What to do About Inflation?

Since the beginning of summer 2022, inflation in France has been around 6 per cent. According to the latest available forecasts, carried out by the National Institute of Statistics (Insee), prices increased by 5.9 per cent between August 2022 and August 2021, after rising 6.1 per cent in July. ‘This slight drop in inflation is due to a slowdown in energy prices, particularly those of petroleum products’, the institution pointed out. But it does not reverse the steady increase in prices that began in mid-2021 and strengthened following Russia’s invasion of Ukraine.

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Inflation is Being Caused by a Multidimensional Supply Shock

Since the financial crisis of 2008/2009, inflation in France has only occasionally exceeded 2 per cent. It reached this level in September 2021 in a context of post-pandemic recovery and already visible tensions on world energy markets. It has since increased progressively to 3, 4, 5 and now 6 per cent. And an upturn is not expected any time soon. ‘In our scenario, inflation would stabilize a little below 6 per cent over one year in September-October, and then rise to around 6.5 per cent in December”, anticipates Insee. And for the Observatoire français des conjonctures économiques (OFCE), we will have to wait until 2024 to see inflation subdued to around 2 per cent in France.

As elsewhere in Europe, this inflation is fuelled mainly by exogenous shocks that affect supply (France’s production system) more than demand (consumption). This multidimensional shock was first of all related to the pandemic. But while in Europe lockdowns seem to be behind us, China insists on pursuing a zero-Covid policy which is disrupting world trade. The shock became geopolitical in early 2022, with the war in Ukraine considerably increasing energy prices in Europe. Finally, France faces the consequences of a climatic shock caused by the drought of summer 2022 which, writes Insee, ‘has affected certain agricultural production and limited the navigability of the Rhine, the primary commercial waterway in Europe’. In France, more than half of industrial companies now report supply difficulties, compared with only 15 per cent in autumn 2020.

The OFCE estimates, however, that French growth should remain positive in 2022 (2.6 per cent) and 2023 (0.6 per cent). With no shock on the energy markets, the institute computed that growth would have been 0.6 GDP percentage points higher in 2022, and 1.2 percentage points higher in 2023. These forecasts are exposed to several hazards, however, such as the magnitude of energy shortages in the coming winter or the evolution of household savings rate. Although it decreased in the first half of 2022, this rate remains above its pre-Covid level. The central bank of France is therefore cautious: according to its latest forecasts, France’s GDP could experience a decline in 2023 (-0.5 per cent), but also an 8 per cent increase.

The Price Cap on Energy Prices Has Halved French Inflation

At this stage, energy is the main driver of inflation. However, the surge in prices has been largely reduced by the price cap on energy implemented by the government in the fall of 2021. It froze regulated gas prices for households at their October 2021 level and limited the annual increase of regulated electricity prices, which occurs each February, to 4 per cent. Otherwise, the increase in electricity tariffs proposed by Électricité de France (EDF) would have risen by 35 per cent in February 2021, and the gas tariffs of the energy supply company Engie, which vary monthly, would have increased by 105 per cent in less than a year. As a result, this double price cap reduced French inflation by 3.1 points between the second quarter of 2021 and the second quarter of 2022, Insee recently calculated. This partly explains why France has one of the lowest inflation rates in Europe and the euro zone, where average inflation was around 9 per cent in August.

Unlike other European countries, France is also less dependent on Russian gas, which at the beginning of 2022 was only 19 per cent of its total gas supplies, compared with 48 per cent for Germany, for instance. France is also well equipped with LNG terminals. Several weaknesses tarnish this picture, however: heating in France is mainly electric-powered, and the French nuclear fleet is too old to be a valuable asset in this energy crisis. At the beginning of September 2022, 32 out of the 56 French nuclear reactors were shut down. As a result, their operator EDF expects production of 280 TWh in 2022 against 410 TWh on average over the period 2000 to 2015.

Energy-intensive companies also benefit from relief measures, as well as small compagnies (with turnover below 2 million euros) since September, but the price cap is designed mainly for households. As a consequence, this measure does not completely prevent the transmission of rising corporate production costs to consumer prices. In France, agricultural producer costs have increased so much (+35 per cent between July 2020 and July 2022) that food is now becoming the main driver of inflation. In industry, apart from energy producing firms, production prices also increased by 20 per cent. ‘For services, less directly impacted by the rise in world prices, the increase was around 7 per cent’ over the same period, as calculated by the National Statistical Institute.

Inflation does not affect everyone in the same way. The average inflation rate hides major discrepancies between households, linked to the share of energy or food expenditure in their total expenses. Thus, in April, average inflation was 4.9 per cent in France, but reached 6 per cent for farmers, 5.9 per cent for households living in rural areas, and only 4.5 per cent for managers. These characteristics can obviously overlap, leading to particular individual situations. Either way, precarious persons in France (the 20 per cent poorest of the population) suffer more from higher inflation than the richest 20 per cent. Inflation therefore increases inequalities. From this point of view, France is no exception in Europe. However, the gap between the two ends of the distribution remains at contained levels in comparison with other countries, thanks to France’s strong welfare system.

