Blackouts and the Burden of Uncertainty
In the U.S., people largely take the constant flow of electricity for granted. Uncertainty about availability doesn’t affect decisions. Businesses and households don't have to think about, or plan around, fluctuations in electrical power.
When I visited India many years ago, the situation was quite different. The availability of electricity fluctuated throughout the day, often in apparently random ways. It was a focus of planning, thinking, and conversation in a way that, while entirely natural, was quite unusual to me as an American. (Unfortunately, it appears that there has not been much improvement since my visit.)
I see an analogy with the global economy.
From the mid-1980s through 2008, central banks had the tools, the will, and the knowledge to protect the economy from sharp swings in the demand for goods and services. They raised interest rates to head off surges, and lowered rates to prevent severe slumps. As a result, households and businesses could count on an economy in which aggregate demand grew relatively steadily. Nobody had to think about, or plan around, the possibility of persistent shortfalls in prices and employment.
That has changed. Since 2008, central banks haven’t been able or willing to defend against a sharp and highly persistent fall in aggregate demand. They have used much of their toolkit, and seem reluctant to employ the tools that remain. As a result, the flow of demand has become uncertain. Market participants and others are focused on what could go wrong, and how central banks might -- or might not -- respond.
Before 2008, global aggregate demand was like electricity in the U.S. -- just something in the background that everyone could count on. After 2008, it became like electricity in India -- desperately needed, but subject to random and persistent shortages. Just as the uncertainty of electricity provision hobbles India's economy, the uncertainty of aggregate demand impairs the global economy. To reduce uncertainty and promote higher growth, both systems need overhauls.
How should the world overhaul its system for providing aggregate demand? To me, this is the key question facing macroeconomists today. Answering it will require a big change in the discipline. Before 2008, most macroeconomists studying the U.S. and Europe largely ignored the possibility of long-lasting shortfalls in demand. This may (at least arguably) have been appropriate for most questions of interest before 2008. Now, however, they need different models and approaches to understand the effects of aggregate-demand uncertainty, and figure out how best to eliminate it.
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