Category: Economical policy

Categories
Economical policy Global economy

Turning points in Monetary Policy

For three decades, monetary policies have adapted to what has been a profound change in the methods of regulating the economy. After the successful fight against double-digit inflation in the first half of the 1980s, through a monetary policy which led to peaks in interest rates but which inevitably caused a deep recession in the process, the economy gradually changed its ways of self-regulation. Monetary policy also changed.

The cyclical downturn in inflation – essentially caused by the sharp slowdown in the economy due to skyrocketing interest rates – gradually led to a structurally low inflation regime. Monetary policy was not the only reason here, or even the major reason. The 1980s were indeed, on the one hand, the moment of financial liberalisation – financial deregulation and globalisation (cross-border liberalisation of capital movements), in the financial sphere. And, on the other hand, in the real sphere, the moment of the beginning of globalisation which was strongly heightened in the following two decades.

Financial globalisation puts increased pressure on the interest rates of countries experiencing more inflation.

And globalisation unquestionably leads to the emergence of competitive, cheaper labour, implying a necessary wage moderation in advanced countries (and a massive exit from poverty in emerging countries).

Finally, this moment was also that of the appearance of a new technological revolution, the digital revolution which, if it did not show a massive increase in productivity gains in the statistics, was a brake on the growth of wages in certain categories of human labor tasks through the possibilities of substitution with automation that it entails.

This double movement – a globalisation of the market of capital and goods as well as investments coupled with a technological revolution – was already known at the end of the nineteenth century and the beginning of the twentieth, with the same result in the appearance of a low inflation regime.

As a result of this new regime, since the 1990s monetary policy has not had to worry so much about fighting against possible excess inflation and has thus legitimately used its available means to promote a more consistent level of solid growth. To the point, moreover, that economic models have taken these in- depth changes into account and have provided a theoretical basis for the “new” monetary policy, going so far as to promote the hypothesis of a new capacity for the latter to allow a period of great moderation, in which real cycles were greatly mitigated and inflation was stable, if not completely, under control.

However, another phenomenon has not been taken sufficiently – if at all – into account, that of the reappearance of financial cycles. It was thought that financial stability increased when we ensured consistent growth and low and stable inflation. However, without much monitoring, parallel to this period of great moderation, phases developed – longer than the real cycles – of rising indebtedness (of the private and/or public sector depending on which instances) and the development of heritage asset bubbles (mainly shares and real estate, but art can easily be included).

Financial deregulation and globalisation, as the long view of history shows, facilitate this kind of phenomena linked to the intrinsic pro-cyclicality of finance.

The monetary authorities did not then take into account these financial cycles which see indebtedness and bubbles develop during the euphoric phase of the cycle, which then inevitably generate serious crises of solvency, liquidity and catastrophic explosions of the bubbles. Thus, from 1987 (equities), then in 1990-1991 and the following years (real estate), in 1997-1998 (sudden stop crises in emerging countries), in 2000 … (equities) and of course in 2007-2009 (debt and real estate), systemic crises have reappeared, with the bursting of successive speculative bubbles, as well as increasingly pronounced credit and over-indebtedness crises.

This return of financial crises provoked a wise reaction from international central banks and regulators to first of all avoid a catastrophic unfolding of these crises – and avoid the return of long periods of depression such as that following the crisis of 1929 – through remedial actions (the reaffirmed role of the central bank as lender of last resort) and also preventive efforts to limit the risks taken by the banks and in particular to impose on them sufficient capital requirements to absorb any significant losses.

prudential regulations were put in place, in order to limit the pro-cyclicality of credit and financial markets.

However an asymmetry became gradually rooted within monetary policy itself.

In order to avoid the effects of systemic crises, including the depression and deflation that could result from them, they made the correct decision of lowering their key rates (which are short-term interest rates) towards zero, or even for some below zero (including the ECB).

And faced with the limit of their action represented by the proximity of their rates to 0%, they launched in particular an innovative policy deemed to be unconventional, that of “Quantitative Easing”, which consists of directly taking full control of long term rates and risk premiums, particularly bonds, by purchasing securities directly on the markets, by significantly increasing their balance sheet in doing so. These policies prevented any self-destructive speculative boom, but also, by positioning long market interest rates below the level of the growth rate, they facilitated the deleveraging of the many players who needed it.

The problematic asymmetry in monetary policy stemmed from the fact that, for numerous reasons, central banks did not reverse (or tried to do so and then quickly abandoned) their Quantitative Easing even when growth had got back on track and the credit supply was returning to a satisfactory level. Thus, monetary policies have gradually facilitated, in both the advanced and emerging regions, a very strong valuation of the equity market and an even more visible bubble in the real estate market, as well as a sharp rise in the public and private debt relative to GDP in many countries. Even if rates had remained very low for even longer, the ensuing financial vulnerabilities could not have avoided becoming a marked financial instability forever.

