Martin Sandbu: The devastating cost of central banks’ caution: "Timidity on monetary policy since 2008 has been as costly as the financial crisis...
...For years, central bankers have fretted about being ready to “normalise” monetary policy, a term whose main function has been to make a shift to monetary contraction in crisis-scarred economies sound responsible rather than risky. Their common concern has been that, without a timely contraction in monetary conditions, economies would overheat. The characteristics of growth beyond capacity—unsustainably high employment; inflation exceeding and potentially accelerating above target—would then be hard to rein in.
Ten years on, we know how wrong this was. Overheating is nowhere to be seen. In the US, the furthest ahead in the cycle, employers keep adding jobs without having to increase wages much. While unemployment has been at record lows for a long time, labour force participation remains below its historical peak even adjusting for demographic change. The growth spurt that followed Donald Trump’s huge tax cuts suggests that the economy can absorb a chunky aggregate demand stimulus.... The error is this: if major economies are only now returning to full capacity, then central banks could safely have accelerated demand growth aggressively to close these output gaps much earlier. Once this mistake is acknowledged, the devastating cost comes into relief. For example, assume that the average output gap over the decade was 2 per cent of economic activity at full capacity. Halving this by boosting demand more and earlier would have saved 10 per cent of annual gross domestic product. That is enormous — and more than the immediate loss of GDP in the 2008-9 recession. Still, this probably underestimates the damage. Many major economies remain some 15 per cent below the pre-crisis GDP trend....
Central bankers’ caution may have cost more in lost livelihoods than the recklessness of private bankers. Keep this firmly in mind during the Lehman anniversary...
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