The real challenge in 2015 will be to avoid the economic shipwreck of the Eurozone in what is often presented as a Japanese-style deflationary scenario. Unfortunately, that scenario seems more and more plausible – prices have been going down over the past two years and the inflation rate will become negative at the beginning of 2015. Technically, of course, this could be described as disinflation rather than deflation, or as a trend towards low inflation, in order to avoid stigmatising a general fall in prices.
A distinction could also quite justifiably be drawn between good and bad deflation – a drop in oil prices causes good deflation, whereas a drop in demand and pay causes bad deflation. Or, resorting to purely technical definitions, it could be pointed out that “deflation” means a fall in at least 60% of the prices on the inflation index (oil products excepted), and this has not happened.
But these subtle academic distinctions are of no interest whatever. We are in the midst of a demand crisis. Demand is too weak and is producing insufficient growth. The economic actors are postponing their consumption and investments, causing a price fall which is leading to deflation. Many major economic factors are at play here: an ageing population, the shift of growth centres to other continents, the lack of a forward-looking industrial policy, an inability to modernise our economies through non-confrontational social dialogue, the maintenance of a partially ineffective welfare state, insufficiently entrepreneurial attitudes etc… How can we break out of this deflationary scenario? There is no silver bullet, only a set of overlaid solutions requiring the simultaneous easing of budgetary and monetary policies.
Economists often draw a distinction between supply policy and demand policy. Policies to stimulate supply aim to flexibilise production costs and reduce constraints on the supply of goods and services. Demand policy, on the other hand, uses Keynesian techniques. It is all about stimulating demand for goods and services by boosting public investment and consumption, so as to trigger a rise in private demand (including through social transfers and lower taxes).
Managing an economy involves striking a balance between demand policies and supply policies, but one thing is for sure – at a time of very weak growth and of deflation, it is vital to stimulate demand. If the economic actors are running scared of a sombre economic outlook, they will rein in their consumption and investment. In which case a superior being, representing society as a whole, has to move beyond individual worries by making major collective investments designed to kickstart private consumption and investment. The Juncker plan follows that logic. True, the automatic stabilisers did come into play at the onset of the crisis, with the realisation that tax revenues were going down and social spending was going up. But, probably frightened off by the rise in public debts and the need for common public debt thresholds, States reverted too quickly to deficit reduction constraints. And this is where we can see that the imposition of a Stability and (cynically enough) Growth Pact was maybe put in place at the wrong moment. The Pact requires that excess public debt be reduced by 5% per year, so as to bring it down to 60% of GDP. This rule is now bound up with what is termed the “golden rule”, namely that the “structural” deficit (i.e. ignoring any cyclical vicissitudes) should not exceed 0.5% of Gross Domestic Product (GDP). The Pact prevents any demand policy and is therefore helping to fuel recession and deflation.
Since the onset of this crisis, I have been among those who are convinced of the need for inflation. The crisis has to be “monetised” by diluting debt. Some countries (the US, the UK and Japan) have done so. They were intellectually inclined to take this course because they felt intuitively that inflation is a way of silently diluting past debts in a context of recession and thus of lower interest rates. So there was a need to refinance public debt through money creation by the ECB. But my expectations were dashed. The ECB decided to apply a restrictive monetary policy, to such an extent that its balance sheet almost returned to its 2008 level .And unfortunately, it may now be too late to implement a more supple monetary policy, as interest rates are at the lowest they have been for several centuries and the commercial banks are flooded with savings. As the past thirty years have taught us, two years of mistakes can cost ten years of deflation.
So to lift the Eurozone out of deflation, two aims have to be aligned. The application of the Stability and Growth Pact should be temporarily put off, so that each country can individually implement major investment programmes, without being penalised in any way for the resulting increase in debt. These loans would cost almost nothing, given the present weakness of interest rates. In parallel, monetary policy absolutely must be eased by a cash injection which, even if it is not decisive, will provide the economy with some oxygen.
To sum up, monetary and budgetary austerity has, at the very least, contributed to this situation of deflation and recession. All of this reflects the incompleteness of the Eurozone and the peculiar position of monetary authorities who have had to fall in line with the monetary logic of a genetically deflationary currency. But strangely enough, few public voices have been raised in concern at this situation. The fact of the matter is that deflation is accompanied by very low interest rates. And States, bogged down in public debt and soon to be drowned by pension finances, know that any rise in interest rates would reveal their financial vulnerability. So the monetary authorities of the Eurozone may implicitly be prioritising deflation over growth and employment. However, I am deeply convinced that prolonged deflation would mean a partial defeat of the euro.