Category: Global economy

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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
Global economy Management

Entrepreneurs (and entrepreneurship) play a vital dual role

First, economically. For many, growth is a matter of innovation and creation. This is notably what breaks rents, allows for technological revolutions, productivity growth, thus growth in non-inflationary wages, etc.

Growth momentum comes from the economy’s capacity for movement, to experience changes in consumption standards, such as production standards, etc.

Moreover, entrepreneurs are the ones who take the risks of innovation, novelty and bold calculations. Entrepreneurs can take action within companies, provided they give them the opportunity and space to do so. They can also be company founders. Over the long term, the economy experiences the emergence and disappearance of firms. These two moments coexist and are necessary for each other. Some sectors are expanding while others are evaporating. And this is one of the drivers of the economy’s growth and its ability to adapt. This is the creation/destruction mechanism so well analysed by Joseph Schumpeter, then brilliantly reinterpreted by Philippe Aghion.

Secondly, but not less importantly, entrepreneurs are also essential because they contribute to equal opportunities. Rents hinder the latter. The ability to innovate, produce something new, can allow categories of people with lower levels of insertion or less established within the existing system to emerge and create wealth for society and for themselves. Entrepreneurship thus makes it possible to disrupt the established order, when the rules of the game in force make the current situations more rigid. Of course, for this to work, the “institutions” have to allow it and promote it. This applies to competition law, education, methods of financing innovation such as the start-up ecosystem or start-ups, etc. as well as the culture of each company that promotes and values, or not, successes or failures…

The entrepreneur, whether a founder or developer of a business, must be one of the leading figures of our societies in order to promote both economic growth and equal opportunities. Two pillars that strengthen one another and which form the basis of the social pact.

Categories
Economical and financial crisis Global economy

How can we deal with inflation?

The facts are clear. Some economists have claimed in recent years that debt did not matter because they thought that interest rates would remain very low in relation to the growth rate (negative i-g) for a long time. On the one hand, this analysis was based on a bold anticipation of future inflation, and on the other, it did not take into account budgetary constraints, which, even if low when interest rates are below the growth rate, still exist(1). Thus, this assertion led to a recommendation to spend more, undoubtedly to deal with the major challenges we are facing, but without worrying about constantly expanding debt. It was as if central banks had entered an unlimited policy of quantitative easing, both in terms of duration and amount. I explained previously why (2), even assuming that inflation did not return, which was by no means sure, such a situation may not be sustainable, given the financial vulnerabilities it added to. And given the possibility of a major recession. And, finally, as the monetary system is a debt settlement system, given that confidence in money could disappear because debts can never be constantly growing faster than the real economy.

Inflation has now returned(3 & 4) and is no longer merely transitory. Let us analyse the consequences of its return in force for all players.

Central banks: they must combat inflation. This is essential, because an inflationary regime must be avoided, that is, a system in which indexation is triggered between prices and prices, prices and wages, wages and prices. Thus, the inflation rate is neither low nor stable. Such inflation creates inequalities between households, which obviously do not have the same capacity to react to protect their purchasing power. It also leads to inequality between companies that do not all have the same capacity to “set prices”. In addition, as history has shown, once the stability and predictability of the inflation rate is disturbed, confidence wanes among economic players, producers and consumers. Prices can no longer be set easily, and need to be reset several times a year, or even more in the case of hyperinflation. This undermines confidence. Between employees and companies where employee representatives may have to request a second round of negotiations within a year, or more. This undermines the reliability of negotiations between the company’s employees and management, causing tension. Between lenders and borrowers, with lenders no longer knowing how to set lending rates, as interest rates are constantly rising. This widespread uncertainty creates tension and undermines confidence, which is one of the cornerstones of economic efficiency, growth and life in society. This is why rather low and stable inflation, ideally around 2% or 3%, is highly desirable, and why central banks have no choice but to implement a monetary policy that can at best ensure inflation is maintained at this level, and, if necessary, brought back to it.

However indispensable it is, this mission of central banks is difficult under the current circumstances. If interest rates rise too sharply or too much, this can easily trigger a recession, a hard landing. It may indeed be over-calibrated, if it is assumed that the transitory component of current inflation will weaken in the near future. Supply constraints can and should indeed ease over time, excluding the consequences of the unfolding war in Ukraine, which could exacerbate shortages of energy and certain agricultural products.

However, raising interest rates too slowly would not do enough to combat the return of high inflation by allowing indexation to develop. And reacting late, once inflation expectations are no longer anchored at a low level and indexations are put in place, is much more costly in terms of growth, since deep recessions are difficult to avoid.

