The post-Covid economic paths are very narrow

02.18.2021 5 min
Find the complete version of my column published in the edition of Les Echos of February 16, 2021.

This much is obvious: the longer the pandemic lasts, the higher the debt will be. To counter the economic effects of the lockdowns, governments and central banks have taken powerful and vital desensitising actions. After the pandemic, they will have to reduce, and then end them. With the very good outlook brought by the vaccines, fortunately; but this phase is when the economic crisis will gradually surface, with a rise in bankruptcies and lay-offs in the affected sectors. Then will come the “debt trap”. Either the central banks will pull out of their quantitative easing policy little by little, and long-term interest rates will rise, triggering the insolvency of many companies and governments, if the latter do not find a new credible trajectory for their debt. Or they do not, and fuel the financial and real estate bubbles that exist already, which after a while would pop, bringing disastrous economic and social consequences. And, ultimately, a possible loss of confidence in money. What paths could be taken to best escape falling into this debt trap?

Cancelling the debt, a mandatory government bond issue or tax hikes are not real solutions.

Cancelling the public debt is an idea that makes no sense – as it is a zero-sum game – which is very dangerous for the credibility of a country. A mandatory government bond would be considered confiscatory. It would lead to a drop in consumption to build up savings. Savings that these days are no longer stored under the bed, but used by banks to finance loans. Lastly, taxing wealth would not make any more sense given the extent of the stakes at hand and the absolute necessity to value entrepreneurs and innovators in these changing times. A general tax rise in France, where mandatory contributions are among the highest in the world, would have a negative impact on both demand and supply.

A “Covid debt”: It would be necessary for the ECB to continue warehousing the higher government debt resulting from the pandemic over a fairly long period of time, to avoid a loss of confidence of the markets if they suddenly had to take on this part of the public debt purchased by the central banks over the period.

But the fundamental solution lies in an increase in potential growth. In the hope that controlled inflation will also come and contribute to solving the debt issue. The vital reform allowing the government to improve its efficiency will have to be launched later. The pension reform can be made now. It would contribute greatly to reducing the public deficit. Longer life expectancy requires increasing the number of annuities. Which would increase potential growth, thanks to a rise in the participation rate, and incite the French to save less, having greater confidence in their future pensions.

The unemployment benefits system also has to be reformed: the number of jobs that go unfilled remains high. The formula currently proposed, which could adjust different allocation criteria according to job market indicators, appears to be well adapted. The essential corollary: the need for individual protection, notably via a more intensive and more efficient professional training strategy to support employees during the major transformations underway.

Lastly, coming out of the Covid era, what will the economic policy mix be? The support and stimulus fiscal and monetary policies need to remain in place as long as there has not been a return to a stabilised level of growth. Austerity must be avoided. But the governments and the central banks will quickly have to commit to following a path to a return to “normal” over several years to install confidence in the debt and money. The idea that near-zero interest rates mean that there is no need to worry about debt is based on a theory according to which money and finance are neutral. History has proven the contrary. The exit paths described here are narrow, but are probably the only ones possible without significantly further exacerbating the risks.


Original column from Les Echos 16th Feb 2021

This much is obvious: the longer the pandemic lasts, the higher the debt will be. The real economic difficulties are therefore ahead of us. To fight the effects of the pandemic, governments and central banks have taken powerful and vital desensitising actions. After the pandemic, they will have to reduce, and then end them. This phase is when the economic crisis will gradually surface, with a rise in bankruptcies and lay-offs. Then will come the “debt trap”. Either the central banks will pull out of their quantitative easing policy little by little, and long-term interest rates will rise, triggering the insolvency of many companies and governments, if the latter do not find a new credible trajectory for their debt. Or they do not, and fuel the financial and real estate bubbles that exist already, which after a while would pop, bringing disastrous economic and social consequences. And, ultimately, a possible loss of confidence in money. What paths could be taken to best escape falling into this debt trap?

Cancelling the debt, a mandatory government bond issue or tax hikes are not real solutions. Cancelling the public debt is an idea that makes no sense – as it is a zero-sum game – which is very dangerous for the credibility of a country. A mandatory government bond would be considered confiscatory. This would lead to a drop in consumption to build up savings. Lastly, taxing wealth would not make any more sense given the extent of the stakes at hand and the absolute necessity to value entrepreneurs and innovators in these changing times. A general tax rise in France, where mandatory mandatory contributions are among the highest in the world, would have a negative impact on both demand and supply.

Increasing potential growth will be key in order to face the debt problems. The vital reform allowing the government to improve its efficiency will have to be launched later. The pension reform can be made now. It would contribute greatly to reducing the public deficit. Longer life expectancy requires increasing the number of annuities. This would increase potential growth, thanks to a rise in the participation rate, and incite the French to save less, having greater confidence in their future pensions. The unemployment benefits system also has to be reformed: the number of jobs that go unfilled remains high. The formula currently proposed, which could adjust different allocation criteria according to job market indicators, appears to be well adapted. The essential corollary: the need for individual protection, notably via a more intensive and more efficient professional training strategy to support employees during the major transformations underway.

Lastly, coming out of the Covid era, what will the economic policy mix be? The support and stimulus fiscal and monetary policies need to remain in place as long as there has not been a return to a stabilised level of growth. Austerity must be avoided. But the governments and the central banks will quickly have to commit to following a path to a return to “normal” over several years to install confidence in the debt and money. The idea that near-zero interest rates mean that there is no need to worry about debt is based on a theory according to which money and finance are neutral. History has proven the contrary. The exit paths described here are narrow, but are probably the only ones possible without significantly further exacerbating the risks.

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

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