Category: Economical policy

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Economical policy Management

Are we unhappy at work or has work lost its value?

An increasing number of news stories are focusing on young people who have decided to stop working and simply scrape by, saying that minimum social security benefits are enough for them. As if it were normal to count on those who work to choose not to work. This signals a shift in how young adults think about work.

People point to sociological surveys to show that French companies are home to a quasi-pathological malaise at work, which would explain the refusal of the majority to postpone the retirement age.

Something appears to have broken between French people and their work, the latter having become a source of dissatisfaction and even psychological and physical disorders.

The urgency, then, is to address this distinctively French phenomenon of unhappiness at work, stemming from the poor organisation of companies and the insufficiently regulated “exploitation” of employees.

Naturally, job satisfaction depends on the particular situation of each company, and even more specifically on the company department and line managers. But numerous French companies are working to improve their management, identify what good management entails, and develop best practices.

What if the problem is not about this widespread sense of unhappiness at work? What if this new and oft-repeated discourse hides something else? A number of surveys and polls show that many employees trust their company and have struck a good work-life balance. More than a sense of malaise at work, perhaps the problem is about the erosion of the value of work itself? And this goes beyond the crucial improvements to be made regarding arduous or highly repetitive work and, notably in public hospitals and schools, cases of growing pauperisation and a lack of recognition of the importance of the work of these professionals.

Is it not the case in France over the last 40 years that the switch to a 35-hour week, the introduction of a fifth week of paid holidays and the decrease of the retirement age to 60, regardless of the obvious individual benefits and the justice of such measures, have undermined the essential value of work, both individually and collectively? Or do some people now see work as pointless, or perhaps as a necessary evil, but one that needs to be reduced to a minimum?

Our welfare society – an invaluable collective asset that needs to be safeguarded – has been considerably corrupted by requiring too few obligations for ever extended benefits.

During the Popular Front, for example, the unemployed were required to accomplish tasks of general interest in exchange for subsidies.

And financially, as well as for the social contract to remain widely acceptable, we are no longer in a position to grant more and more benefits; instead we are obliged to roll out revolutionary reforms, as in the Nordic countries since the early 1990s and in Germany since the early 2000s. This shift consists in putting a stop to the unquestioned provision of aid by introducing clear requirements and conditions for benefits, the aim being to save the country from economic and financial collapse and to preserve the social pact allowing a high level of social protection, as the Nordic countries did in the 1990s.

Our society as a majority is not suffering from a widespread malaise at work caused by businesses themselves; it is prey to a growing disaffection for work combined with the rise of unbridled individualism adroitly dressed in discourses of solidarity, alternative approaches to labour, and even the rejection of capitalism. Benevolence – a fine and increasingly advocated value – can be conceived only if accompanied by a parallel and equally strong sense of requirement. Failing this, under the pretext of understanding and explaining everything, benevolence allows anything and everything. This could destroy the relationships between benefits and obligations that form the basis of the social contract and harmonious co-existence. What we need, then, is benevolence with requirements, healthy demands on oneself and others, in families, work and school. This sense of requirement is free of any connotation of intransigence.

Constantly supported and protected while giving nothing in exchange, too many people have lost sight of the relationship between, on one hand, the right to income, health and a pension and, on the other, work.

If the value of work is not restored as soon as possible, a major economic, financial and social crisis may occur. We need to understand that the only source of wealth is work. And that the high standard of living and social protection enjoyed in France relative to other countries can only be defended in the short to medium term by the work of the French themselves.

Work is a source of liberation and socialisation rather than alienation. Socialisation, social ties, and the act of forging one’s place in the world all constitute a key social need and are most often made possible by work. Work enables shared projects to be achieved. It gives meaning. It organises social life. Companies and company departments need to constantly strive towards the best way of working and empowering individuals in their work and that of their teams, without idealising reality but also without systematically blackening it ideologically. We must not forget that work serves to collectively safeguard – and to improve – the standard of living and social protection of the entire population.

Categories
Bank Economical and financial crisis Economical policy

Central banks: towards a policy of “small steps”

The global economy is slowing. This will complicate the situation of highly indebted governments and private players. But in principle it should facilitate disinflation, thus slowing the rise in interest rates and possibly facilitating their subsequent decline. However, activity is holding up better than expected and labour markets continue to be tight – high employment rates and low unemployment rates – which is maintaining the level of core inflation. This is consequently accompanied by very low or even zero productivity gains.

