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Policymakers are wishing away our economic troubles. February 7, 2022Economy, finance, and budgetsPolitics and law
A central lesson of economics is that there’s rarely such a thing as a free lunch. Most policy choices involve trade-offs or benefit some people while incurring costs on others. Every so often, exceptions arise—cases of market failures owing to asymmetric information or incomplete markets—in which the government can improve welfare for all. But most of the time, state intervention in markets creates winners, losers, and distortions. Behaviors change in response to policy, creating long-term costs and unintended consequences.
This guiding principle is notably absent from most economic policymaking today. Instead, policymakers operate under the assumption that government intervention is always a net good, even if it is poorly designed. In recent years, members of Congress have not only cited Modern Monetary Theory but acted on its recommendations. During the pandemic, the federal government sent no-strings-attached checks to almost everyone and expanded unemployment insurance without considering how these policies would discourage work or worsen inflation (let alone answering who might pay for it one day). Meantime, the Fed pursued a loose monetary policy to prop up financial markets and bought many of the bonds being issued.
This represents an important shift. After decades of magical thinking, economists came to accept in the 1980s that monetary policy, too, involved trade-offs. The economy can’t run hot indefinitely without causing a mess, and cleaning it up means even more pain. As Raghuram Rajan, a finance professor and former Indian central banker, notes, developed economies created mechanisms—balanced budgets, inflation targets—to guard against the temptation to ignore trade-offs. Yet we seem to be suffering from a collective amnesia, once again hoping inflation will right itself once the economy returns to form and supply-chain disruptions are resolved. Inflation often starts with a supply shock, but once it takes hold it is hard to shake.