Now it seems that this dominant economic paradigm has reached its limit. It first began to wobble after the global financial crisis of 2007-09, as policymakers were confronted by two big problems. The first was that the level of demand in the economy—broadly, the aggregate desire to spend relative to the aggregate desire to save—seemed to have been permanently reduced by the crisis. To fight the downturn central banks slashed interest rates and launched quantitative easing (qe, or printing money to buy bonds). But even with extraordinary monetary policy, the recovery from the crisis was slow and long. gdp growth was weak. Eventually, labour markets boomed, but inflation remained muted (see chart 1). The late 2010s were simultaneously the new 1970s and the anti-1970s: inflation and unemployment were once again not behaving as expected, though this time they were both surprisingly low.
This threw into question the received wisdom about how to manage the economy. Central bankers faced a situation where the interest rate needed to generate enough demand was below zero. That was a point they could not easily reach, since if banks tried to charge negative interest rates, their customers might simply withdraw their cash and stuff it under the mattress. qe was an alternative policy instrument, but its efficacy was debated. Such disputes prompted a rethink. According to a working paper published in July by Michael Woodford and Yinxi Xie of Columbia University the “events of the period since the financial crisis of 2008 have required a significant reappraisal of the previous conventional wisdom, according to which interest-rate policy alone...should suffice to maintain macroeconomic stability.”
The second post-financial-crisis problem related to distribution. While concerns about the costs of globalisation and automation helped boost populist politics, economists asked in whose interests capitalism had lately been working. An apparent surge in American inequality after 1980 became central to much economic research. Some worried that big firms had become too powerful; others, that a globalised society was too sharp-edged or that social mobility was declining.
Some argued that structurally weak economic growth and the maldistribution of the spoils of economic activity were related. The rich have a higher tendency to save rather than spend, so if their share of income rises then overall saving goes up. Meanwhile in the press central banks faced accusations that low interest rates and qe were driving up inequality by boosting the prices of housing and equities.