But, in addition, inflation made a comeback as the lockdowns emerged, stoked by the effects of the war in Ukraine on energy and agricultural commodity prices… This brings us to the monetary policy turning point of 2022 and to the ridge path they must now follow.

The sudden revival of inflation necessarily led central banks to sharply raise their key rates.

On the one hand because inflation is very unfavourable to companies as well as households which cannot easily match the rise in prices through their own prices or wages. On the other hand, because a high and unstable inflation undermines the benchmarks necessary for an orderly, confident, and therefore uncontested price setting and wages, essential for an efficient economy. Moreover, it was necessary to finally move on from a period where interest rates were too low for too long, with the consequences described above.

All of this explains, among other things, after a moment of hesitation as to the transitory nature or not of inflation, the strong and rapid rise in central bank rates. And at the same time the beginning of Quantitative Tightening. But it also underscores the unique situation facing central banks today, which requires them to proceed very carefully and take small steps from now on.

Underlying inflation has not been defeated and therefore requires higher rates or at least being maintained for a long time at the current levels.

But at the same time, too fast or too strong a rise in rates can bring forth the accumulated financial vulnerabilities created by rates that are too low for too long. On the liabilities side of the balance sheets (too much indebtedness) as on the assets side (highly or overvalued assets) of many private and public players.

Interest rates at current levels, or even higher, have and will tend to strain the financial strength of many players.

Central banks have therefore entered into driving a monetary policy which will constantly scrutinise the state of global financial stability and will maintain a cautious approach. Without losing their essential credibility in their fight against inflation.

Finally, it should be noted that we have very probably expected too much from monetary policy alone. It is not a cure-all. It is crucial that fiscal policy is oriented in a manner which is compatible with the phase in which the economy finds itself and that the necessary structural reforms are carried out.

Categories
Economical and financial crisis Economical policy Global economy

Global fragmentation: economic and financial consequences

Growing geopolitical tensions have and will have lasting effects on international trade (including the reorganisation of goods flows) and on the international monetary system. These tensions are generating global fragmentation by heightening commercial and financial polarisation between the increasingly marked zones of influence of the two superpowers, the United States and China, even if many countries would like to keep them at an equal distance. This situation follows several decades of globalisation in terms of trade, investment and finance, having served to significantly reduce world poverty and the gap between advanced and non-advanced countries and resulting in a lasting period of disinflation. But they have also led to profound upheavals in national industrial structures, with necessary and sometimes painful reorientations.

The economic, financial and social risks involved in planetary fragmentation are the subject of increasing debate. And major international bodies are rightly concerned about the fragmentation process under way. Globalisation has significantly reduced inequalities between rich and poor countries. In 1981, 40% of the world’s population lived below the extreme poverty line, compared with just 10% today. In China and India, for example, two billion people have risen above the poverty line. And what is true of income is also true of health, with the difference in life expectancy between advanced and non-advanced countries having narrowed considerably. The effects of highly developed international trade and globalised capital markets are, by these standards, clearly established.

We also know that the optimal functioning of globalisation hinges on mutually accepted and respected rules regulating international trade and on national policies serving to support transformations in production structures and the nature of the resulting jobs. But in the last ten years, the acknowledgement of the indispensable nature of these international rules and regulations has been undermined, particularly by China’s growing thirst for power and the attendant reaction of the United States.

Sino-American tensions are clearly central to these concerns. The rise in US protectionism largely initiated in the policy proposals of Donald Trump has continued under the Biden administration, with security measures restricting technology exports and the recent introduction of the Inflation Reduction Act. In the opposite camp, China persists with its numerous anti-competitive policies, both explicit and implicit.

The consequences of COVID, Brexit and the war in Ukraine have also contributed to the reorganisation of trade routes and capital flows. The risk of fragmentation has been reinforced by the conflict in Ukraine and the resulting increase in sanctions affecting trade, investment and the assets of sanctioned institutions and individuals.

These observations, like the economic and financial implications mentioned here, are not analysed from a moral standpoint, nor from the realistic standpoint of the balance of power between nations with opposing political regimes. Today’s growing global fragmentation has de facto effects beyond the intentions having driven the trend.

Partial de-globalisation, such as the relocation of production plants, could have favourable consequences for the climate and, in all likelihood, for the number and nature of jobs for the middle classes in advanced countries. But the resulting rise in structural inflation will erode their purchasing power. Symmetrically, it will slow down catch-up on the part of less advanced countries, with the corresponding social impact. Lastly, the reduced mobility of capital resulting from fragmentation will create fewer opportunities for financing, especially for development projects in less advanced countries. And it will increase the cost of borrowing.

