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Review of macroeconomic policy after the pandemic

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The political reaction of governments and central banks to the pandemic was massive and unprecedented. In the US, the Federal Reserve channeled $ 3 trillion into the economy between March and June 2020, the same amount it did in the first hundred years of its operation, 1913-2013. In the UK, the Treasury Secretary asked Parliament to approve £ 40 billion in deficit spending in March 2020, and ended up borrowing £ 400 billion over the next 12 months, 92% of which was financed by the Bank of England. This note examines whether this “unorthodox” policy justifies a review of macroeconomics.

Keynes established macroeconomics – the study of economics as a whole – as a separate subject of economics. During the Great Depression of the 1930s, Keynes, in his famous work The General Theory, introduced the concept that the key to full employment was sufficient demand to keep all available resources in the economy at full employment. . As private consumption and investment, together with net exports, do not in themselves guarantee sufficient demand to ensure the supply of all national product produced, government expenditure could provide the necessary additional demand.

< The idea that the state budget could be used as an instrument of economic policy was revolutionary at the time. This is how the idea of ​​"counter-cyclical fiscal policy" came about, which was the dominant macroeconomic policy framework from the post-war period until the end of the 1960s.

Money supply

By the 1970s, however, faith in fiscal policy had been shaken. The long delay in fiscal measures, and policy interventions in public finances, have been seen as sources of macroeconomic instability. Meanwhile, a team of economists at the University of Chicago, led by Milton Friedman, has developed an alternative macroeconomic framework focusing on the money supply as the key determinant of economic activity.

The 1970s were marked by the last serious episode of inflation (to date). Global and American demand was fueled by US fiscal spending during the Vietnam War and the large social program of the government of President Lyndon Johnson. At the same time, an OPEC oil shock and strong unions have created a spiral of wage adjustments. It took a sharp rise in interest rates and a severe recession to reduce the resulting inflation. The experience of “stagnant inflation” in the 1970s led to the weakening of Keynesianism and the strengthening of the monetarist approach to macroeconomic policy-making.


Since the mid-1980s, trade liberalization and capital movement, and globalization, have fueled productivity growth and curbed inflation. The huge increase in the global workforce has kept the cost of goods and wages in advanced economies low, resulting in price stability for 40 years. During the same period there was a steady and continuous decline in interest rates. On the way down, interest rates fell beyond the growth rate of the global economy, which is important for debt sustainability. However, with interest rates now at the so-called effective threshold (meaning they can not be further reduced), monetary policy has lost its effectiveness, and fiscal policy has returned to a key role in keeping economic activity at its potential. This theoretical consensus for a shift in fiscal policy was first tested during the global financial crisis.

The severe recession of 2008, caused by the global financial crisis of 2007, required a coordinated response. In 2009 the then British Prime Minister Gordon Brown, at the G20 summit in London, secured an agreement for such a coordinated fiscal expansion. This mitigated the effects on economic activity, but, as many countries were already heavily indebted, it led to further deficit spending and a sharp rise in public debt. The narrative of a “debt limit that must not be exceeded” was strong enough to reverse the coordinated fiscal expansion at the G20 summit in Toronto in 2010. A period of austerity followed with negative economic and social consequences.


The austerity mentality influenced policy-making during the eurozone crisis, especially in the case of Greece, where the economic and social consequences were unjustifiably serious. It is possible that with the current mentality of public debt and the support of the Central Bank, the eurozone crisis would have been treated differently. The limited fiscal expansion during the Great Recession of 2008 meant that the recovery from the financial crisis was slow. The recovery has been delayed by austerity as many countries face a legacy of high debt as well as concerns that they will have some room for maneuver in dealing with the next crisis. The next crisis came in an unexpected form.

With the onset of the pandemic, the ground was more fertile for a coordinated response by governments. There has been an immediate and substantial budgetary response to protecting income and employment, and keeping businesses afloat. The macroeconomic policies implemented globally during the pandemic were contrary to the two basic rules of prevailing macroeconomic orthodoxy, which were (a) no large-scale deficit spending and (b) no central government debt financing. Bank. Both terms were set aside during the pandemic.

After the pandemic

We have now entered the post-pandemic period and the question is whether a new macroeconomic narrative is emerging. To address the effects of the pandemic, governments around the world have pursued broad-based, expansionary policies in both the fiscal and monetary spheres. Fear of rising public debt to GDP shifts to the potential impact of fiscal and monetary expansion on inflation. The question now is whether the high inflation we are experiencing is due to the policies implemented against the pandemic. According to traditional macroeconomic thinking, this would be to be expected as a result of the excessive deficit spending financed by central banks during the pandemic. However, the dual shock of supply due to the pandemic and the Russian invasion of Ukraine, which has led to sharp rises in energy and commodity prices, complicates the debate over the causes of the high inflation that people are experiencing today.

< p>Economists are torn between those who focus on supply constraints and those who see overspending as the main cause of the inflationary pressures we are experiencing today. Initially the central banks were of the opinion that inflation was a temporary phenomenon and did not take any substantial measures. A simultaneous shock of demand and supply, however, poses a sharp dilemma for central banks: in order to signal their independence and that they seriously intend to avoid uncontrolled inflation, they must keep inflation expectations low, quickly normalizing monetary policy. which carries the risk of recession.

Gentle landing;

Although the goal is to have a “mild landing” of their economies, that is, to reduce inflation without recession by doing very little, there is a risk that a larger monetary contraction and a much larger rate hike will be necessary later and in the short term. , if inflation gets out of control. The likelihood of this happening depends on the state of the labor market in each economy. A spiral between wages and prices would only happen if workers had enough bargaining power to lead to wage increases in anticipation of future inflation.

Macroeconomics has gone through various phases since its inception in the 1930s, which included a major review of both theoretical approaches and radical changes in the direction of macroeconomic policy. The most recent example of this process is the “unorthodox” policies pursued during the pandemic. Could these policies be seen as a temporary departure from “normal practices” for dealing with an unprecedented emergency, or could they lead to a more radical macroeconomic review? If these policies can be used to tackle a crisis without causing uncontrolled inflation, why can't they be used to tackle a crisis like climate change? The answer to these questions depends crucially on the verdict on the causes of current inflation. Time will tell to what extent we should reconsider macroeconomic policy. Meanwhile, central bankers are not taking any risks as they begin a process of raising interest rates.

{YPOGRAFH} * Former World Bank Director and former Minister of Finance of the Republic of Cyprus. This text was also published on the Blog of the Cyprus Economic Studies Company https://cypruseconomicsociety.org/blog/blog-posts/{YPOGRAFH}

Source: politis.com.cy

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