Thank you.
I'd like to summarize a paper on macroeconomics that will be released shortly by the Macdonald-Laurier Institute.
Almost all economic analysts agreed on the necessity of adopting extraordinary monitoring and fiscal stimulus at the worst of the recession in 2008 and 2009. However, few at the time imagined such stimulus would be maintained and even augmented nine years after the onset of the crisis.
A growing number of analysts and organizations, including the Bank for International Settlements, are critical of maintaining such stimulative fiscal and monetary policies for such an extended period of time. These reservations centre on whether the negative impacts of stimulative policies on long-term potential growth exceed their short-term benefits, whether the short-term benefits even exist anymore, and whether the risks they cultivate in the global financial system threaten to aggravate the turmoil they were originally designed to redress.
Briefly, there are two types of macroeconomic policy: cyclical policies aimed at quickly bringing the economy out of recession or cooling off an over-heating economy; and structural policies, such as trade to boost long-term growth potential. These two types of policies, cyclical and structural, are often in opposition to each other. The dynamics of growth in the long run are different and often the opposite of the determinants of growth in the short run.
Containing inflation involves slower growth in the short term, which is tolerated because lower inflation boosts the long-term potential of the economy. Policies designed to stimulate the economy in the short term, such as budget deficits, dampen long-term potential growth. Policy-makers accept this trade-off because the harmful social and economic effects of a recession are worth minimizing, even at the cost of somewhat lower growth in the longer term.
Conversely, policies that boost long-term growth potential often dampen growth in the short term, such as moves to increase labour market efficiency or liberalized trade. In the words of Robert Shiller, “We must therefore consider the short run and the long run separately, and the policy responses to the two are very different.”
As William White, former deputy governor of the Bank of Canada and chief economist at the BIS, observed, the long run is not just a series of short runs. Because of the harm to long-term potential growths, counter-cyclical policies should only be implemented for short periods of time.
That policies designed to stimulate the economy are harmful for the long-term trend of growth is demonstrated by the way nobody advocates ultra-low interest rates, quantitative easing, or budget deficits throughout the business cycle. These policies are considered extraordinary medicine only to be administered when the economy is faltering and needs stimulus. They were not meant to address persistently slow growth, which is increasingly what they're being asked to do.
Chronically slow growth reflects structural forces, notably low productivity gains, that can only be addressed by structural reforms. Most macroeconomic stimulus policies inhibit productivity growth. At the worst, they encourage excessive debt growth that results in unstable financial conditions and a prolonged and severe slump in the economy.
The main argument of this brief is that the damage to long-term potential growth from nearly a decade of extraordinary measures has outweighed their usefulness for some time. They've failed to return growth to normal rates and have reduced the long-term potential growth rate of the economy. The constant stimulus applied to most advanced economies may even plunge the global economy back into recession by increasing the financial system's exposure to risk from either asset price bubbles or a destabilizing of international capital flows.
There are reasons to believe that beyond damaging long-term potential growth, monitoring and fiscal policies are exhausting their ability to stimulate growth in the short term. These diminishing returns partly reflect, after years of stimulus, that there's little spending left to shift from the future to the present. As the BIS observed, tomorrow eventually becomes today.
As well, both monetary and fiscal policy are reaching the absolute limits of stimulus, particularly as we approach zero interest rates in North America. There are clear implications of this line of analysis for the “new normal” thesis that the western world is mired in an era of slow growth due to weak demand and the aging of the population.
An alternative view, as laid out by the BIS, is that the protracted slump in growth reflects the dulling impact of monetary and fiscal policies adopted in response to the 2008 crisis and since amplified as the recovery has sputtered. As the years have passed, these economic chickens have come home to roost in the form of structurally lower potential growth. Worse, the possible formation of bubbles in several asset markets raises the possibility of another financial crisis for which policy-makers will have fewer tools than in 2008.