Monetary policies are therefore set to continue with their interest rate hikes, albeit with great caution. And at least maintain this level of interest rates, for longer than was expected by the financial markets. There are many reasons for this necessary caution. The new financial conditions have tightened, which in itself results in a slowdown in credit and the economy. Interest rates are therefore higher, risk premiums (“spreads”) larger, lending conditions more stringent, liquidity less abundant, etc. Further monetary policy tightening is therefore not necessarily required. Small steps will now be key, with a study of all the available data between each decision, so as not to do too much or too little.

But above all, the vulnerabilities of the financial system as a whole are obviously what has made central banks very cautious. Of course, the recent signs of this instability had partially idiosyncratic causes. Silicon Valley Bank was poorly managed and under-supervised. The simultaneous increase in the number of cases and the resulting contagion nevertheless show the potentially systemic nature of these events. Long-term rates too low for too long have made many balance sheets highly vulnerable. On the liabilities side, because many companies and governments, and even individuals, both in advanced and emerging countries, were able to take on debt without apparent pain, up to the point of over-indebtedness with a normalisation of interest rates. On the assets side, because in order to seek a little yield in times of zero or even negative interest rates, end investors, either directly or through various asset managers, were encouraged to take more and more risks, whether by extending the maturities of the assets purchased, by a greater dissymmetry between the duration of assets and of liabilities, by accepting higher credit or equity risks, by increasing leverage, etc. The rapid rise in interest rates marked an abrupt break from this long period of rates that were too low (i.e. below the growth rate), during which these weaknesses accumulated. Today, the large global real estate bubbles appear increasingly vulnerable, and the fall of the equity markets will be even greater if they continue to ignore the gradual effects of the general tightening of financial conditions. And the risk of insolvency of many highly indebted players has risen sharply.

Central banks are very aware of this situation, such as the risks generated by a very tense geopolitical situation, leading to, among other things, a costly fragmentation of economic zones. And although on average banks are much stronger than during the big financial crisis, with shadow banking remaining much less regulated, monetary policy authorities will double down on caution, but will preserve their indispensable credibility in their fight against inflation.

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Economical policy Euro zone

Monetary policy cannot do everything

Today, inflation has returned for the long term. Central banks must counter it. But an excessive rise in interest rates can trigger a recession, a hard landing. It can be too strongly calibrated, if we think that the transitory component of current inflation will weaken in the near future. Supply constraints have already begun to ease over time, barring the consequences of an escalation in the war. But an excessively slow rise in interest rates would lead to an increase in indexation. Reacting late, once inflation expectations are no longer anchored at a low level, would cost much more. Making deep recessions inevitable.

Interest rates too low for too long have globally led to very high debt ratios and bubbles in both equities and property. Rates must therefore be raised and quantitative easing policies gradually come to an end. But central banks are facing the risk of bursting bubbles, with impacts on growth, and the risk of insolvency for the most indebted companies and governments. This situation is therefore problematic for central banks, which must be very determined and very cautious. As a result, they have begun the normalisation of their policy and will go as far as its neutralisation. Including through a gradual exit from quantitative easing. But once this stage is reached, they will act according to the circumstances. If growth weakens sharply, if markets fall substantially, they will warn. The state of wage and price indexation, and therefore of the level of “structural” inflation, will then be scrutinised, in order to question the opportunity or danger of positioning interest rates above the neutral rate. If the inflationary regime were to strengthen further, they would very likely tighten their policy, both by raising their interest rates above the potential growth rate, and increasing quantitative tightening.

In this context, they will conduct monetary policies that are closely linked to data as they arise. While avoiding being dominated by fiscal issues and financial markets.

Meanwhile, governments have no choice but to have a credible medium-term solvency trajectory. An overly strict fiscal policy would destroy growth, but doing nothing when the level of indebtedness is high would undermine their credibility, which would be a very high risk in the short term.  They therefore need to put in place a policy of managing public finances without austerity, but which in reality is an exit from support policies. The unexpected, brutal and temporary pandemic is indeed to be differentiated from a possible change in inflation regime.

