It’s hard to pinpoint the exact date, but at some point in the last twenty years the world got into a very, very strange place. The phenomenon occurred on both sides of the Atlantic, although Europe and the United States reached this unique world by different paths. Some even say that Japan, which always lives in the future, reached that strange reality in the 1990s. The date and method for this trip matter less than the destination in any case. What we can say is that, during the past two decades, the usual laws of economics have not quite worked as the textbooks said in many places.
In economics, there is a more or less clear and understandable relationship between interest rates, inflation, employment, economic growth and fiscal deficits. Low interest rates tend to create inflation; have full employment too. Fiscal deficits cause prices to rise. Cheap money speeds up economic growth, which in turn can tend to overheat the economy. These are things you learn in your first macroeconomics class; the mechanisms behind all this are clear and simple.
What we saw after 2000 is that the developed countries, however, stopped responding to these schemes. The Federal Reserve and the European Central Bank lowered interest rates to historically low levels in response to more or less normal economic crises (the end of the 1990s boom, the hangover from German reunification, and 9/11); economies on both sides of the Atlantic responded with relatively anemic economic growth first, and stable prices later. The United States, for example, had a fiscal stimulus and tax cuts, triggering the deficit. Inflation did not move. What we did have was a monumental financial bubble, a crisis that led to even lower interest rates for even more years, even bigger deficits, anemic economic growth, and… no inflation.
There are a multitude of theories about it, from secular stagnation to the great moderation to China to inequalities to god knows what, but nothing was as it seemed. should be
For one reason or another, the relationship between rates, employment, growth, inflation, and deficits had been broken, or changed, or dissipated in some other unknown place. There are a multitude of theories about it, from secular stagnation to the great moderation to China to inequalities to god knows what, but nothing was as it seemed. should be. For two decades, the leaders of Europe and the United States lived in a world where borrowing was free, prices did not rise, and the economy never seemed to get off the ground, despite all that fiscal and monetary stimulus, but where, post 2010, there were no recessions either. It was very rare.
Even stranger economic times came with the pandemic, however, and the rulers reacted with more fiscal and monetary stimulus. It worked out, with economies recovering relatively quickly from the colossal blow of 2020. What caught almost everyone by surprise, however, is that, with the recovery, the old laws of 20th-century economics seemed to be coming back into play. vigor, and those old problems of which our parents and grandparents spoke were again present.
It turns out that an economy can grow fast enough that workers are scarce. And that fiscal deficits can raise the price of borrowing. And that, contrary to what has been seen during the last two decades, prices can go up if the economy overheats too much. Yesterday’s world is back, and that thing called the budget constraint that the ancients recounted is very real again. The rulers must worry about the natural rate of unemployment and the curve of Philips, that aggregate demand doesn’t grow faster than supply, and that issuing debt can have real consequences if it turns out that the markets don’t think you can afford it and/or your currency devalues. Even mortgages are going to have interest rates positive these days, something we haven’t seen since time immemorial.
In Europe, the euro has shielded the bloc from major currency upheavals, but inflation is real, economic slowdown considerable
The consequences of this return to (relative) normalcy are curious, and depend largely on the country. The United States has always been a place where rulers can create their own reality thanks to the enormous importance of the dollar. The country export inflation, thanks to the rise of its currency in response to the rate hike. Even with those, economic growth has stalled, albeit without rising unemployment (for now). In Europe, the euro has protected the block from large money disorders, but the inflation is real, the economic slowdown considerable, and the fiscal stimulus options expensive and limited.
The immediate economic consequences of this return of inflation and recessions induced by central banks to control it are clear. What I think is more uncertain and potentially dangerous is the fact that we have a whole generation of leaders who have been raised, so to speak, in a world where neither deficits nor prices matter and that they now face a return to a world where macroeconomic policies have consequences. The eurozone and the US are so huge that these consequences are not immediate, but the history of the UK these days makes it abundantly clear that there are many, many politicians who have forgotten the old stories and their lessons.
Deficits matter. Prices can go up. Nothing is free, again, and money and debt even less so. Governments today have less room for manoeuvre. Doing politics in such a world is much more difficult than in pre-covid times, and the consequences of this for our political systems are difficult to estimate.
Governing is not easy, no doubt, but things are getting complicated out there. We are going to have an interesting winter.
