Letter to the President of the Republic: « How France and Europe will defeat inflation »

This Letter is once again devoted to inflation, the prime concern of French citizens. This is our priority as a central bank, and we are firmly committed to defeating it within the next two years. But first we need to shed light on the causes and symptoms of what is an economic and social disease. The current inflation wave was initially imported, resulting in late 2021 (post‑Covid recovery) and early 2022 (Russian invasion of Ukraine), from external shocks on energy and agricultural products. Even today, these two items are legitimately the focus of attention of our fellow citizens, as they are seeing the sharpest rises, especially food prices. But they are neither the most significant – only 30% of our consumption – nor the most lasting: energy inflation has already slowed down, leading to a significant drop in headline inflation for the euro area, from 10.6% at the end of October to 6.9% today, and from 7.1% to 6.7% for France.

Share links

In the meantime, inflation has become more domestic, and has unfortunately spread to all goods and services: “underlying” inflation, excluding energy and food, has reached 4.6% in France, and may become more entrenched. This is precisely where monetary policy can and must act.

The disease of inflation would be even more serious if it were to become chronic: purchasing power would be significantly impacted, whereas it was ultimately preserved on average in 2022, and should continue to be so in 2023, even though this is obviously not the perception of our fellow citizens. The danger would be a runaway price‑wage spiral and a price‑margin spiral in certain sectors: but these two risks currently call for vigilance rather than a full‑scale alert. Lastly, the confidence of French
citizens in their currency, the euro, remains historically high at 73%. These relatively favourable observations are a further reason to treat the disease at an early stage.

The fiscal treatment was the first to be implemented in France: the price shields put in place since 2021 were effective in temporarily damping the energy shock, but they cannot eliminate it. Once again, it is essential to move away from the “whatever it takes” approach, which was only justified for the exceptional Covid shock. While our government deficit will be this year one of the highest in Europe, these costly measures – around EUR 50 billion in 2022‑23 – must be brought towards zero, by taking advantage of the current slowdown in energy prices, and unfunded tax cuts must be stopped.

The most effective weapon against inflation is now monetary: without causing the feared recession, the Eurosystem has acted quickly and decisively over the past year to exit from the
exceptionally accommodative financial conditions previously required by too low inflation. Today, credit is logically more expensive in Europe: however, it is in France that it remains the most favourable, and widely accessible to households and businesses. The soundness of the French banking system shields it from the specific problems experienced by certain US regional banks or by Credit Suisse. Given the one to two‑year lag in the transmission of the current monetary tightening, the central bank is committed to bringing inflation back towards 2% by end‑2024 to end‑2025. Household and business inflation expectations show a reasonable degree of confidence at this horizon, and should therefore contribute to a gradual decline in inflation from its current peak.

However, our country must also mobilise to contain inflation and increase our growth: to meet demand, we must produce more and do so more efficiently by beefing up our supply and innovation capacities. The disruptions in our environment thus call for a comprehensive, fair, and enduring economic transformation strategy, in four areas. The first two concern the whole of Europe: achieving both the energy and climate transformation and the digital transformation.

But two areas of supply capacity concern our country more specifically: in order to address the public services crisis, we need to achieve a public services transformation that improves the efficiency of current spending and makes spending for the future the priority; the Banque de France is a modest but real example. And above all, in a re‑legitimised social dialogue, pursue the transformation of work that must, at the collective level, involve a greater number of people still and, at the individual level, must be more qualified and attractive; recruitment difficulties are still the main obstacle to production for 52% of French companies today. Our work remains the key to our collective success, to our purchasing power and to full employment. In the face of inflation and current uncertainties, the levers of our economic destiny are largely in our hands: beyond the pressure of urgency, this conviction should give us greater grounds for confidence.

Banque de France