“Controlled inflation will help to boost growth”

Some eco­nom­ic play­ers are wor­ried about the return of infla­tion. Is this good or bad news, and are there grounds for such fears?

To under­stand infla­tion, it helps to look at Japan. For the past 25 years, the coun­try has had no infla­tion and slug­gish growth des­pite an ultra-expan­sion­ary mon­et­ary and fisc­al policy. The money sup­ply issued by the Bank of Japan has increased ten­fold while pub­lic debt has reached 250% of GDP – more than double that of France! The situ­ation is totally para­dox­ic­al. And yet, it is worth noth­ing because since the fin­an­cial crisis of 2008 it the lack of infla­tion also con­cerns the euro zone and (to a less­er extent) the United States.

This “sec­u­lar stag­na­tion” is explained by a per­sist­ent lack of demand due to demo­graph­ic age­ing. People are sav­ing for their retire­ment, then for their health expenses and finally to pass on to their chil­dren and grand­chil­dren. This is com­poun­ded by rising inequal­ity, which con­cen­trates pur­chas­ing power in the hands of the wealth­i­est people, who have high sav­ings rates, and by slow­ing pro­ductiv­ity gains, which encour­age house­holds that are more pess­im­ist­ic about the future to save more.

To coun­ter­act a decline in demand, cent­ral banks lower their interest rates. This dis­cour­ages house­holds from sav­ing and encour­ages com­pan­ies to invest. But at the heart of the cur­rent prob­lem is that cent­ral banks have run out of ammuni­tion: interest rates can­not go below 0%. No fin­an­cial asset can have a return sig­ni­fic­antly lower than that of money. Cent­ral banks can cre­ate money, but this has no mac­roe­co­nom­ic impact, since savers are hoard­ing. In these cir­cum­stances, con­trolled infla­tion is desir­able because it would stim­u­late demand.

Infla­tion is favour­able right now because rising prices melt the value of sav­ings like snow in the sun.

Explain this to us.

Infla­tion is favour­able right now because rising prices melt the value of sav­ings like snow in the sun. House­holds there­fore have an incent­ive to con­sume. They anti­cip­ate high­er prices and buy goods before they become more expens­ive. The increase in con­sump­tion increases the need for labour by com­pan­ies, which gen­er­ates upward pres­sure on wages and prices. Infla­tion can become a self-ful­filling prophecy.

Will we see a return of inflation?

In the United States, it is pos­sible. Aging of the pop­u­la­tion is less pro­nounced than in Europe and fisc­al policy is much more aggress­ive and strongly stim­u­lates demand. Before the pan­dem­ic, we were already see­ing infla­tion­ary pres­sures fuelled by Don­ald Trump’s expan­sion­ary fisc­al policy, which allowed the US to reach full employ­ment: 3.5% unem­ploy­ment. The US fisc­al stim­u­lus has been sig­ni­fic­antly amp­li­fied by the pan­dem­ic. Joe Biden is now com­mit­ting a stim­u­lus pack­age of $1,900 bil­lion, in addi­tion to the $900 bil­lion decided last Decem­ber. This brings the total to $2,800 bil­lion, a stra­to­spher­ic fig­ure that rep­res­ents 13% of GDP. The risk of infla­tion exists, but there is no con­sensus among eco­nom­ists on this sub­ject. It will depend on the reac­tion of the Fed, the US cent­ral bank. But the US seems will­ing to take the risk of mod­er­ate infla­tion to avoid the lost dec­ades seen in Japan.

Can infla­tion get out of hand?

We can­not elim­in­ate this pos­sib­il­ity, but the risk is under con­trol. The Fed has tools and can raise rates. And, if neces­sary, taxes can be raised, for example through the intro­duc­tion of a value-added tax (dif­fer­ent and much more fisc­ally pro­duct­ive than the cur­rent “sales tax”). This would curb demand and thus inflation. 

What about Europe?

There may be tem­por­ary infla­tion linked to recov­ery and bot­tle­necks in sup­ply chains. But the risk of sus­tained infla­tion is low in the euro­zone because the fisc­al stim­u­lus is mod­er­ate. The European Commission’s stim­u­lus pack­age is lim­ited to €700 bil­lion, half of which is in loans, all spent over five years and spread across 27 coun­tries. In the Euro­zone, as is often the case, it is “too little, too late”. This is a pity because the pan­dem­ic is a unique oppor­tun­ity to gen­er­ate a massive fisc­al stim­u­lus and to get out of sec­u­lar stag­na­tion once and for all. Let’s remem­ber that the United States only really turned the page on the Great Depres­sion with a massive fisc­al stim­u­lus: the Second World War. That said, the dif­fi­culty of the situ­ation should not be under­es­tim­ated. Des­pite a great deal of bold­ness, Japan has still not man­aged to return to growth and escape the liquid­ity trap.

Are there oth­er ways to stim­u­late demand?

There are sev­er­al aven­ues. For example, eco­nom­ist Larry Sum­mers sug­gests dis­cour­aging sav­ings by strength­en­ing social pro­tec­tion with more redis­tri­bu­tion, more gen­er­ous health insur­ance or by devel­op­ing pay-as-you-go pen­sions. In the United States, this is a pos­sible way for­ward, but in France we have no room for man­oeuvre. Anoth­er solu­tion would be to replace paper money with elec­tron­ic money, which would allow neg­at­ive interest rates by tax­ing bank depos­its. But that would not be very pop­u­lar… Infla­tion is a much more pain­less way to tax deposits!

Interview by Clément Boulle