In an attempt to stem this inflationary spiral, the European Central Bank (ECB) raised its main key interest rate in July (+0.5 percentage points) and then again in September (+0.75 percentage points) and October (+0.75 percentage points). The interest rate now stands at 2.00 per cent, after being equal to zero since 2016. This shift in the conduct of monetary policy, still unthinkable a few months ago, has significant consequences for the cost of sovereign debt.

Even if France is not the country most exposed to the rise in ECB rates, the France Trésor agency (AFT) – which issues debt on behalf of the French government – must now serve interest rates of around 1 per cent when it borrowed for 5 years, while this rate was still negative a year ago. The OFCE forecasts an interest rate of 3 per cent for 10-year French bonds in 2025, compared with 1.9 per cent in 2022. As a consequence, while the public debt should remain stable in France – at around 112 per cent of GDP – during Emmanuel Macron's second five-year term, the interest expense would increase from 1.5 to 2.3 per cent of GDP in 2027. Going into debt is therefore more costly for the French government. However, it will take some time before this increase affects all of the existing debt stock, because the average maturity of French debt is eight years.

Wages Increasing Less than Inflation

Another consequence of inflation is that wages are being reduced little by little. In the public sector, the index point value used to compute the remuneration of civil servants was unfrozen in 2022 for the first time since 2010 (+3.5 per cent from 1 July 2022). This move was requested by trade unions, which now insists on the need to go further. Indeed, this revaluation does not compensate the drop in the value of the index point during the past decade. Compared with its 2010 level, taking inflation into account, the value of the index point has fallen by 18 per cent. With the recent boost, this drop has been reduced to 15 per cent, which is still substantial.

In the private sector, the indexation scheme linking nominal wages to prices was abolished in France in 1983, at a time when the socialist government led by Pierre Mauroy was trying to cope with the inflation induced by the oil shock. Today, only the minimum wage remains linked to inflation and has been revalued three times in 2022 (in January, May and August). For a full-time job, the minimum gross salary is now 1,678 euros per month, compared with 1,589 euros per month in October 2021, which corresponds to an hourly wage of 11.07 euros instead of 10.85.

The challenge for trade unions is therefore to take action in order to negotiate wage increases in occupational branches. ‘The wage increases already negotiated for 2022 stand in many branches between 2.5 and 3.5 per cent, whereas they were often below 1 per cent in 2021’, France’s central bank declared in May. There has been an improvement, though insufficient to offset inflation.

There is therefore no generalized ‘price-wage loop’. However, such a loop does exist in services, a sector in which inflation is driven by minimum wage indexation on inflation and the wage increases negotiated in occupational branches. Because the sector is not the main propagator of inflation, the most dangerous mechanism today is the transmission of energy prices to the production costs of industrial and agricultural companies.

In the absence of certainty about the duration of the current inflationary episode, employers prefer to respond to wage claims with bonuses and to develop profit-sharing schemes rather than to propose proper wage increases, underlying the additional costs they have to cope with due to supply difficulties and rising energy prices.

Are Benefits Fuelling Inflation?

In France, after increasing in 2021 as a consequence of the government’s ‘whatever it takes' policy to cope with the pandemic, the margin rate of companies in all sectors declined at the beginning of 2022. No ‘price–profit loop’ has therefore emerged in the economy as a whole. The absence of a price–profit loop at the macroeconomic level does not mean, however, that there are no excess profits in specific sectors, such as transport or energy. Total Energies, for instance, recorded an 18.8 billion dollar profit in the first six months of 2022, almost three times the previous year’s profit.

Emmanuel Macron has argued for a ‘European contribution mechanism’, which would allow the taxation of excess profits in the energy sector, even though the word ‘tax’ was carefully avoided. But contrary to what the left-wing opposition is calling for, Emmanuel Macron's government has always refused to tax energy companies’ excess profits at national level, even though this measure could help to contain inflation in the short term and, furthermore, generate additional revenue to fight its adverse consequences. According to the Bruegel Institute, France spent 71 billion euros between September 2021 and September 2022 coping with inflation, the equivalent of 2.2 per cent of GDP.

In the EU, France is second only to Germany (albeit by some distance) in this regard. Berlin’s anti-inflation package has been raised to 300 billion euros after the September announcements of a massive set of relief measures (200 billion euros). It represents the biggest effort in Europe (more than 8 per cent of GDP).

To finance its measures, the French government faces a complex budgetary equation. As the executive wants to fight inflation while pursuing its supply-side policy, consisting of lowering corporate taxes, it only has one lever left: controlling public spending. Part of the measures taken to mitigate the consequences of inflation is being financed by cuts in expenditure related to the health crisis. Otherwise the government intends to curb spending increases at 0.6 per cent per year on average, which requires a reduction in local authorities’ operating costs by 0.5 per cent per year and in state expenditure by 0.4 per cent, from 2024. The sources of the cuts are still unclear and those already announced (the fight against fraud and the elimination of tax and social loopholes) are considered optimistic by the High Council of Public Finances. While the government led by Elisabeth Borne is focusing on cutting spending, the left-wing opposition is calling for an increase in state revenues, including the taxation of superprofits.

