What we can see more clearly now than we could then, is that the collapse of Lehman Brothers on this day 15 years ago and its punishing global consequences changed the way we thought about economic policy.

In doing so, it prepared us to respond better to the COVID-19 pandemic than we would have otherwise.

After 15 years and with the intervening COVID-19 crisis, we are perhaps beginning to forget what a shock the Lehman crisis and its consequences were to the world.

World growth went from 4.4 per cent in 2007 to -1.3 per cent in 2009, a downturn the world had not experienced in peacetime since the Great Depression 80 years earlier.

In the US, GDP growth at 2 per cent was pretty slow in 2007, but then it plummeted to a GDP contraction of 2.6 per cent in 2009.

The value of US stocks in the S&P500 fell by more than half from early 2008 to early 2009. That certainly fixed the attention of financial markets.

I was Treasurer at the time and I can tell you the abruptness and the severity of the change in 2008 was startling.

We didn’t know how far it would go; how soon the decline in output and the rise in unemployment would slow, or what the long-term consequences would be.

We didn’t know how hard Australia would be hit, or to what extent the financial catastrophe in the US might be replicated here.

All we knew is that we had to act fast and at a scale commensurate to the scale of the economic calamity.

That’s exactly what we did, with some of the fastest, biggest and best targeted responses in the world, using both fiscal policy and monetary policy.

Busted conventions

In doing so we busted conventions about fiscal and monetary policy that had been in place for decades.

For a quarter century before the 2008 crisis we were told fiscal policy was about balancing the budget and monetary policy was about stabilising output growth.

In particular, we were told, you should not use discretionary changes in spending or revenue to change demand in the economy.

Sometimes a deficit would happen anyway.

Unemployment would rise, for example, activating the so-called automatic stabilisers of bigger jobless payments and reduced personal income tax, but you should then create a corresponding surplus to have the budget balanced through the cycle.

That was the fiscal ‘golden rule’.

On the monetary policy side, the rule was that you should use it to stabilise demand. The conventional view was that central bankers had only one tool – interest rates, and only short-term interest rates.

The collapse of Lehman Brothers was the climax of the sub-prime mortgage crisis.

In 2008 we learnt something different. We were reminded that sometimes it is necessary to use both fiscal policy and monetary policy to support demand – simultaneously and in a big way.

The US federal deficit expanded from 1.1 per cent of GDP in 2007 to 9.7 per cent in 2009, directly as a result of the financial crisis in that country.

The Australian federal deficit also expanded. We ran a surplus of 1.7 per cent of GDP in 2007-08, and then eased policy by a pretty big 3.8 per cent of GDP to record a deficit of 2.1 per cent of GDP the following year.

The shrill indignation of the Liberal Party, then briefly led by Malcolm Turnbull and then Tony Abbott, was something to behold.

Design, not luck

So Australia came through the GFC by choice, not by chance.

There was a big difference between the US and ourselves in respect of how we used fiscal policy.

In the US, the additional budget spending was used primarily to bail out financial businesses that would otherwise have gone bust. It was a very big number, but not much of it supported household consumption.

In Australia we directed it predominantly to supporting household consumption.

I have pointed out many times that despite the claim we avoided recession because of exports to China, in fact the big expansion, the difference between an expanding economy and a contracting economy, was provided by household consumption.

We also saw the US central bank directly supporting financial institutions under strain and buying government bonds to keep long-term interest rates down – this had been a no-no for decades.

So, 2008 changed the paradigm of what monetary and fiscal policy could do.

I am proud to say Australia was among the leaders of that change, and arguably more effective than most in implementing the changes in a way that supported the economy. Certainly, we were one of the few wealthy countries that escaped a recession.

What we can now see, which of course wasn’t evident then, was that this revolutionary change in our understanding of what monetary and fiscal policy were capable of set us up to battle the COVID pandemic.

The sudden demonstration in 2008 and its aftermath that the limits we had imposed on ourselves in economic policy could be removed and that the lives of millions and millions of people could be better as a consequence was a vitally important outcome of the response to the GFC.

