How the Crisis Has Changed the Economic Policy Paradigm

In the midst of the worst economic crisis since the Great Depression, policy makers in the U. S. and in other nations have reduced interest rates, expanded central bank balance sheets, increased deficits to levels generally not seen since World War II, and begun seriously rethinking financial regulation. This may come as no surprise to any student of macroeconomics prior to, say, the 1980s. However, the current crisis follows a period during which the vast majority of economists had come to a consensus (referred to by economists and hereafter in this paper as the “New Consensus”) regarding macroeconomic and regulatory policy, while the policy initiatives undertaken since the crisis began are almost entirely, and often violently, at odds with most of the New Consensus. This has led at the very least the return of some previously spirited debates that most might have thought had been settled. For now, at least, it appears that most economists fall into two different camps: the first group considers the current crisis to be a one-time “shock” after which policy can return to “normal”; the second group, on the other hand, is highly critical of the first group and of policy makers for deviating from the New Consensus. Finally there are others, some of them high-ranking members of the “consensus” view, who suggest that nearly everything needs to be rethought. The purpose of this paper is to describe some of these re-opened debates being driven by the current crisis, and then also to present the foundations of an alternative macroeconomic paradigm backed by some economists and economic research institutes that coherently incorporates the current crisis as well as the impact of current and proposed policy responses, which the previous consensus does not.