a more inclusive economy.