likely to remain more restrictive than in the second half of risks of the region settling on a wage/price loop which would 2022. This is predicated on our belief that the Fed won’t want force the ECB into even more tightening. A conflict is however to cut rates as quickly as the market is currently pricing (second likely to emerge towards the second half of 2023 as significant half of 2023) since they will want to be satisfied that they have government issuance would clash with the ECB’s likely decision properly broken the back of inflation. The price to pay for this to gradually reduce the reinvestment of the bonds it purchased will be a recession in the first three quarters of 2023 in the US during Quantitative Easing. Even if the European fiscal which will trigger the usual adverse ripple effects over the surveillance system were to allow for another prolongation of entirety of the world economy next year. the exemption from the deficit reduction rules, we expect the budget bills for 2024, which will start to be discussed in the Memories of past mistakes often inform policy-makers action. summer of 2023, will mark the end of fiscal profligacy. Just like the premature monetary tightening of the 1930s was the mistake Ben Bernanke wanted to avoid at all costs in his Looking for a growth model management of the aftermath of the Great Financial Crisis of 2008/2009, this time it’s the 1974 error which is probably Over the last two decades, monetary and fiscal support has haunting Jay Powell. Indeed, contrary to popular belief, the Fed often dissimulated the underlying lack of dynamism of the initially responded to the first oil shock of 1973 by rapidly hiking developed economies, faced with slowdown in productivity rates. Its fateful decision came at the end of 1974 when, adding to the demographic woes. In some countries, and that’s worried by the significant rise in unemployment, the Fed certainly the case in the US, the decline in labour market reversed course although inflation was still in double-digit participation is another source of weakness for potential GDP territory. This laid the ground for rampant inflation throughout growth. Now that policy support is past its peak, those the second half of the 1970s, ultimately forcing the Fed into a structural flaws will take centre stage. massive tightening in 1980. The recent experience in the UK is interesting from this point of In a way, what lies ahead of us is the mirror image of monetary view. While the content of the plan was deeply flawed – policy “over-activism” of the last two decades. Central banks upfront, unfunded tax cuts combined with vague promises had come to the conclusion that it was only by driving the about structural reforms – at least Liz Truss’ administration economy “red hot” – well above potential – that they would tried to address the deterioration in potential growth in the UK. manage to bring inflation back to target from their stubborn, The U-turn on the fiscal stance by the Sunak administration is near zero new trend. Today, the conclusion they have reached of course welcome from a financial stability point of view, but is that it’s only by driving demand below an already low supply what is missing is a plan to re-start the economy. pace that they will be able to bring inflation back to 2%. No pain, no gain. On the list of macro challenges, we need to add the likely “greenflation” looming – the necessary fight against climate Fiscal activism’s last gasp change is forcing the adoption of cleaner, but usually more expensive technologies, while we expect more regions beyond While the monetary tightening is synchronized across the the EU to adopt forms of carbon pricing. “De-globalization” is Atlantic, the fiscal stance has started to diverge. In the US, the also a risk, especially for countries which have made the choice Inflation Reduction Act – which in reality is a Green Transition of extroverted growth – such as Germany. The US is probably in Act – will probably be the last big program of Biden’s mandate a more comfortable position than Europe. Its demographic as the Republican’s midterm gain of the House majority will position, although deteriorating, is less problematic, and the probably usher in at least two years of policy paralysis. But this country can at least count on cheap, domestically produced is probably “what the doctor orders” at the moment in the US: energy. The European Union at the time of the pandemic had there is little point in fiscal policy attempting to offset the Fed managed to give substance to its long-term growth strategy by stance given the need to address the economy’s domestically- breaking the taboo of debt mutualisation to fund the “Next focused overheating. The situation is very different in the Euro Generation” programs. We find it concerning that the member area where governments have engaged in a new series of fiscal states have not found the same capacity to respond to the fallout stimulus to mitigate the impact of elevated energy prices on of the Ukraine war with another concerted investment effort. households’ income and corporate margins in the context of the Ukraine war. While we are confident that by the middle of 2023 the world economy will start improving again, we would warn against any There is still probably some degree of complementarity excessive enthusiasm. Beyond the cyclical recovery, many between fiscal and monetary policy in Europe. Households structural questions will remain unanswered. receiving temporary income support from governments may reduce pressure on more persistent wages, thus limiting the 4