“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