But there’s more. The mission of central banks is all the more difficult because we have experienced interest rates that were too low for too long. Of course, long-term and short-term rates had to be driven towards zero in order to enable us to emerge from the major crisis of 2007-2009 and the risk of deflation that it entailed. It was also necessary during the pandemic. However, as soon as growth returned (in 2016-2017), maintaining such low interest rates, on the pretext that the natural interest rate was very low, was dangerous. Moreover, the natural interest rate is a concept and not an observable variable. It is neither theoretically indisputable(5) nor easy to use. Similarly, it is possible that the very low inflation rate of the period – which quantitative easing policies did not manage to raise – was due to structural forces (globalisation and the technological revolution), with a Phillips curve made flat as a result, and not to a lack of demand, and therefore to a cyclical phenomenon. Keeping rates too low for too long has led to consequences that the Bank for International Settlements has described very well for years. When the interest rate is too low in relation to the growth rate for too long and there is a growth phase, bubbles develop. Equity bubbles, real estate bubbles and over- indebtedness of governments and private agents. Today, if rates must be raised and quantitative easing policies gradually come to an end in the face of a major risk of a change in the inflation regime. As assets (equities and real estate) are highly valued and the level of global debt is very high, central banks must face the risk of sudden bursting of these bubbles and solvency crises of economic actors with too much debt. With the attendant risks to growth(6).This situation of macro-financial vulnerability is therefore necessarily problematic for central banks, and they must therefore be very determined and very cautious. This is why they have begun to normalise their policy and will go without debate until they reach what they consider to be their neutralisation (i.e. a monetary policy that is neither restrictive nor growth-promoting) towards the end of 2022 or the beginning of 2023. But once this stage is reached, they will act according to the circumstances. If growth slows down sharply, if the markets fall dramatically, they will take action. The state of wage and price indexation, and therefore of the level of underlying inflation, will then be scrutinised to determine whether it is appropriate or dangerous to position interest rates above the rates already reached. If the inflation trajectory does not take a satisfactory downward path, we can bet that the central banks will continue to tighten their monetary policy in order to make it more aggressive, both by a stronger rise in key rates (i.e. short rates) and by sustained quantitative tightening in the United States and by its initiation in the euro zone, thus contributing to a stronger and more rapid rise in long interest rates.

Central banks must remain credible in the face of inflation. They must be clear in their statements, showing an unwavering determination to fight it. Conversely, they must be gradual and prudent in their actions, without however being dominated by governments or financial markets.

Governments, for their part, have no choice but to have a credible medium-term solvency trajectory(7). An excessively strict fiscal policy would destroy growth, but doing nothing when the level of indebtedness is high would considerably undermine their credibility, causing a high risk on the public debt markets in the short term. They therefore need to put in place a policy of managing public finances without austerity, but which in reality provides an exit from any kind of support policy, with a focus on the weakest populations, must therefore be put in place. The pandemic, by its very nature unexpected, brutal and temporary, should clearly 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, particularly current expenditure, as well as by structural reforms(8). These are absolutely necessary for increasing potential growth, for public finances and for increasing supply, which is itself a factor in the fight against inflation. Certain supply-side policies may have positive effects quickly, others more in the medium term, both on inflation and on growth. This includes policies that increase the employment rate, such as pension reform, as well as unemployment benefit reform. The shortage of jobs in recent months is in fact preventing the supply of goods and services from being higher, as well as supporting the phenomenon of (partial) wage indexation.

Companies with too much debt, for example according to the ratios proposed by the ECB itself, must

pursue a reasonable but real deleveraging policy in order to better get through this coming period of rising interest rates and fewer financing facilities.

For households, the question of purchasing power arises(9). It will be difficult to preserve it completely. For companies, it will not be possible to index systematically wages to inflation. Moreover, since 1983, the Delors and Bérégovoy Act has prohibited companies from indexing wages to prices. If they did so, they would precipitate rising inflation and also destroy their competitiveness or profitability, both of which would severely reduce their ability to invest and employ in the future. Companies cannot therefore do everything. And they can only act according to their specific situation. It is also impossible for governments to protect everyone against inflation over the long term, as for many of them, their fiscal room for manoeuvre has already been tested. It should also be noted that such a policy is contrary to that pursued by central banks. This non-cooperation between economic policies could prove dangerous in terms of financial stability. The generalised support of purchasing power, together with insufficient supply, is also precipitating the deterioration of the foreign trade deficit, which has already been affected by the rise in the cost of imported energy. The rise of interest rates will further accentuate the budgetary constraints of the States, for those of them that are more indebted. There is still a possibility of protecting households’ purchasing power as effectively as possible: we are in a special situation in which inflation needs to be reduced, purchasing power protected and a proven labour shortage needs to be addressed. Most companies are short of employees. Increasing wages a little in exchange for a moderate increase in working hours could be part of the solution, as long as it is the choice of companies and employees themselves.

This would be good for growth, good for public finances and good for foreign trade.

CEO of BRED and Professor of Financial Macroeconomics and of Monetary Policy at HEC Paris

Bibliography :

Categories
Economical and financial crisis Global economy

Inflation and purchasing power: breaking out of an impossible equation

Inflation has just exceeded 5% in France and growth for the first quarter fell by 0.2%. Companies will not be able to (and should not) compensate for the entire loss of employees’ purchasing power, as this would lead to a drop in their results, which would sooner or later undermine their investment capacity, their competitiveness and therefore employment capacity, especially since they have already been financially weakened by supply difficulties and the rising cost of raw materials and many intermediate products.

