A persistent very low inflation rate is worrying. It is a paradox because during decades, governments have taken up a price stability target and central banks had as a mission to act to reach it. We still had, in Europe, the remembrance of the consequences of the German crisis in the Twenties which has not been without relation with the Nazism rise. Today, we are in the opposite situation. Central banks have interpreted their mandate in the opposite direction from what was foreseen at the origin. Instead of adopting monetary policies having as an objective to reduce prices increase to a level inferior but near 2%, in the Euro-zone for instance, they act to make inflation rising to reach this level. That very low inflation is going along with a too slow economic growth. And the Japan case is frequently quoted with the threat of a secular stagnation.
Until now, in the euro-zone, this target is not fulfilled but that policy is giving rise to a sharp controversy because it has driven to negative or near zero interest rates regarding maturities up to ten years. The European Central Bank has also become the main creditor of member States (30% of the German and Dutch debt, 20% of the French and Italian ones) through buying since 2015 on the market middle and long term bonds under its accommodating and quantitative easing policies. The results of this policy are disappointing, inflation as growth is staying at a very low level. Would it be necessary to change monetary policy as have asked for several former central bankers who put forward the inconvenient of these low rates for banks as for retirees who gave their savings to pension funds? Would it also be necessary, as the former chief economist of the International Monetary Fund, Olivier Blanchard said to decide a stimulation of demand, notably with an increase of public expenditures or through an adaptation of tax policies?
This debate will necessarily become more intense in the coming years because there are very few chances that inflation makes a comeback. The economic reasoning is not taking enough that point into account and has been until now incapable to lead to proposals which correspond to this new reality. Inflationist factors which were numerous in the past have almost disappeared.There were first the two oil shocks in the Seventies and the worry about a scarcity of this indispensable resource for growth. The “Roma Club” in 1973, even announced that production will never overpass 85 billion b/j. It reached 94.7 billion in 2018, despite the conflicts and the crisis which were affecting producers. The development of new extraction techniques as the slowing of the demand provoked by policies which tend to reduce greenhouse gas emissions are guaranteeing that there are no structural factors which lead to an increase of fossil fuels prices. With very few exceptions, it is possible to say the same for the other materials and farm products, set aside climate or biological bumps which can temporarily affect a plant or an animal species.
The intensity of the competition plays an essential role to keep prices stable. France made that experience. Until the middle of the Eighties, the administration was controlling prices but its policy had the opposite impact to what was looked for and the country was frequently criticized in Europe about its incapacity to fight against inflation. With the reforms started by Pierre Bérégovoy and pursued by Edouard Balladur, and the progressive but systematic freeing of the prices, competition has put an end with a great efficiency to what was looking like a French disease. The phenomenon took another scale with the globalization and not only because of the appearance of producers taking advantage of their low costs like China. Competition between companies from every country to capture market shares has put pressure on prices which has profited to consumers who, atop of that, have benefited from a much larger supply of products.
The demographic factor and the ageing of populations have also been put forward, based on the Japan example, to explain the inflation disappearance. Old people would save more and consume less which would explain the stagnation of the demand and the pressures on price levels. But this point is not very convincing because countries like France and Germany, with different demographic characteristics are confronted with the same problem.
At last, innovation has played an essential role, which is far from being come at an end. New production technologies have allowed spectacular costs reductions and an increase of the capacities of the products, like in the consumer electronics. Digitalization has opened new opportunities for costs reductions, passed on consumers by the impact of competition. The phenomenon has been spread to services thanks to the many platforms which operate in activities from tourism to mobility, including food deliveries at home, and to the banking sector with the facilities offered by Internet. It is highly unlikely that this trend reverses itself.
For all these reasons inflation belongs to the “old economic world” in developed countries and policies which, under the pretext to make it rebounding, aim at stimulating growth are not anymore appropriated. Keeping interest rates at a very low level is not anymore sufficient and it has not contributed to reduce unemployment in the countries where it reached a high level due to their demographic situation. That policy reaches also its limits when it affects the stability of the banking sector, which is confronted with a flat rate curb which hurts the profitability of its activities.
During the past, inflation was acting as a transfer from poorly protected savers to the State. Its debt was artificially reduced and its fiscal and social receipts quite so artificially pumped up. It is not by chance if good management criteria used ratios having as a denominator nominal GDP. These ratios were decreasing as fast as prices were blowing up. Today the State takes advantage of the reduction of the cost of its debt but the debt itself in real value is not anymore falling as in the past. The economic stagnation, to the opposite, heavily weights on its receipts. Enterprises see their financial costs falling, but that incites them to indebt themselves, not to make productive investments, because demand is not strong enough, but to propose a better remuneration to their shareholders and to make financial investments. The level of the volumes is starting to worry and is reminding us the situation before the sub-primes crisis in 2007.
The disappearance of inflation is not a bad news because it has put an end to the spoliation of the savings lodged in banks or in saving accounts. But the traditional economic reasoning in this context leads to conduct economic policies which are not without risks and which are not able to bring back a growth level, strong enough to make unemployment really falling. The real challenge, it is to find new policies suitable to a world without inflation. To limit deficits, an increase of some VAT rates could be included in these policies because it would be difficult to transfer them to household.