Increased geopolitical tensions and the resulting sanctions, de facto and de jure, reduce the international mobility of capital in financial markets as well as in cross-border bank lending.

Consequently, financial vulnerabilities are also expected to increase, as capital could become scarcer for some countries, banks less internationally financed and therefore more fragile, and “sudden stop” or currency crises more frequent. This could undermine global financial stability. And overall – trade, investment and finance combined – it is likely to reduce global growth.

This process of fragmentation will also impact the international monetary system, potentially transforming it. What role will the US dollar and Chinese renminbi play in the future? Can and will the dollar lose more and more clout in foreign exchange reserves and international payments? The issue is important both macro-financially and for US power itself.

The dollar’s share of international trade has held steady over the last 20 years, while the relative weight of the US economy in world trade and GDP has declined slightly, measured in purchasing power parity.

In contrast, the share of the US dollar in central bank reserves has fallen by over 10 percentage points. This has not benefited the euro, sterling or yen, which generally stand to gain from the diversification of foreign exchange reserves. Instead it has benefited the renminbi, for one quarter of the decrease, along with other currencies including those of Australia, Canada, South Korea and Singapore, for the remaining three quarters. In addition, gold has once again become a source of reserve diversification, particularly for emerging central banks.

The US fundamentally needs the US dollar as a de facto, if not de jure, international currency. The country’s current account is structurally and significantly in deficit and its net external debt is constantly growing (from 10% of GDP in 2000 to roughly 70% today).

As such, the US dollar’s role as the world’s reserve and transaction is essential to the United States’ maintaining its position as a superpower. It enables the country to refinance its deficits problem-free and reduces its borrowing costs. China perfectly understands this correlation between global power and global currency and is patiently building the basis for the internationalisation of its own currency. China is encouraging countries having entered its zone of influence to gradually break free from the greenback or invoice and trade less in the currency. It is also gradually building the necessary infrastructure by creating future offshore renminbi clearing houses.

In another key factor, the United States, by using the dollar to develop the extraterritoriality of its law, and to impose sanctions (including the freeze on Russian central bank reserves), could run the risk of precipitating the decline in the use of the dollar as both an international transaction currency and a reserve currency. The monetary weapon of power is thus double-edged, as the refinancing of deficits and the vertiginous external debt of the United States would not be able to withstand a gradual de-dollarisation of transactions and reserves.

Symmetrically speaking, as long as Chinese government policy largely dominates the economy, it will be extremely difficult for the renminbi to internationalise. To be successful, a currency needs to inspire trust. Money is a debt, a bank debt relative to non-bank economic agents in a country. And internationally, money stands as a country’s debt. Which is why across-the-board trust in political, military and economic power is essential. But this trust also depends on how the currency is regulated and, hence, on the validity and stability of the institutions that define and supervise the currency. If it were to occur, the de-dollarisation process would therefore be extremely gradual, taking place over the long term.

Today’s fragmentation trend is a clear consequence of ongoing global disorder and polarisation. Political, military, economic and demographic forces, as well as the greater or lesser wisdom of leaders and peoples, will determine the final shape (on a transitional basis at least) of today’s transformations. These developments will impact growth, standards of living, quality of life and financial stability around the world.

Bibliography:

  • Geo-economic fragmentation and the world economy
    Shekhar Aiyar, Anna Ilyina
    27 March 2023 – Vox Eu columns
  • Confronting Fragmentation Where It Matters Most: Trade, Debt, and Climate Action
    Kristalina Georgieva
    16 January 2023 – IMF
  • Geopolitics and Fragmentation Emerge as Serious Financial Stability Threats
    Mario Catalán, Fabio Natalucci, Mahvash S. Qureshi, Tomohiro Tsuruga
    5 April 2023
  • The Stealth Erosion of Dollar Dominance: Active Diversifiers and the Rise of Nontraditional Reserve Currencies
    Serkan Arslanalp, Barry J. Eichengreen, Chima Simpson-Bell
    24 March 2022 – IMF
  • Le passage à une situation de multiples monnaies de réserve (The transition to a multiple reserve currency situation)
    Patrick Artus
    5 January 2023, Flash Economie
  • Le système monétaire international et le financement des Etats-Unis (The international monetary system and the financing of the United States)
    Patrick Artus
    30 March 2023, Flash Economie
Categories
Economical policy Finance Finance

Text of my speech at the EURO 50 conference in June 2023

Can the risk of financial instability come from Non-Bank Financial Institutions?  (NBFIs)