I can recall, even now, the sense of daring and the grave concern that dominated the G20 conference in Washington where we pressed these ideas. The sense that we were taking big risks by dramatically amending a quarter-century consensus on the limits of fiscal and monetary policy.

But we did take the risks, because we understood that not acting would have had devastating consequences.

The result was that the world began to recover from the financial market catastrophe of 2008 far more rapidly than expected.

The big change in government attitudes and in the economics community as a result of the GFC was the demonstration that – if you needed to do so – you could use monetary and fiscal policy together and you could use them in a big way.

And again, despite the economic horrors predicted by opponents of the bold use of monetary and fiscal policy, it worked.

Value for money

In my view, it was money well spent.

It helped prevent a long-lasting global depression, and we find ourselves three years after COVID hit, three years after large parts of major economies were shut down, with real global GDP about one-tenth higher today than it was in 2019.

Teetering on the edge of the Global Financial Crisis, then prime minister Kevin Rudd and his treasurer Wayne Swan opted for a cash injection. Photo: Getty

We did indeed have a spell of high inflation caused by supply shortages crashing against high household demand, aided and abetted by the rise in food and energy prices caused by Russia’s invasion of Ukraine.

It is true, too, that Treasury predicts deficits will continue for years to come.

It is important to realise, however, that increased interest payments on Commonwealth debt account for a relatively small proportion of those deficits. As a share of GDP, net interest payments on Commonwealth debt are no higher than before COVID.

Without that boldness in monetary and fiscal policy, without the policy lessons we learned in the GFC, world GDP today might easily be one-third less than it was before the pandemic, rather than one-tenth more.

In 2020, the Liberal Party’s shrill indignation was no longer to be heard.

Where do we go from here?

One thing I think we have shown in both crises is that fiscal policy has a big role in managing shocks that hit our economy. I agree with Phil Lowe on that.

Where I don’t agree with Phil is the notion that this part of fiscal policy should be managed by an independent authority like the RBA.

We are after all a democracy. We do have a Parliament responsible not least for the economic welfare of Australians. I can see the case for government assigning monetary policy to an autonomous entity, but not for assigning also an important element of fiscal policy.

How could governments face the Australian electorate if they disclaim responsibility not only for monetary policy, but for the economic role of fiscal policy as well?

Fiscal policy is a powerful tool not only for managing fluctuations in demand, but also for pursuing other goals.

It can be designed to resist the growing inequalities in Australian society. It can work to help diversify our economy. It can help lift productivity, for example, by funding skills training.

The key lesson to learn from this experience is the need for governments to be much more active in using tax and expenditure measures to promote growth and higher living standards.

The lesson is simply that we ignore the distributional outcomes of economic policy at our peril.

The failure of many Western countries to follow Australia’s lead through the GFC through weaker stimulus or its early withdrawal, and the imposition of austerity across the developed world, has left a legacy of dangerous economic and political consequences – lower living standards and political extremism on the rise.

The GFC shone a light on growing inequality in the developed world. The inadequate response to the crisis in many developed nations has led to an acceleration of income and wealth inequality and produced a ring of fire of nativist extremist political forces.

For Australia to have emerged from these two major crises with an unemployment rate near record lows, and without a generation of workers scarred from long-term unemployment, is a triumph of effective public policy and how it changes lives.

Proud history of nation building

In an era of mistrust in government and in institutions more generally it gets harder and harder to convince people of that.

During the GFC the Liberals and Nationals demonised Labor for deficit and debt, with constant and exaggerated claims of economic mismanagement, overspending and incompetence.

We were attacked by the Greens and the far left, with the Greens loudly objecting to our first attempted stimulus package in the Senate.

As Liam Byrne has recently observed, “a political party’s history is the core of its identity, its values and its mission”.

Now is the time for Labor to draw strength from our proud history of nation building and, just as we did during the GFC, take on the extreme left and the extreme right with the strength of our principles and our record.

Wayne Swan is a former federal Treasurer, the ALP national president and author of The Good Fight. He is currently the chair of Cbus. 

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