Monday 20/05/2019

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If the economic scenario were to be stagflation?

Head of Macro Research

If deflation occurs in Europe, there is no evidence to suggest it would persist, as most countries are flooding their economies with additional money backed by public debt. Furthermore, inflation is on the rise, albeit slowly in some countries. I would like to share a perception that first occurred to me in 2010. What if the European economy faced a scenario of stagflation, that is to say a combination of economic stagnation compounded by persistent unemployment and moderate inflation? This is a matter I would like to discuss.

What are the attributes of this footprint stagflation? Besides the aspects of state solvency, they are the same as the symptoms as witnessed during the 1970s: a low rate of economic growth combined with a marginal decrease in productivity, structural and high unemployment (structural dislocations characteristic of economy), underutilization of production capacities, low expectations of earnings (at least in the medium-term), low capital investment to moderate a scarcity of bank credit for private investment, balance of trade deficits and widespread deindustrialization.

The effects of stagnation can essentially be detected by structural unemployment, which is already well established in some areas. Beyond the visible effects the retirement of a significant portion of baby boomers have, (which merely postpones the problem of their replacement income to future governments) unemployment is related to different phenomena: industrialization, inadequate education, exhaustion of the growth model by debt, lack of flexibility in the labor market, entrepreneurship and especially weak ancillary mindsets that have not yet integrated into growth areas. There are also issues surrounding immigration; for example, will it be redesigned to ensure new continued growth in employment?

Inflation meanwhile is not a desirable solution, since it poses a risk of self-power and only nominal increases in state spending. It would appear that as a consequence, this unavoidably leads to the monetary rediscounting of public debt. Of course, inflation depletes returns, especially since the savings are invested in fixed income securities. But as Keynes advanced (1883-1946), “it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier.

"Some economists even argue an iconoclastic theory that the banking, state and economic crises are the result of a period characterized by excessive disinflation. This period, known as “the great moderation" apparent between 1985 and 2005, would benefit from the expansion of trade areas (through globalization) and a low-cost accessibility to employment pockets, to mask the reality of the repayment of private and public debt. The expansion of demand did not lead to an inflation crisis because western governments absorbed this by their trade deficits.

Why does the perception of inflation raise the specter of secular deflation with many economists (which constitutes a strong collective preference for liquidity and is often confused with disinflation)? Because money created ex-nihilo with coupons which become claims on other coupons, and recalling the words of the economist Jean-Baptiste Say (1767-1832) "the currency is just a veil", as implemented by the central banks, is a treatise on the future, meaning reimbursement will become uncertain. It is indisputable that the States and also the central banks are currently conducting a monetization of the debt with its corollary of liquidity creation and possible delayed inflation. The recent measures therefore create money without creating a capital.

Finally, we must ask ourselves how European monetary authorities dared to simultaneous impose an extremely low annual inflation target of 2%, whilst authorizing Member States to increase their public debt in such proportions that the most intuitive way to reduce its weight or to reduce its relative value is through inflation as the ECB now intends to stimulate.