“Stopping inflation does not mean acting brutally”
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Lhe inflationary wave that is overwhelming the world has surprised by the speed and extent of its progress. Some economists and political leaders only want to see it as a “supply shock” linked to the pandemic crisis and the war in Ukraine. Inflation would therefore not require a major remedy. In France, faced with the oil shocks of 1973 and 1979, the leaders had also hesitated for a long time between rigor and recovery, while their German counterparts showed great determination in their fight against inflation. Germany was rewarded.
Today, reducing inflation to a “supply shock” may be politically shrewd, but ultimately dangerous. This ignores a fundamental element: loose monetary policies have gotten us to where we are.
In 1979, when Paul Volcker took over as chairman of the US Federal Reserve (Fed), analysts continued to believe that inflation was driven by oil price shocks. Paul Volcker nevertheless decided to raise the Fed’s interest rate to 20% in two years. The action was brutal, terribly unpopular… and extremely effective. Mr. Volcker considered that besides the shock of supply, the demand largely exceeded the capacities of the American economy. Only a monetary adjustment could make it possible to regain control of inflation.
An overheated world
This situation of the 1970s is close to that experienced by the United States today. Inflation is at 8.5% and the unemployment rate at 3.5%. In other words, the United States is overheated, due to an unprecedented monetary policy, conducted by a central bank that is too attentive to the financial markets.
In 1996, Alan Greenspan, then chairman of the Fed, denounced “the irrational exuberance of the markets”, but he did nothing to break it. In autumn 2008, faced with the financial crisis, his successor, Ben Bernanke, implemented a policy of massive monetary creation that he had imagined for a case of deflation, that is to say a general fall in price. This policy was necessary to restore confidence, but it has been pursued for far too long. Growth soon returned, but prices never fell.
The result of these expansionist policies, which have had a worldwide following, can be found in a statistic that sums up the scale of the problem: while during the half-century preceding the 2008 crisis, the size of the Fed’s balance sheet was remained unchanged, around 5% of the American gross domestic product (GDP), it now represents 36%. The balance sheet of the European Central Bank followed the same trend, but even more significantly due to the latent euro crisis (69% of eurozone GDP).
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