Rich-world economies consist of a billion consumers and millions of firms taking their own decisions. But they also feature mighty public institutions that try to steer the economy, including central banks, which set monetary policy, and governments, which decide how much to spend and borrow. For the past 30 years or more these institutions have run under established rules. The government wants a booming jobs market that wins votes but, if the economy overheats, it will cause inflation. And so independent central banks are needed to take away the punch bowl just as the party warms up, to borrow the familiar quip of William McChesney Martin, once head of the Federal Reserve. Think of it as a division of labour: politicians focus on the long-term size of the state and myriad other priorities. Technocrats have the tricky job of taming the business cycle.
This neat arrangement is collapsing. As our special report explains, the link between lower unemployment and higher inflation has gone missing. Most of the rich world is enjoying a jobs boom even as central banks undershoot inflation targets. America’s jobless rate, at 3.5%, is the lowest since 1969, but inflation is only 1.4%. Interest rates are so low that central banks have little room to cut should recession strike. Even now some are still trying to support demand with quantitative easing (qe), ie, buying bonds. This strange state of affairs once looked temporary, but it has become the new normal. As a result the rules of economic policy need redrafting—and, in particular, the division of labour between central banks and governments. That process is already fraught. It could yet become dangerous.