“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