07/04/2022 - Published by EUCC-RIID

Dr. Christophe AUBIN-NURY de Malicorne

Ph.D., DES, MBA. Senior manager in international banking and financial services, specialized in investment and economic development advisory. Consultant Specialist in finance & economics at ARS, a US government agency and member of CEDIN, Research Center in International Law.

THE US CENTRAL BANK: A PRAGMATIC HYPOTHESIS TOWARDS INFLATION

Since the global financial and economic crisis of 2007-2012, very large amounts of public debt have been issued by States. This has also particularly worsened more recently, due to the 2020 crisis following the devastating effects of the COVID-19 virus.

As a result, according to the IMF, the global public debt ratio jumped to a record high of 99% of global GDP and at the beginning of 2022, outstanding debt is now equal to 133% of GDP in the United States and nearly 97.7% for the European Union. The growth of debt is particularly high in industrialized countries, where public debt has risen from around 70% of GDP in 2007 to 124% of GDP in 2020.

Until now, low interest rates have made it possible to easily refinance public debt, support businesses and households and more generally, revive overall economic growth. However, central banks have triggered rate hikes in 2022 to counter the rapid emergence of inflation. This increases the borrowing costs of States, which nevertheless continue to spend a lot to support their economies.

From economic research, inflation can also participate to help a State to reduce its debt. From the effect of inflation, the purchasing power of each dollar falls since the prices of what we buy with it increase. Tax revenues are logically increased due to amounts collected from Value Added Tax on higher prices, or Income Tax on higher salaries and bonds issued by a State would lose more value over time in a period of high inflation. Inflation thus reduces the real weight of the debt, as cash in the future is worth less than current cash.

Therefore, in the actual environment of indebtedness conditions, States could really benefit from an accommodating monetary policy. It would notably lead to a higher level of inflation than the one allowed by the current mandate of the american Central Bank. The rise in prices would erode the real value of public debts and as a consequence, make them more bearable to public finance. This would also promote growth, which in turn would help reduce the debt burden relative to the GDP.

Understandingly, the US Central Bank can sometimes give the impression of abandoning its current objective of price stability, including an inflation rate close to 2%. However, from past historical data, inflation levels have been much higher during certain periods (1980s notably, over 14% in the US) but its impact on the population has not prevented the US or the world from experiencing its greatest economic expansion. In reality, it has averaged about 3.8% in the United States since 1960, in the early stage of world economic globalization. Events happening since this period have definitely modified and accelerated the pace and shape of mutations not only in the US economy, but also worldwide.

Therefore, we argue that the Fed should adopt a New Mandate, in order to include a "more realistic" inflation target at around 3.5%. In doing so, the US Central Bank would Indeed be taking into account its more recent comprehensive historical average. Moreover, it would at last take into consideration the beneficial effects of a controlled inflation, in a context of a rapidly evolving global economy, having drastically changed its benchmarks since the later part of the 20th century.