François Villeroy de Galhau: Fiscal policy and the debt challenge in
the present crisis
Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at the 2022
G30 Conference, Washington DC, 15 October 2022.
* * *
I will take here the view from advanced economies: we have a significant debt
challenge (112% of GDP in France, 96% in the euro area, more than 120% in the US).
This is the main figure where we see still significant Covid economic sequels. But it's
not a pressing sustainability issue; it's an obvious intertemporal and intergenerational
issue: fiscal policy must in the long run first stabilize, and then diminish the burden of
public debt.
There are two difficult short- term prerequisites for that. Let me today focus on these
two "consistency challenges" for fiscal policy in this crisis:
1- about its stance : how do we ensure its consistency with the anti- inflationary
Monetary policy? In Covid they were spontaneously aligned, much less so today
2. About its content and quality : how do we ensure the consistency of fiscal support
for households and SMEs, with the energy transition we have to succeed in?
1. On the first question, the textbook answer is that, as monetary policy is, fiscal
policy should be tightening too. I agree in principle, but let us acknowledge that the
democratic reality we fortunately live in put our elected governments under opposite
pressure- and hence I'll introduce two economic nuances to guide sensitive fiscal
choices. Fiscal support against the energy shock might and should be tailored
and segregated:
a) Tailored:
No "one size fits all" policy solution à country by country approach
Large negative shock on terms of trade in Europe (unlike the US), with
skyrocketing gas and electricity prices à risk of excessive decline in domestic
demand (far beyond what is warranted by the negative supply shock) with liquidity
constraints and distribution issues: there is a case for fiscal support
b) Segregated:
Within fiscal spending: providing some protection against the energy shock
should not result into a relaxation of fiscal discipline and some form of fiscal
dominance
The standard distinction between structural/cyclical fiscal deficits is not the
relevant gauge in this case.
Better to use a differentiated expenditure rule in which exceptional measures
related to the energy crisis are temporarily segregated.
Better to have a nominal rule (gradually consistent with the 2% inflation target)
than a real expenditure rule: real "regular" expenditures have to slow when
inflation accelerates above target. By the way, in a long-term perspective, current
("run") expenditures should diminish relatively to future oriented ("change") ones.
2. On the second question ( content ), here too we should go somewhat beyond the
textbook (no price caps / no tax cuts / no subsidies). Let me come to the famous
"Targeted and temporary" rules:
c) targeted: through a mix of targeted income transfers and price caps/subsidies.
This mix should take into account the welfare system characteristics of each
country.
If welfare benefits and the minimum wage are indexed, there is a case for a mix
favoring price caps/subsidies. Not paying twice and diminishing the risk of 2nd
round effects.
Some offsets to ensure that energy demand remains sensitive to, and
somewhat restricted by, price signals:
The best practical solution seems to be a tiering scheme, with only a
part - 70 to 80 %?- of energy bills protected : it can be based on past
consumption (German or Dutch proposal), or if technically possible on
average consumption and/ or income data
Nudging households to save energy and limit their gas/electricity
consumption: limiting temperature to 19°,-
d) temporary: this remains the most difficult challenge, if (as plausible) energy price
levels change durably.
Targeted support should be gradually suppressed, as real income gradually
recovers. The French government will start that in January 2023 (+15%)
Monetary policy should not be under the illusion that price caps reduce
nd
underlying inflation (they may nevertheless help to reduce the risk of 2 round
effects): they reduce current measured inflation at the possible expense of future
measured inflation (inflation smoothing). We rightly incorporated this differed
effect in our latest inflation forecasts
Conclusion: While monetary policy is fairly clear under present circumstances,
fiscal policy is for sure more difficult. I suggested today going from a simple (?)
TT rule to a more sophisticated TSTT rule - but this is the best way to reconcile
short term and long term fiscal requirements.