Fuel Discount: An Untargeted Measure – and Ecological Nonsense

Among the flagship measures adopted by the executive since inflationary pressures began to appear is the cap on energy prices, as already mentioned. Also important is the fuel discount: set at 18 cents per litre when it was created in March 2021, and initially planned for four months, it has recently been extended until the end of 2022 and its amount raised to 30 cents per litre. The cost of this reduction is estimated at 4.4 billion euros for four months and 7.5 billion over the whole year, including previous discounts.

The fuel discount obviously constitutes consistent relief for many households. But it has not been free from criticism. The main objection is that it benefits everyone, regardless of income. Better targeted, the measure would be less expensive or, for the same total spending, the assistance provided for low-income households could be increased. The same criticism can be directed at the price cap on energy prices, which the government recently extended. The next increase in the regulated electricity tariff, scheduled for February 2023, has been limited to 15 per cent.

Initially, the government was working on transforming the initial fuel discount of 18 cents into a kind of fuel allowance of a few hundred euros for workers with incomes below a certain threshold. But the opposition, in particular the Republicans, would not go along with it, so the government found this compromise.

Another criticism, just as important, is that the fuel discount does not send the right message from an ecological point of view. By making oil cheaper, it does not encourage businesses or households to change their behaviour and make more effort to renounce fossil fuels.

Emergency Measures to Prevent the Loss of Purchasing Power

To prevent the erosion of household purchasing power, the executive took a number of measures enshrined in a law (‘for the protection of purchasing power’) passed during the summer. A number of transfers to the most vulnerable people have been scaled up. The prime d’activité (which provides an additional income for low-paid workers), the revenu de solidarité active (RSA) (which guarantees a minimum income for people without work), as well as retirement benefits were increased by 4 per cent on 16 August 2022 backdated to 1 July 2022.

It is better than nothing at all, but insufficient as the pace of growth remains below the level of inflation. Personalized housing aid was also increased by 3.5 per cent in July – after being reduced at the beginning of Emmanuel Macron’s first five-year term – but rents can continue to increase in the same proportion. The adopted package has indeed blocked rents for inadequately insulated dwellings but has authorized, for the rest, increases of up to 3.5 per cent for rent revisions between the third quarter of 2022 and the second quarter of 2023.

Bonuses Instead of Wages

This anti-inflation package adopted just after Emmanuel Macron's re-election confirms the paradigm: relief from inflation will come from economic activity and labour compensation. Curiously, however, this does not entail wage increases. To contain the erosion of employees’ purchasing power, the executive has bet mainly on bonuses. The ‘prime Macron’, introduced during the Gilets Jaunes mobilization and recently renamed the ‘prime pour le partage de la valeur’, has been made permanent and its ceiling tripled. Employers can now pay up to 3,000 euros per year per person in this form, as against 1,000 euros previously, without having to pay employers’ contributions. Previously restricted to employees paid less than three times the minimum wage, it is now available for all wage levels.

It is clear what the advantages of bonuses are for employers. They are one-off and can easily be reduced or even withdrawn. Employees whose end of the month is difficult will of course welcome a bonus. But they risk losing out in the long term, if these bonuses replace wage increases.

This trend also weakens social security finances because these contribution exemptions are expensive. The left-wing opposition has therefore criticized it as a ‘policy of empty coffers’: they accuse the government of cutting social security revenues, then sounding the alarm about the level of the deficit thus induced, before arguing that there is a need to reduce public spending in order to ‘stabilize’ it. During the budget presentation for 2023, the Minister of Economy and Finance Bruno Le Maire warned that no new expenditure projects would be discussed during the parliamentary debate if not funded.

Could we have done otherwise? The left-wing opposition, including La France Insoumise (LFI), Europe Écologie-Les Verts (EELV), the Socialist Party (PS) and the Communist Party (PCF), is calling, in order to fight the cost-of-living crisis, for alternative measures. In particular, a cap on the price of basic necessities, a rent freeze and ‘massive investments in ecological bifurcation (…), in particular in less expensive and ecological renewable energies’. Because of the current inflation, we are indeed paying the price for our dependence on fossil fuels. This is why left-wing forces are also calling for investments ‘in public transport to make it available for all, as well as in housing insulation to reduce bills and pollution’.

Are we doomed to have to live with inflation until these long-term measures pay off? Not necessarily, because states can mitigate price rises by different means and, in particular, prevent inequalities from rising by helping the most vulnerable. To stamp out inflation definitively, however, these emergency measures are not sufficient. The fight against inflation urges us to fundamentally rethink our production and supply schemes. And that might take quite some time.