This would therefore be very damaging to households themselves in the long term. It would very dangerously strengthen the indexation spiral, with inflation then spiralling out of control. This is why, since 1983, companies have been prohibited from systematically indexing wages to prices.

At the same time, the French government will not be able to protect households over the long term as it has done today by taking on their extra costs. Monetary policy will no longer make it possible to finance the resulting excess public debt, and the markets will probably be less willing to swallow this extra debt at today’s rates… a very worrying snowball effect on debt could ensue.

As such, households will to a certain extent lose purchasing power while inflation remains high, taking their part of the burden, with the resulting economic and social risk. Companies will also be required to contribute. The government will increasingly limit itself to protecting the weakest.

However, this loss of purchasing power is not inevitable. Working households could better protect their purchasing power without leading to a wage-price loop if productivity gains were sufficiently high or if the wage-to-value ratio remained broadly stable following wage increases. This would allow companies not to increase their prices further and protect their competitiveness and their capacity for employment and investment.

The solution would be for employees to work a little harder in exchange for higher pay, in a proportion to be negotiated.

Unfortunately, productivity gains are now zero. The only possibility for the economy to come out of this in the best possible way – for households, companies and the government – is for employees to work a little harder, depending on their type of job, in exchange for an increase in wages, in a proportion to be negotiated. This is possible, as there are bottlenecks due to labour shortages in many sectors.

Thanks to the increase in activity, this would also boost receipts from social security contributions and taxes without raising their rates, so would help maintain our high level of social protection, while promoting better control of the public deficit and debt. Retired households can only maintain their purchasing power if the number of years of contributions of working people is increased (depending on how hard the work is), although pension accounts will continue to deteriorate.

There is a real room for manoeuvre for France. In addition to the efforts companies can make to partially limit the loss of their employees’ purchasing power – a mix of wage increases and PEPA bonuses, for example – it is perfectly possible, without changing the law, to open negotiations at company level before the end of the year on this additional compensation in exchange for additional work. It is also possible and advisable to consider company agreements that allow each employee or team to choose their own balance.

In any case, it a way out of a major problem that could otherwise quickly become an impossible and painful equation.

Categories
Euro zone Global economy

Inflation, interest rates and debts: an explosive cocktail

Should central banks have to finance public deficits linked to reindustrialisation, climate change or rearmament over the very long term, as opposed to the “we’ll do whatever it takes” approach that only lasted as long as the pandemic did? Does the debt not matter, in that case? Trapped by too many contradictory objectives, extremely accommodative monetary policies would then be prolonged, with interest rates remaining well below the growth rate and central banks’ balance sheets continuing to swell. No way! This is a convenient idea, but it’s a recipe for a very painful future. So, central banks are taking a different path.

Before the war, because inflation was more than only transitory, central banks had to exit quantitative easing and raise their interest rates gradually. But because of very high global debt levels and high valuations on financial and real estate markets, they toughened their tone cautiously when a strong surge in inflation occurred due to the war in Ukraine. An inflation that gets out of hand through indexation, even if imperfect, of prices to prices and wages to prices would indeed be a source of many evils. It would de facto lead to a significant inequality in income trends in real terms, both between households and between companies, as the ability to pass on price rises would be far from equal. Wage negotiations would become very contentious; price signals between producers, distributors and consumers would be unstable; loan contracts would lead to a disruption in the way interest rates are set between lenders and borrowers. Stable and low inflation is indeed essential for confidence among market participants, and therefore for an efficient economy. Today, faced with the threat of stagflation, central banks are faced with an even more delicate dilemma.

They must not undermine this weakening growth, but they have no choice other than to react if they have any hope of combating the major risk of uncontrolled inflation. \Therefore, if and when central banks normalise their monetary policy, they will have to do so with a great deal of clarity for the sake of their credibility, but also with great caution. They will have to test the effects on the financial markets, including government debt, at each stage. The ECB has an additional challenge: the eurozone is made up of countries with very divergent economic situations. At the same time, governments will have to show a credible fiscal trajectory, by making investments that promote potential and greener growth, but also by protecting the poorest from inflation… Structural reforms will also be essential, and more than ever, to facilitate growth and to participate in the solvency path – we are talking in particular about that of pensions in France. This narrow path is the only one possible.

If central banks were to perpetuate ad libitum a policy of financing public deficits and maintaining excessively low interest rates, serious financial crises due to the bursting of increasingly uncontrollable bubbles would cascade, structurally damaging growth. Inflation would sky-rocket to the detriment of the weakest and damaging the overall efficiency of the economy. And, sooner or later, confidence in money itself could be called into question. The flight from money would eventually lead to the collapse of the economy and the social order. Historical examples bear witness to this. Monetary policies will therefore tighten and interest rates will rise. There is little time left for highly indebted agents, public or private, to prepare for this.