As expected by financial markets, the Federal Reserve Bank in Washington rose its interest rates this week by 0.25% to 2.25% and nothing in the comments of its chairman makes us thinking that the institution has renounced to rise it again before the end of the year. Some days before, Mario Draghi who chairs the European Central Bank was delighted about the inflation in the Eurozone which was “sound” and convinced that its target to come back to 2% will be reached. Financial markets have deduced that the end of the accommodative policy was confirmed and that they can expect a first interest rate rise during 2019 autumn.
These decisions and these comments show to which point the world has changed and to which economists and political leaders reasoning must adapt themselves. Until the 2007-2008 crisis, inflation was the enemy and the central banks mandates were to use all the tools they have to their disposal to fight against it, if necessary in rising interest rates and in slowing money supply. ECB mandate was to bring back inflation to a level under but close to 2%. Its action, for almost ten years is, to the contrary, to sustain activity to get back to this level.
What’s happened since the crisis? The union of several factors both related to the economic situation and structural ones. The deep fall of the activity in 2009, the slow rebound after, the new difficulties caused by the crisis of the euro have generated a strong rise of unemployment and at the end has weighted on wages and production costs, except in China whose growth remained very strong compared to developed countries one. That situation progressively did turn over and apparent unemployment has fallen almost anywhere in the world, but definitely at a different rhythm, the French case shows it. But that was not strong enough to generate tension on wages. So the apparently low level of jobseekers in England ant in the U.S. is hiding the fact that activity rate is also much lower than before the crisis. It has discouraged many former salaried to look for a new job. So there is no tension on wages in these two countries.
If economic factors can evolve by definition, structural ones, atop of them is innovation, are there to last and they have been predominant these previous years. The fall of oil and natural gas prices is the direct consequence of the rise of the American production with the shale revolution made possible by new technologies. Cost reductions both in industry with robots and in services with all kinds of platforms and digitalization are there to stay and probably will amplify. Innovation seems to be driven by the will to axe jobs. It is enough to look at the interest prospects of driverless cars are offering. The weight on employment and wages will not diminish.
So, the light rebound on prices has not, as in the past, had its origin in an excessive demand but in factors, which, for most of them, are external to usual market mechanisms. The recent rebound of oil prices is mainly due to political circumstances, crisis in Venezuela, sanctions against Iran or the persistent instability in Libya. The institution of custom duties by the U.S. and the threat on trade exchanges also generate rising costs on related markets, as have just reminded to the American president Ford managers and before them GM ones.
But this inflation rebound has not been passed on real interest rates. Despite recent rises, they stay in the U.S. near to zero and, in addition, the spread between short and long term interest rates is inferior to 1%. In Europe, the curve is more sloping but real interest rates are still more negative than when inflation was close to zero. The French 10 Years bond rate is still lower than 1%, against official forecasts made at the beginning of the year, when inflation at the end of September, year-on-year, was above 2%. Regarding short term interest rates, they are stagnating between -0.5% and -0.6%.
In France the state is the winner on all purposes. It is at the origin of prices rise because it has increased, and it proposes to do it again next year, taxes on energy and tobacco and it has raised tariffs on several public services. It profits also from these new fiscal receipts. That allows it to have a better management of its budget deficit, instead of reducing it in real terms. But compared to GDP, which grows faster thanks to these price rises, it succeeds in keeping its deficit to GDP ratio under the 3% imposed by Brussels. But it takes also advantage from the fact that 90% of its debt carries fixed interest rates and is not indexed on inflation. It can reimburse it as one goes along with a devalued money and refinance itself at a cheap rate on financial markets. So, on Thursday September 20th, the Treasury issued bonds for an amount of 9.4 billion euro carrying rates between -0.4% and +0.4% with maturities between 3 and 8 years.
The only uncertainty is about indexed bonds. They are few but the rebound of inflation can be costly in the future. So it is asked why the state is still issuing new ones. Indexation bill has increased the debt charges by 2.31 billion in 2017, in accordance with Agence France Tresor data basis published in its monthly bulletin. But this one indicates for 2018 and 2019 an annual charge of about 800 million when official Finance Bill documents mention 3.4 billion charges each year on the same period. Has government decided, without making it public, to start to constitute provisions for the future Finance Bills in putting on 2018 and 2019 accounts expenses which will come only from 2020?
If the State is the winner on all matters (fiscal receipts rise, GDP increase in real terms and reduction of the debt charges), it must exist losers. The answer is easy, they are households. Employees and pensioners are affected by the rise of their charges and price increases and by the reduction of their purchasing power. Regarding small savers who own accounts or life insurance contracts in euro, inflation reduces the real value of their financial assets. Among them, only these who have financed the acquisition of their home through a loan carrying a low and fixed interest rate are taking advantage of the situation, especially since the value of the asset they are acquiring has appreciated. But the consequence is the stagnation of the economy since the beginning of the year. It would be very presumptuous to believe it will break off. If the purchasing power is stagnating and even falling for some, it is an illusion to believe that consumption will increase. And without clients, whatever the allowances or the charges and taxes reductions they receive, there is no chance that enterprises invest and hire enough to support activity and make unemployment significantly fall.
They are no miracles in economy. The artificial profit the state takes in France from very low interest rates and in the same time from a rebound of inflation, to which, in other respects it has contributed to, cannot be used as an economic policy and has low chance to generate the expected results.