The New New normal

It has become trite to call the world is a very uncertain place. There are always unknowns, because the economic and political future is inherently unpredictable. Many scientists can make accurate predictions because the laws of nature allow them to.

But in human affairs, there is always room for surprise. Nonetheless, there are several reasons why the next decade or so could be quite different from the preceding era, including interest rates, scarcity, geopolitics and technology. Exactly how different is where the uncertainty lies.

Earthquake and aftershocks
Starting with interest rates and inflation. In the immediate aftermath of the Global Financial Crisis (GFC) of 2008, the term ‘New Normal’ was widely used to describe the global economy (the term was popularised initially by Bill Gross and Mohammed El Erian, then from PIMCO). It was a New Normal of paying off debt, low inflation, low interest rates, and persistently weak demand. In simple terms, there was too little spending and too much saving as households and firms focused on repairing their balance sheets. A few years later Harvard economist and former Treasury Secretary Larry Summers would revive a 1920s term to describe what was happening: secular stagnation.

Then Covid came. And though it was a health event, from an economic point of view, it was much more like an earthquake, The economy’s seismometer, usually fairly stable, went haywire as economic activity stopped, and then shifted rapidly and deeply. One obvious example is the ongoing embrace to remote work. No one could imagine giant office buildings standing empty several days a week, but now they do.

If Covid was the earthquake, inflation was the aftershock, followed by a surge in interest rates, another aftershock. Inflation seems to be fading in most countries and as a result, interest rates look set to decline next year. At any rate, that is what the market is pricing in. But do we return the world of persistently low and stable inflation and interest rates? What does the New New Normal look like?

Some of the factors that resulted in low inflation and low interest rates remain, for instance ageing populations across the rich world (in fact, demographics is the one corner of social science where long term trends can be forecast with reasonable certainty). But other disinflationary forces might have dissipated.

For instance, the post-GFC period was characterised by premature attempts to cut government debt levels, and therefore fiscal policy was too tight across the rich world. Monetary policy had to overcompensate, which is one of the reasons we saw zero interest rates and quantitative easing. Central banks were “The Only Game in Town” as the title of El-Erian’s book put it (The title of his forthcoming book, “Permacrisis”, pretty much sums up the current mood).

In contrast, the response to Covid saw a massive fiscal injection, particularly in the US. One of the reasons the seismometer went wild was because, thanks to stimulus cheques, US household incomes rose, even as millions lost their jobs. This has never happened before. This was followed by billions more in support when energy prices surged in the wake of Russia’s invasion of Ukraine. Governments, led by the Biden administration in the US, are also ramping up investment in green energy and high-tech manufacturing. More muscular government interventions like these seem likely to become a more permanent feature and are potentially inflationary. They also raise new concerns over long term debt levels. When government long bond yields were hovering between 1% and 2% on both sides of the North Atlantic, the market was practically begging for more borrowing to take place. Now that it is happening, yields might have to settle at higher levels even if they are below recent peaks.

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