Inflation and purchasing power: breaking out of an impossible equation

06.16.2022 2 min
Read my column in the 15 June 2022 issue of Les Echos.

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.

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