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Rethinking Maximalist Macro Policy

In the period of low interest rates and low inflation after the 2008 financial crisis, fiscal and monetary policies underwent a radical reassessment. But now that macroeconomic and financial conditions may be changing once again, the reassessment will have to be reconsidered.

CAMBRIDGE – The long era of ultra-low interest rates that began after the 2008 financial crisis has led to a significant reassessment of monetary and fiscal policy. Should the sharp, global increase in inflation call into question policy recommendations that were shaped largely by events of the past 15 years, rather than by longer experience? One might think so, even if neither mainstream economic forecasters like the International Monetary Fund nor financial markets seem to be anticipating much of a shakeup to the status quo. I am not so sure.

Everything comes down to one’s confidence that “lower for longer” real (inflation-adjusted) interest rates actually means “lower forever.” If real interest rates are negative (the short-term real interest rate in the United States as of this spring was an incredible -5%), private creditors are effectively willing to pay governments for the privilege of lending. Under these conditions, governments can be far more aggressive with fiscal policy, because they don’t have to worry about jeopardizing their ability to react to future crises, much less creating a genuine debt problem.

Moreover, the argument that average long-term growth rates are reliably higher than average interest rates paid on government debt implies that any level of debt relative to income is sustainable. If one genuinely believes this, governments can therefore use deficits with abandon to fight recessions and crises, because they no longer need to worry about reducing the debt in good times to prepare for the next downturn.

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