What should the aim of macroeconomic policy be? Arguably, it should maximise the real standard of living in the long term, ideally while minimising the volatility of growth along the way. But since the introduction of inflation targeting in most advanced economies in the 1990s, the prevailing assumption has been that macro policy can have little or no effect on long-run outcomes. We have assumed that the best it can do is to manage aggregate demand in the short term and so dampen the business cycle.
That restricted ambition might be acceptable if it succeeded in its own terms, by reducing volatility. Looking at the chart below, however, there is little evidence that this has been achieved — the UK, for example, has by and large moved downwards on the chart below (i.e., achieving no material decline in volatility but at the same time delivering weaker average growth rates).
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Fathom’s CEO Erik Britton recently called for a major rethink in the way global macro policy is conducted. Speaking at a pre-Davos panel discussion hosted by Fathom Consulting and Chatham House on 11 January, he pleaded that “we need to do something else”. The exchange of views that followed revealed deep scepticism about current global macroeconomic policy among many present, with questions raised over its paucity of ambition, its failure to produce either growth or stability, and also how competently it had been implemented. This note summarises the key conclusions from that session.
Creon Butler (Director of the Global Economy and Finance Programme at Chatham House) countered that the global institutions that support free trade, financial stability, effective regulation and sound governance have served us well over many decades and that demolishing them would be a disproportionate response to the admittedly poor macro performance of advanced economies in recent years.
Somewhat supporting Mr Butler’s view, Shamik Dhar (Chief Economist at BNY Mellon Investment Management) argued that there were many successes attributable to the current framework, not least achieving low and more stable inflation after the 1970s when inflation averaged in excess of 10%. That said, he argued that it did make sense to think again about whether the policy architecture was fit for purpose: for example, the pursuit of price stability when there was deficient demand on a global scale, not least because of the rise of China. The policy framework allowed that to happen; and in the aftermath of the GFC it was unable to ‘shake us out of our torpor’.
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Maria Demertzis, Senior Fellow at Bruegel, the European economics think tank, argued that the focus of economic policy on short-term demand management was important but should be secondary. In her view, policy has become too reactive, looking too much in the rear-view mirror. Other parts of economic policy urgently needed to focus on long-run objectives, such as the climate and filling the investment gap needed to finance the transition towards green energy. With the Chips and Science act and the Inflation Reduction Act, the Biden administration has recognised the importance of greater investment in boosting economic growth. The UK might need to show similar ambition, with investment having remained subdued for the past 25 years or so (in the UK’s case, raising subdued levels of R&D spending could be particularly important).
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Ultimately, the event’s audience of journalists, policymakers, investors and attendees from major corporates was asked to cast its opinions on the recent performance of the current economic policy framework. The mood in the room was particularly gloomy — 84% of the audience judged that the period of inflation targeting had not led to good economic outcomes, with 64% arguing that a new macro policy framework was needed to ensure improved performance in the long run.
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The views expressed in this article are the views of the author, not necessarily those of LSEG.
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