In addition, the investments needed to increase potential growth or green growth must be financed. However, this financing must be secured by more rational and efficient management of public spending, as well as by structural reforms. The latter are necessary to increase potential growth, i.e. sooner or later for a better ratio of public debt to GDP. They are also a means of combating inflation, the origin of which in Europe is more linked to a supply shock. And when the labour supply is very insufficient, job shortages can be alleviated by the reform of the labour market and the unemployment system, as by pension reform. In France, the employment rate of people over sixty is much lower than that of the rest of the eurozone.

The road is narrow. The essential fight against inflation, without too many economic and financial difficulties, requires a good combination of monetary policy and structural policies. Monetary policy can do a lot, but it cannot do everything on its own.

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Conjoncture Economical policy Euro zone

“Inflation, interest rates and debt”

Updated on 21/10/2022

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Economical policy Euro zone

The new debt equation in the next five years period

Should interest rates be lower than the growth rate for the long term, implying that debt is not important? This is not my thesis and I believe that central banks will initiate or continue a gradual increase in their rates. What will be the possible and relevant reactions for any government with a high level of debt?

Before the very recent war in Ukraine, growth was strong, even if it fell slightly in view of the slow return to a more normal growth rate after the 2021 rebound.  Monetary policy was therefore expected to be at least normalised, smoothly due to the high overall debt and highly valued financial and real estate markets, by gradually exiting the quantitative easing policy, as well as by cautiously raising interest rates.  This need for tightening came from the risk of overheating. But also from the risk of monetary policy being exhausted in the event of new (and there are always) future crises. Finally, from the development of bubbles due to interest rates that have been too low for too long compared to growth rates.

Then, several months ago, there was an upsurge in inflation. It was clear that part of this inflation was not transitory and that we were probably changing inflationary regime.  The Fed, then the ECB, were therefore prompted to accelerate their announcement of a gradual end to their net securities purchases on the markets.   They also said they would raise their rates a little faster than expected. For the same reasons as described above, however, the issue was still not to proceed too quickly in exiting their very accommodative policy. Moreover, the ECB had to deal with the more specific and difficult eurozone issue, due to the large imbalances between the countries of the South and the North.

At the same time, governments had, and still have, a need for investment for the development of new technologies, re-industrialisation (even partial) and the energy transition. There was therefore a conflict between, on the one hand, the objective of financial stability undermined by interest rates that have been too low for too long and now the fight against inflation and, on the other hand, the objective of financing the necessary new investments and the solvency of governments, or even private players, whose debt had increased sharply since 2000 for the private sector and since 2007 for the public sector, with in addition a significant increase in public debt due to the pandemic.

Hence, the raising of several voices in the eurozone. The first stating the need to change the common budgetary rules, by excluding investment budgets from the calculation of constraints on public deficits. This proposal is sometimes coupled with the idea that, under current circumstances, the level of public debt was of little importance, and that the central banks would continue to finance future deficits for a long time. Another voice showed a narrower path, but it seems to me much more credible, certainly explaining the need to change the eurozone’s common rules, which are dated and ineffective, but at the same time stressed the importance of the compromises to be found between the countries of the North and the South on these changes in rules so as to select as candidates for exclusion only investments that actually generate potential growth or facilitate the energy transition. All expenses not always resulting in more potential growth. And the improvement in growth potential not always requiring additional spending. It was also crucial, from this point of view, to agree on reasonable budgetary rules, preventing any “free rider” behaviour.

The spectre of stagflation

Today, the war situation has created the spectre of stagflation. Therefore of a slowdown in growth which will be at least 1% and inflation even stronger than expected before the start of the war. This will create an even more intense dilemma for central banks. However, if the very sharp upsurge in inflation were to lead to no reaction or a very weak reaction on their part, a major risk of an inflation spiral could arise. Today, the question of whether there will be a second round of inflation no longer arises. Many industrialists and large retailers are increasing their prices, otherwise they are no longer able to cope with rising costs. And many companies have begun to raise their wages. They cannot act otherwise, in order to retain their skills, as well as to be able to recruit. The upcoming wage negotiations will reinforce this phenomenon.

