Read the complete version of my column in the 14 May 2020 issue of Les Echos
The central banks took swift and effective action. States, including France, also acted rapidly and appropriately in an attempt to handle the cost of the unprecedented fall in production as effectively as possible. They did so by enabling, as far as possible, the financing of company losses and by taking on the cost of labour, since businesses generating zero revenue cannot continue paying their employees. The key objectives are to prevent layoffs and bankruptcies, protect production capacities, in some measure, and avoid an appalling rise in poverty.
In essence, the set of measures introduced temporarily lifts the monetary constraint from the various economic players, businesses and households. Monetary constraint applies in normal periods as it is vital to the efficient functioning of the economy.
The sole businesses that are likely to survive in the medium and long term are those that do not bleed money in an uninterrupted fashion. Otherwise, economic efficiency – which French politician Michel Rocard famously said was the only good way to spare human suffering – would not be possible and no Schumpeterian growth permitted. The same applies to households, which cannot spend more than they earn on a lasting basis.
But in today’s economic meltdown, the normal exercise of monetary constraint would be catastrophic, leading to bankruptcies and countless irretrievable job losses.
For their part, the central banks, while ensuring the liquidity necessary to the financial system, have wisely suspended the monetary constraint of states.
Once the health crisis is well and truly over, reactivating monetary constraint will not be a simple matter. But it will be indispensable. And it would be misleading and dangerous to let people believe that monetary constraint at all levels could be durably lifted simply by central banks buying state and company debt on an ad lib basis.
While monetary constraint should not be abruptly reintroduced, as this would send the economy into a new downward spiral, neither should it be suspended for too long. This is because we must absolutely avoid a flight from currency, the value of the latter being wholly dependent on the trust placed in the effective exercise of monetary constraint, and, hence, the trust placed in banks and central banks, as well as in the quality of debt, and public debt in particular.
In this respect, I believe that central banks should make a part of the additional public debt resulting from the health crisis interest-free on a practically indefinite basis to lighten the load and foster the return of growth. But they must do so in a precise and strictly circumscribed manner. The idea of central banks permanently suspending monetary constraint is a fatal illusion.
While there has not been a correlation between the money supply and inflation since the 1980s, the major risk involved in acting as if monetary and economic constraints no longer exist is not a return of traditional inflation (which would be welcome if it were to remain limited) but a loss of confidence in currency through widespread mistrust.
Sooner or later, this would lead to the appearance of a form of hyper-inflation and major financial instability. Economic history, right up to the present day, is littered with examples of interminable ruin and crises with terrible social impacts resulting from the illusion that no constraint exists and that everything is possible without having to produce the requisite wealth.
The reopening could thus entail elevated risks of economic policy mistakes. Under the sway of emotion and the pressure of public opinion, policy may seek to return too swiftly to orthodoxy or believe that we are exempt indefinitely from any and all constraints.
A solid supply policy must be led to rebuild the country’s production capacity and even increase it to reduce its strategic dependence. The process will require all the energy, capacity for work and entrepreneurial spirit of everyone involved. The supply policy must further mobilise labour and include a substantial focus on recapitalising businesses and facilitating investments. Failing this, companies will exit lockdown heavily in debt and unable to invest sufficiently on a lasting basis.
The supply policy must be accompanied by a policy to boost demand, since both have suffered considerably during the crisis. Increasing taxes will not be compatible with either policy. Consequently, we will need to accept budgets with extremely gradual deficit reductions and the fact that monetary policies can only return to their unconventional practices in a cautious fashion. But to salvage trust in state debt and in currency, this should be achieved as part of a highly explicit plan.