The giant euro symbol stands in front of the Eurotower in Frankfurt, home of the European Central Bank.
In the face of the Covid virus, most developed countries have started to bear any cost. Is there a similar prescription (at least in its effect on protecting welfare) for a negative supply shock?
Atlantico: The World Bank announced that we’re heading into one of the biggest commodity shocks we’ve seen since the 1970s due to the war in Ukraine. Are we heading towards this?
Gabriel Jimenez Roche: Now, in fact, we’re heading towards that. Russia and Ukraine are major exporters of grain, but also other raw materials such as ores and materials for the automobile industry or for the manufacture of electronic components. So they are suppliers of essential products to the food industry, but also to the heavy industries. Thus, the increasing scarcity of these products in the world market causes an increase in the costs of intermediate producers, those who transform these raw materials into consumer and other industrial goods.
Markets are already pricing in their continued scarcity for the coming months and this shows in today’s futures prices. This is cost inflation. Consequently, producers in the tertiary sector have higher costs and will find it increasingly difficult to absorb them. Finally, they will have to pass it on to a greater or lesser degree to consumers. The latter would have no choice but to pay a higher price. This can already be seen in the food and automobile sector.
Today, the question is how long this will last and the inflationary pressure on consumer goods comes from that.
What can we do about this situation, both at the state level and at the central bank level?
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This is all about monetary and fiscal policy. When we are faced with this kind of situation, when prices are rising, the authorities decide to use fiscal and budgetary policies to allow families to have more purchasing power. This could mean lower taxes or grants, such as checks. Thus, the population has greater monetary purchasing power and can manipulate prices. The problem is that if the situation persists, these policies have to be followed over a long period and this maintains the situation, because giving more money to families only absorbs the current inflation.
Another solution comes from adjusting to pressure from the central bank to allow the economy to absorb cost increases. Thus, it will inject money in order to allow businesses and households to have more money to pay these prices. Thus the money will circulate throughout the economy. This injection of cash enters the economy through the banks that distribute this money by granting loans.
Currently, there is concern about this. Monetary policy has been expansionary since at least 2000 in the aftermath of the dotcom crisis and the 9/11 attacks, then exacerbated during the 2008 financial crisis and further strengthened during the sovereign debt crisis in 2012. This is a strong additional monetary expansion to deal with the pandemic and now this war. Inflation actually arose from these cumulative expansions, because the money was already in circulation, but concentrated in the financial markets and real estate. Commodity prices were not visibly rising and there seemed to be almost no inflation. In fact, the core of inflation was already there, the liquidity created by the central banks followed by the credits created by the commercial banks. It was only concentrated in certain markets. Now all this money is flowing back into the “real” industrial and consumer goods markets and everyone can see it in the prices.
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Add to that the frequent use of fiscal and budgetary policies which are absorbed by an expansionary monetary policy, only leads to a sluggish inflation. We give checks, we lower taxes and we allow residents to bear prices, but it works once because the state is in debt and we have to play with monetary policy to give continuity to all of that. It is a mechanism based on a vicious circle between monetary policy and fiscal policy. One feeds the other.
Do we still have the means to make this mechanism work?
There is a very easy way to stop inflation: to stop pumping money into the system. The problem is that this is felt immediately because interest rates are rising immediately and there is a shortage of capital for companies and households. Then corporate refinancing becomes more expensive as well as replenishment of state debt, which will not be able to support generous fiscal and policy policies. It is a trap and today the authorities fall into this trap.
Cost inflation exists. So they have two options, either try to keep the economy growing artificially or stop inflation with stagnation immediately. The ideal would have been to curb monetary expansion while using generous fiscal policies to make investment and consumption easier and more dynamic. Fiscal discipline will be offset by revitalizing household and business spending. However, for this, a more stable structural and geopolitical situation is needed.
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Today, the most important thing is to find a solution to the conflict in Ukraine and that the epidemic is definitely resolved, because these two factors affect prices. One by directly affecting the costs of goods, and the other by impeding global supply chains.
During the Covid crisis, most developed countries have launched “whatever it takes”, so can a solution like this help solve the current situation?
It is possible to do something similar and this is what President Macron is doing with the distribution of checks. All presidential candidates proposed to increase monetary purchasing power to try to maintain real purchasing power. But supporting inflation does not solve the problem. It is interesting to see that this type of measure is politically acceptable to the population, who do not see these solutions as exerting strong inflationary pressures that constantly degrade purchasing power.