However, if inflation takes hold through price-to-price, wage-to-price and price-to-wage indexation, with slower growth, we will enter a potentially lasting stagflationary dynamic. When Volcker, then Fed Chairman, tried to exit a long stagflation, in 1979, he had to provoke a deep recession in order to break the indexation phenomena. Ignoring inflation would also be very dangerous in terms of inequality, because no one is equal, neither among employees nor among companies, in the face of the ability to pass on any price increases in their incomes. Moreover, there is a need to fear inflation that could be transformed into a system of hyperinflation, causing economic agents to lose their bearings. Stable and low inflation allows for viable wage agreements; reliable price catalogues between producers, distributors and consumers; loan agreements to set interest rates between borrowers and lenders based on shared inflation expectations. In short, stable and sufficiently low inflation is essential to confidence. However, it is necessary for an efficient economy. Monetary policy must therefore react in a timely manner. If it were not to do so, it would have to act later by taking much more risk. Central banks must remain credible.  By supporting growth, of course, but clearly by combating inflation. Uncontrolled inflation also undermines growth itself.

This path will be very narrow

This path will be very narrow.  The monetary tightening policy must therefore necessarily be very cautious, and therefore very gradual. As a result, this trajectory will also require governments to play their part. On the one hand, governments will have to make the aforementioned necessary investments, generators of potential growth and, on the other hand, reduce unnecessary expenditure or reallocate it usefully. France has had the highest public expenditure as a percentage of GDP in the eurozone for a long time, but in some areas this expenditure has, in recent decades, provided a quality that bears little relation to the level of expenditure incurred. The OECD’s many comparative measures testify to this on a regular basis. Thus, the effort must not be only financial. The essential investments can therefore only be made if the essential reforms are carried out. Such as the reform of retirement – which while reducing the public deficit – supports potential growth because it increases the population available for work, whereas currently France is one of the countries with the significantly lowest employment rate after the age of 60.

All in all, it is imperative that central banks neutralise, at least, but cautiously, their monetary policy, in order to combat too much inflation, as well as to avoid financial instability due to bubbles that would continue to develop. And, at the same time, it is essential that governments increase potential growth through investment and reform and ensure better control of spending. In order to give credible trajectories to their fiscal policy and ensure their solvency in a world where interest rates will be structurally rising.

On 16 March this year, the Fed increased its intervention rate by 25 cents and indicated that there would be numerous hikes in the future. The following day, the ECB, in turn, announced an end to its net securities purchases at the end of June and paved the way to subsequent rate hikes. Furthermore, if the ECB did not perform such a policy change, the euro would continue to depreciate against the dollar in particular, leading to even higher inflation, due to the rise in prices in euros of imported products. The trend therefore seems to be underway.

The idea of a “war economy”, war against climate change, war for re-industrialisation, as well as a military war, as begins to be mentioned here and there among some economists – if it led to the belief that debt was of no importance and that the central banks would be obliged to finance any new deficit thus allowing very sustainable spending without constraints – could lead to a disaster. This concept of war economy, as previously stated, inevitably leads to the idea of a very long period of time.  Unlike a “whatever it costs”, limited to the duration of the pandemic. However, this idea includes an unthinkable: money. Money is the foundation of the debt settlement system. Having confidence in money means having confidence in the effectiveness of the debt settlement system. Therefore, if ever the monetary constraint[1] were suspended for too long, then confidence in money could be called into question. And if we no longer had confidence in money, we could experience, not traditional inflation, but a flight from money. If the central banks were to never stop quantitative easing and endlessly keep rates too low relative to the growth rate, not only would there be regular serious financial explosions, but sooner or later this would also lead to a flight from money that would be dramatic. This would result in the disorganisation and collapse of the economy and society. Because money constitutes the social link. As Michel Aglietta says: “confidence in money is the alpha and omega of society”.

[1] Either the obligation to pay one’s debts or, more precisely, for governments and companies, to refinance them at maturity with lenders other than central banks.

Categories
Bank Economical policy Finance

Can the risk of financial instability come from non-banks?

Practices, but also accounting rules, have their influence on the behaviour of banks and the non-banking sector, two complementary but competing segments. Regulation also has its role. Hence the need to think about regulation for non-banks.

