The threat of stagflation

– The current price crisis is a subject on which many different opinions have been expressed. What is your analysis? Is the high inflation temporary?

Some of the inflation is hopefully temporary: the energy and food price shocks, the disruption of supply chains and the Chinese Covid crisis. We are also facing the inflationary pressure of the past stimulus policies. What we need to avoid is inflationary expectations and the price-wage spiral, so as to avoid the stagflation experience we had after the oil shock of 1973. The increase in interest rates of the early 1980s to break the inflationary spiral of the 70s was socially very costly, and we can only hope that we won’t have to see a repeat of such an episode. Indexing salaries to prices today would be very dangerous. Europe is suffering from an inevitable loss of purchasing power. The question is how to allocate the loss between workers, companies, and between present and future taxpayers. Indexation, inflation and recession would be a very expensive way to do it.

In the US, there is a very strong momentum and a very tight market, and a need to slow down the activity through a rise in interest rates. In Europe, the market is less tense, and our countries have lost purchasing power; the need to raise rates is not as strong. That being said, the current differential between inflation in Europe and the very low nominal interest rates is really striking.

– One of the biggest “sick men” in Greece is considered the state. What would you say are the elements that determine the success of a public administration reform?

The concept of the state has changed. The modern state should correct market failures. It should regulate banks, guarantee fair competition, tax externalities such as CO2 emissions etc. It should provide for an economic and societal framework in which individuals’ and companies’ incentives are, as much as possible, aligned with the common good. It should build a set of insurance mechanisms that protect citizens against mishaps of life (from being born in a disadvantaged family and not having access to a good education, to having bad health or having an accident, to losing one’s job), while keeping incentives in place (for example not insuring homeowners who have knowingly built in a flood-risk area). In a nutshell, it should promote a harmonious society.

In contrast, the modern state is no longer a provider of jobs through the civil service and a producer of goods and services through public enterprises. Rather, the state ideally sets the rules and intervenes to correct market failures, rather than substituting itself for the market as a mediocre manager of enterprises.

In its operations, the state should be nimble and reactive.

In “Economics for the Common

Good” I describe some principles and experiments around the world. It is important to use benchmarking both domestically and with foreign countries to evaluate performance and identify problems. The state should allow experiments and innovation, trust the management of schools, hospitals, public financing, and other undertakings, while evaluating ex post their performance and acting upon the information. It should define goals rather than paths to reach these goals (remember the discovery of the Covid vaccine: We did not know which of the alternative technological approaches would work; fortunately the states remained humble and did not bet on a single approach that they believed would be the most likely one to succeed). Finally budget cuts across the board are not advisable: Cut budgets where they are the least useful. Similarly, spreading budgets across many recipients can be wasteful: One must sow where the soil is fertile.

A last remark: It is often thought that “this is not the right time to reform the state”; some countries such as Canada, Sweden and Germany have however shown that broad reforms of the state can be implemented in difficult times.

– The effects of climate change add one more parameter – an imperative one – to the growth process. Are you concerned that environmental restrictions will moderate future economic growth rates in Europe?

‘The increase in interest rates of the early 1980s to break the inflationary spiral of the 70s was socially very costly, and we can only hope that we won’t have to see a repeat of such an episode’

Combating global warming will inevitably have a cost, even if there is uncertainty about its level. The idea of increased growth based on millions of green jobs is a pipe dream.

Such restrictions as well as cutting-edge green R&D are therefore unavoidable if we want to save our planet. Certainly they will in the short and medium term impact economic growth, but otherwise we are headed toward an economic, environmental, societal and geopolitical disaster.

Minimizing the cost of fighting climate change however is also crucial, first by stopping our collective procrastination and second by using the right instruments.

And among the right instruments, a carbon price is important.