The hit to the economy relative to its potential rate has therefore been negligible. By comparison, in the three years after the start of the financial crisis in 2007, the US economy expanded by only 0.4 per cent, thus falling far below its potential.
The success of macro policy during the pandemic represents a powerful lesson to those who doubted that the economic equivalent of shock and awe can work.
The 'old Keynesian' (economic theory) of increased fiscal spending, combined with aggressive intervention by central banks to stabilise asset markets, prevented a deep recession when a severe and unprecedented demand shock occurred as the uncertainty and then the restrictions of the pandemic gripped the world.
The markets may believe that this transparent success will result in a permanent reduction in recession risk in future, but this is not enough to justify the extraordinary recent behaviour of risk assets. None of the fundamental factors that drove the bull market before 2019 are likely to be as favourable in coming years.
Equity outlook
Equity valuations are now in the stratosphere. The Shiller CAPE stands at 39, an all time high.
Furthermore, the Fulcrum asset valuation model is now predicting real equity returns of only 1 per cent a year over three years, which is abnormally low.
With labour markets now close to full employment, and policy aiming to raise the minimum wage sharply in many economies, there could be an increase in the wage share of national income, relative to profits and dividends.
And the long-term decline in r-star might be slowed or reversed by expansionary fiscal policy in the US and EU, and by the impact of clean energy investment on the level of demand in the economy.
Furthermore, the impact of policies to reduce global carbon emissions, while extremely welcome in the light of the climate emergency, could lead to more volatile energy prices, with unpredictable spikes such as those we have seen in 2021.
It is estimated that the rise in carbon prices needed to restrict global warming to two degrees or less will represent at least 3 to 4 per cent of global GDP in coming years.
This should be seen as a negative supply shock (supply shocks are typically inflationary but negative for growth) similar in scale to the Opec-induced oil price rises in 1973-74, which triggered a period of global stagflation.
Macro policymakers need to start thinking seriously about how to smooth this shock, without 'kicking the can' too far into the future.
This debate cannot be left to the climate scientists; it is now a macroeconomic issue front and centre, though is still barely discussed in macro policy circles.
