Changing of the Guards

Understandably, the French elections and the US presidential race have focused attention on the potential for radical policy experimentation. We think attention should also be drawn to how even mainstream political forces can be affected by a new approach to macroeconomic management straying away from the main principles which have been guiding policymakers since the 1980s. A circumspect attitude towards the role of fiscal policy in cyclical fine-tuning, the primacy of monetary policy and a distrust for direct state intervention in capital allocation are giving way to enthusiasm for activist fiscal policy, a critical view of the capacity of monetary policy alone to deal with inflation shocks and some appetite for price controls. We review a paper by Van Klooster and Weber which in our view encapsulates very well the new Zeitgeist. While we agree that without determined government action during Covid and the energy price shock triggered by the Ukraine war a painful recession could not have been avoided, there is a risk that what was emergency management turns into a structural shift.

Paradoxically, central banks are coming under heavy criticism when they are on the cusp of a victory on the inflation shock. We do not expect any hard decision this week, but the ECB Governing Council meeting should be the occasion to make it clearer that the June cut was only the start of a process, and we expect the next 25 bps cut coming in September.  In the US, the June print for the CPI probably sealed the deal for a first cut in September.

We continue to monitor the latest political developments in France. The President has made it plain he would wait for compromises across political families to emerge before appointing a new Prime Minister. This process could still take some time. We draw attention to the fact that beyond the budget bill for 2025, a new government will have to produce a credible medium-term plan to allow the EU to grant France extra time to bring its deficit to 3%. This will take more than just cobbling up together a non-committal budget.