Market finance and NBFIs (pension funds, insurers, investment funds, hedge funds) have seen a sharp increase in their share worldwide since the Great Financial Crisis. It now accounts for around 50% of global financing and 30% in the corporate sector. Obviously, because banks alone cannot guarantee the full amount to be financed, it is very useful that the NBFIs, as major players on the financial markets, take part in financing. As the NBFIs sector accounts a lot in global financial assets, the correct functioning of the non-bank sector is crucial  for financial stability. However, NBFIs potential fragility has been increasing for the last 15 years or so. All in all, there is a high level of financial vulnerabilities in the financial system. Recent stresses at some banks remind us of the elevated financial vulnerabilities built over years of too low for too long interest rates and ample liquidity. The recent manifestations of these strains – Silicon Valley Bank being a good example – appeared to be more idiosyncratic. This bank was in fact very badly managed and severely undersupervised. But, this bank was not the only bank to face this situation and the fast contagion we witnessed, shows in my opinion, that we are facing a potential systemic issue, rather than a simple idiosyncratic problem. As a matter of fact, as I said, too low for too long interest rates, with very abundant liquidity have led to a high level of vulnerabilities in many balance sheets. On the liability side, numerous firms and states, and even sometimes individuals, in both Advanced and Emerging Countries, have been able to run up debts painlessly, until over-indebtedness is proven when interest rates normalize. On the asset side, because of zero, or even negatives rates, final investors or their asset managers were incited to take more and more risk to get a little return. By lengthening the maturities, by increasing the mismatch between the asset and liability duration, by choosing higher and higher leverage, including by using more and more derivatives, etc. The rapid rise in rates has of course brutally interrupted this too long period of too low rates, during which the accumulation of vulnerabilities took place. As far as banks are concerned, since the Great Financial Crisis, the bank regulation has increased significantly, notably through the increase in the required capital adequacy ratios and the setting of restrictive ratios limiting liquidity risks. So, on average, banks are much more solid than before the Great Financial Crisis. But, there is no such regulation for non-bank financial institutions,  and specifically for funds. So, the former financial environment led the NBFIs, on behalf of savers, to seek returns, but increasingly taking on risks. Let me be more explicative: 1st. In terms of credit risks – including higher and higher leverage ratios, with squashed risk premiums. 2nd. In terms of liquidity, by further extending the securities of bonds or credit, and by lowering the expected level of their liquidity. And doing so, endangering their liquidity risk, with bigger and bigger liquidity mismatching. 3rd.The funds’ use of derivatives (futures, repo, etc.) amplified tremendously their own leverage. For example, between 2015 and 2022, the financial leverage (measured by derivatives over total assets) of macro-hedge funds came from 15% to more than 30%. And for relative value funds: from 15% to 25%. On top of that, Margin calls as well as collateral calls may be fatal.

All this has been highlighted by numerous organisations in charge of supervising financial stability around the world. So, all in all, financial risk could have been partly pushed out of the banking system onto NBFIs, without control.

A piece of evidence: 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. The violence of this flash crisis was much more due to the vulnerability of many funds, than to banks which demonstrated, by the way, their resilience. Central Banks had to buy very large amounts of securities, including high yield bonds, from funds in difficulty. Central Banks had to prevent a catastrophic chain of events, due in particular to sudden withdrawal from final investors, that these funds could not absorb without incurring excessive losses or without a major liquidity crisis.

Of course, additionally, high levels of interconnectedness among NFBIs and with banks can also be a crucial channel of financial stress.

And, obviously, possible repeated Central Banks’ interventions to provide them with liquidity support during systemic stress events could bring a very dangerous moral hazard effect !

So, some ideas arising from these facts and analyses, converging with the IMF proposals: 1st.Robust surveillance, regulation (capital and liquidity requirements) and supervision are needed. 2nd.Public data disclosures are required to post the liquidity mismatch chosen, the level of leverage (including derivatives), etc. 3rd.Only under these conditions, access to Central Banks facilities liquidity at a high interest rate and/or fully collateralized should be envisaged. Otherwise, there would be a free option!

As NBFIs became more and more important in the financial intermediation, and because of their systemic risk and potential vulnerabilities, an appropriate international regulation of the NBFIs seems to me a priority.

Finally, I’d like to say that prudential and macro-prudential regulation cannot do everything. But it is essential to mitigate the intrinsic procyclicality of finance and to prevent -better then to cure-financial instability, as much as possible.
So, in my opinion, prudential and macro-prudential regulation must now be extended and adapted notably to investment and hedge funds.

> Agenda of the last EURO 50 session on the 19th of June 2023 in Luxembourg at the European Investment Bank

Categories
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.

Categories
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.