Economics in the 2020s — where to now?

It is proper in an economic review of 2020, first to give credit where credit is due. The world economy began 2020 in a weak state, with low interest rates sustaining weak growth. Then, in the first quarter of 2020, Covid-19 delivered severe economic shocks to this fragile position.

Stock markets tanked. Negative economic predictions appeared. The US Corporate Bond market stalled. The world appeared headed for a significant and lengthy economic downturn.

In mid-March 2020, the US Federal Reserve injected US$1.5 trillion into the US economy. Major cash injections followed from most other central banks. Governments urgently began large deficit spending.

Nine months later, as 2020 ends, the world economy appears on the up again. These huge doses of monetary and fiscal stimulus successfully kept the world economy from falling into the abyss.

Credit is due to economic policymakers. Although real economies remain patchy, markets are surprisingly improved at year-end, thanks to their efforts. Against the odds, policymakers appear to be winning the very testing Covid economic battle of 2020.

What has been the cost of this Covid battle? Will world economies finally also win the war?

Like pretty much all of life, it is rare to have straight gains from economic policies. Major economic interventions almost always also have downsides — in some cases delayed.

Income drops for retirees and fixed interest-earners; super funds and institutional savers struggling to achieve appropriate returns; zombie companies kept afloat; inflated housing, sharemarket and asset prices; and greater debt right around the world (private, public and central banks) are immediate consequences. Impacts have been very sector-specific: tourism, overseas students, restaurants have been hurt; IT has benefited.

Longer term, traditional economic theory says increases in the money supply cause inflation — an effect which has been surprisingly absent since 2008 when these policies first began.

What can we say about world economies in 2021 and beyond? First, it is likely they will continue to improve over the next year or more, as vaccines (hopefully) suppress Covid, borders reopen and people enjoy an initial burst of travelling again.

Then some negatives may begin to appear. Major economic interventions avoid downturns but appear also to slow recovery. After 2008, world economies were only able to grow at all so long as interest rates remained at ultra-low levels. Japan had a similar experience when it implemented the policies earlier.

With the major new interventions of 2020, this effect may amplify. So after the initial post-Covid and border-opening bounce, stagnant economies rather than strongly growing ones have to be a risk later into the 2020s.

Yes, 2020 has shown that modern economic policies can moderate this cycle — but can they eliminate it for the future?

As house and share prices climb to high levels, can markets safely discount the prospect of future corrections? The jury surely is still out on whether significant economic downturns are truly a thing of the past.

Inflation also has to be considered. Is it correctly calculated when inflation figures fail to reflect rising house and share prices? However it is calculated, logic suggests it should be rekindled by the massive monetary injections since 2008 and especially in 2020. If it does reappear, it will force up interest rates — which will hurt homeowners and impede economic growth. But so far, it is surprisingly quiescent.

Finally, there is debt. Governments and homeowners are loading up on it while interest rates are low. Again history suggests too much debt will ultimately cause trouble — a possibility that is not yet slowing borrowers. So yes, the economic bounceback after Covid should continue and even accelerate into 2021. But thereafter, when the economic sugar rush of the 2020 stimulation ends, concern has to remain.

Excessive debt, the return of inflation, stagnant growth, a return of the business cycle, are all potential long-term future risks. The world would be wise to remind itself that success in the 2020 Covid economic battle is no guarantee of victory in the economic war of 2021 and beyond.