1 New concept of macroeconomic equilibrium – the implications of hysteresis on economic policy

In view of the slow recovery after the crisis and more than 40 years of statistics, more and more studies show the lasting negative effects of recessions on GDP, i.e. hysteresis. This phenomenon calls into question the widespread practice of clearly separating the long-term trend of GDP and the cycles around the trend, and of failing to take into consideration the impact of the cycles on the long-term GDP level. Meanwhile, data show that potential output is not independent from the cyclical path taken by the economy, i.e. from developments in aggregate demand.

In light of the new mechanisms, our perception of the functioning of the economy and the optimal economic policy must be altered. Since potential output is endogenous, economic policy must take into account the potential loss incurred when economic performance falls steadily short of its potential level, due to sluggish demand. In such a scenario, countercyclical economic policy becomes more important, as it places more emphasis on preventing huge downturns, and – if a shock nevertheless happens – it makes bolder interventions to escape the recession, in order to return to potential output. If the recession lowers the long-term growth trend, the high-pressure economy is expected to assist in returning the economy to its pre-crisis path. The notion of the high-pressure economy appeared in economic sciences at the beginning of the 1970s. According to this idea, if economic policy keeps the economy under greater-than-average demand pressure, a permanently higher GDP level can be achieved. A general argument against the high-pressure economy is that it is risky from the perspective of inflation. However, the dynamics of inflation have recently changed considerably with respect to two criteria, decreasing the potential cost of the high-pressure economy. On the one hand, inflation expectations are low and well anchored, and, on the other, the Phillips-curve, which connects the real economy and inflation to each other, has become flat recently. The slow recovery after the crisis verified that monetary policy alone is unable to stabilise the economy in every case. Moreover, the structure and timing of the structural reforms, which used to be regarded as general supplyside instruments, need to be chosen carefully. The emerging new policy mix relies on fiscal policy, since – in light of the latest results – it may be an efficient tool in a weak demand era to stimulate the economic growth. Fiscal policy becomes especially important in the case of a balance sheet recession. The fiscal authorities may be the only actors which are able to boost their expenditure, thereby further increasing their indebtedness, and thus decreasing the real economic costs of deleveraging by other sectors. In this broader context, fiscal policy can be integrated into the framework of a current account targeting regime. With respect to countercyclical fiscal policy, the issue of room for fiscal manoeuvre must be discussed. One of the ways to meet the two main expectations with regard to fiscal policy (countercyclical and sustainable) may be the optimisation of automatic stabilisers. An advantage of automatic stabilisers is that they provide an immediate, symmetric fiscal response to a change in the economic situation, whereas they do not influence fiscal sustainability over the cycle.