The financial system, which matches the financing capacities of some with the needs of others, consists of banks and financial markets. These two components of the system have partly identical and partly separate roles. Both help finance economic players. Market finance has seen a sharp increase in its share worldwide since the great financial crisis. It now accounts for around 50% of financing in general, and 30% in the corporate sector. It is also useful that investment funds, asset managers and institutional investors, major players on the financial markets, take part in financing. Because banks alone cannot guarantee the full amount to be financed.

Markets accept risks denied by banks

In addition, they can provide capital to companies that find getting finance from banks more difficult, including start-ups and innovation in general. Explanations: the credit risk of these sectors is generally too high for banks, which must protect the deposits entrusted to them. Investment funds may accept that they may lose more, if on average capital gains on companies that will survive and succeed are greater than losses, with the final risk being taken by end investors who accept it.

The two types of player in the financial system are also different in terms of financial stability. Firstly, because banks record the historical value of the loans they grant on their balance sheets. They must provision for the risk on a statistical basis, but also on a case-by-case basis depending on their assessment of a possible deterioration in each borrower’s ability to repay. However, changes in average opinions on risk quality are not taken into account and do not result in any accounting changes.

A different approach to risk

The approach is completely different for funds: they must record the change in the market value of their financial investments at each point in time, in accordance with fair value accounting rules.  This leads to a significant difference in behaviour between banks and funds. Banks choose to grant credit based on their analysis of the borrower’s ability to repay over time. For their part, funds choose to buy bonds, for example, based on what they think about changes in the market’s majority view on the value of the risk premium allocated to the borrower. Why lend if they think the value of the bond will fall in the near future, even if they are not ultimately worried about non‑repayment? Unless strongly conditioned by the prospect of securitisation of the loans granted or the resale of risks by CDS, banks’ behaviour is therefore much more stable by nature than that of funds, whose valuation mechanisms are much more volatile, since they are much more related to self-referential behaviour on the markets.

On the other hand, funds do not take on financial risks themselves. Credit, interest rate and liquidity risks are in fact left in the hands of end investors, households or companies. In the case of banking intermediation, banks bear these risks on their own income statements. And they do so in a professional, regulated and supervised manner. This allows households and businesses not to take these risks if they do not have the competence or the desire to do so.

Increased risk-taking from very low rates

Banks and non-bank financial intermediaries such as funds are therefore both very useful, both competitive and complementary. But the portion granted to each in the global financial system plays a major role in overall stability or instability.  We should add a fundamental point, which the major central banks are currently addressing. Since the financial crisis of 2007-2009, the regulation of banks has increased significantly, notably through the required capital adequacy ratios (more equity for identical risks) and the setting of restrictive ratios limiting liquidity risk. There is no such regulation for non-bank financial intermediaries.

However, the monetary policy of very low interest rates for a very long time has gradually led financial players, on behalf of savers, to seek returns by increasingly taking on risk. In terms of credit risk -including increasingly high leverage effects- with squashed risk premiums. And in terms of liquidity risk, by further extending the maturities of credit securities and lowering the expected level of their liquidity. This has made fund assets significantly more vulnerable, as highlighted by all the studies of organisations responsible for supervising financial stability around the world. The risk can thus be pushed out of the banking system and onto non-bank financial agents, without control.

Beware of moral hazard!

The violent financial crisis of March 2020, triggered by the expected impact of the pandemic, was fortunately brought swiftly under control by the central banks. They acted very strongly and very quickly. In this regard, it demonstrated the resilience of banks, but also the vulnerability of many funds. Central banks had to buy very large amounts of securities from funds in difficulty, including high yield. They had to prevent a catastrophic chain of events, due in particular to sudden withdrawals from end investors that these funds could not absorb without incurring excessive losses or without a major liquidity crisis.

Prudential and macro-prudential regulation cannot do everything, but it is essential to mitigate the natural procyclicality of finance and to prevent the risk of financial instability as much as possible. It must now be extended and adapted to non-banking financial intermediaries. It is also essential to combat moral hazard, because without preventive regulation and with bail-outs during major crises, risk-taking may be ever higher, with no limit or almost, thanks to a free option given by central banks against serious incidents. Finally, the proportion between banks and non-banks in the financial system as a whole must also be subject to adequate analysis and policies to determine the most favourable balance for both growth and financial stability.