Perkins estimates that the costs of governments trying to cushion the economic blow of soaring energy prices could cost “at least” 5 percent of gross domestic product. If that bill seems high to some governments, the alternative is worse, says Perkins. Our emphasis below.
Inevitably, governments will be under tremendous pressure to support their economies during this difficult time. They have already announced several fiscal measures, including liquidity provisions (for utilities facing extreme margin calls), income transfers and even energy “price caps”. The final public finance bill could be huge, with a successful intervention likely to cost at least 5% of GDP per year (depending on what happens to energy prices). But European politicians have no alternative, especially since – unlike central bankers – they will eventually seek re-election. Many low-income households will face real poverty this winter, while rapidly rising input prices will destroy the profitability of European companies (particularly the region’s SMEs, which already operate on relatively thin margins). If governments do not act quickly and decisively, they could face an economic crisis similar to the one they successfully avoided during the pandemic: massive pressure on corporate balance sheets, sparking a wave of bankruptcies and a sharp rise in unemployment. cause. In short, a new COVID-style economic crisis requires a COVID-sized policy response.
The problem, as Perkins points out, is that all central banks currently seem to see inflation as uncomfortably high. Although the European Central Bank is not as aggressive as the Federal Reserve, the course is quite clear.
So there is currently a tug-of-war between European governments opening the fiscal taps in various ways to soften the blow of higher energy costs – what Perkins calls “The Everybody Bailout” – and monetary policy essentially trying to slow economic growth gently but firmly. suffocate .
As Perkins points out, this is virtually a complete policy reversal of the past decade, when monetary policy was historically simple and fiscal policy was arguably much tighter than it should have been. The question is where this leads.
A major fiscal expansion, of course, goes directly against the philosophy of Europe’s monetary guards. In fact, governments are trying to protect the economy from an adjustment that the central banks believe is inevitable. But is the public sector’s response to the energy crisis necessarily inflationary?
The answer depends on the persistence of the shock. If energy prices quickly return to pre-2022 levels – or if governments quickly withdraw support – governments will have caused a one-off increase in public debt, which is unlikely to lead to sustained inflation. However, problems arise as the energy crisis continues. Wholesale energy prices could remain high in 2023 and possibly beyond, making it extremely difficult for governments to reduce their support for households and businesses.
Instead, the public sector would come under enormous pressure to continue to subsidize private living standards, leading to large, persistent deficits and higher inflation in the medium term. Add to that periodic power outages and sectoral lockdowns and we could be dealing with a new COVID-style dynamic, with governments simultaneously supporting incomes and limiting supply. Central banks wouldn’t be happy about that, especially since the longer inflation stays high, the greater the risk of expectations being ‘unanchored’.