Jorge de Macedo: Inflation is no longer a threat, but financial stability remains elusive

Jorge Avelino Braga de Macedo, Jubilee Professor at Nova School of Business & Economics and former Finance Minister of Portugal, recently took part as an expert in the Gaidar Forum in Moscow housed by the Russian Presidential Academy of National Economy and Public Administration, where he met with Invest Foresight, the event’s strategic media partner, to discuss evolving economic environment and nuances of financial stability.

What are the major challenges and changes world economy currently faces? According to Mr de Macedo, “2020 is a moment of change. The changes in the global system have been going on since 2016 because there were two major shocks that created a certain thrill in international relations. One – the US election, and the other – the UK referendum. The two more or less took place toward the end of 2016. Since then, we have been thinking that the system is changing, the system that was born after the Second World War: Bretton Woods and the United Nations. It took a while to understand whether the change was for real – and we still do not know, but many people would say that we find ourselves in a different world. We are coming back to something Russia knows very well, which is a balance of power in Europe and the world. Two centuries ago countries were rivals and friends at the same time. In the system of Bretton Woods it was not so. There was a Big Brother, the US protecting its allies, and after the fall of the Berlin Wall it became a one power world in some way. Now, this is changing and this has dramatic implications.”

“Russia is at the heart of the changes,” Professor de Macedo said. “We are going through a change in our perception of the world system. This applies to the world in general and this applies to Europe which now has a new European Commission, a new Central Bank President. The countries outside the OECD, in G20 or BRICS where Russia is a member alongside with Brazil, China, India and South Africa, are much more active now. So we are in the middle of a change which began long ago, yet it is only now that we are realizing how profound the change might become.”

Talking about banks and their functions in the contemporary economy, Jorge de Macedo noted that “Banks are not sovereigns, but they cannot take orders from the governments. This is the key point about the monetary, fiscal and financial policies in the OECD area, where the way the Ministry of Finance or the Treasury and the Central Bank cooperate must be based on mutual respect of competencies. In other words, the direction is set by the government, but the actual technical work must be done independently. Central banks are not servants but should not be masters since they do not have any popular mandate. What is happening now in central banks, they have shown they can reduce inflation, that is true and there is no longer inflation in developed countries. Even in less developed countries inflation is no longer the threat it was before. That success is due to central banks. At the moment central banks can say, we have done our job about money. With financial stability, it is different because in the past there were not too many bank failures. But since 2008, since the great financial crisis, we have very severe problems with banks in Europe, not just in the south of Europe but also in the north, and all over the world. Russia in that sense has been relatively lucky – and the reason is, after Central Bank Chairman Viktor Gerashchenko’s initial inflationary stance of the early 1990s, the Central Bank of Russia has really become very effective in countering inflation.”

Some experts say though, that very low inflation is not good for economy. “When discussing the point, one must say, low compared to what?” Professor de Macedo stressed. “It is certainly better to have inflation close to two percent per annum. That is now a consensus in the US, Euro Zone, Japan. So you do not want it to be much above, but you do not want it to be near zero either – because of the interest rate which is a very important instrument, like the accelerator and the breaks in a car. Yet high inflation is very bad too. So inflation at around two percent a year is the best of both worlds. Now it is too low, but it would not be better if inflation were too high. For instance, hyperinflation in Russia after disintegration of the USSR was a disaster both socially and economically. And it was so in many countries. One of the things that make China so special in the international community is that since its 1949 revolution China has managed to avoid inflation. Inflation is a hidden tax on poor people, it existed in many countries and in Germany it was devastating. It is easy to say low inflation is very bad. But what about high inflation? One has to compare.”

A balanced and predictable inflation is certainly not the only problem economies and governments need to deal with. According to Jorge Braga de Macedo, “We are used to hyperinflation being a symbol of a financial disaster, but financial disasters always involve bank failures. Even if prices do not go up too much, all of a sudden there are no banks as all of them are wiped out. In Portugal, there were several private banks. For various reasons they all were wiped out or bought by Spanish banks. The situation in many countries of Eastern Europe is now like that as they do not have local banks. Some of these countries even prefer such a situation as they thus avoid proximity between the banks and the governments. Thus the worst danger now is not hyperinflation but financial instability.”

Looking at the stability challenge from a historic perspective, Professor de Macedo pointed out that “The Maastricht Treaty was a balancing act between Germany and France and it essentially said, we were going to have Deutsche mark as a stable currency to become European currency called euro. It was a big bargain: stable finances, strict budgetary discipline and the ability to use Deutsche mark. But what was missing? In that union between France and Germany, there was a step-child – in the Maastricht Treaty Europe forgot about financial stability. We thought banks were like any other services in a single market, but they were not. That is why now there is much attention paid to financial stability and why central banks are so important, as in addition to money they also take care of financial stability. They do not have to do it as the mandate may be given to another institution, but after the 2008 crisis financial stability became much more important than at the time of the Maastricht Treaty. Since I signed the Treaty on behalf of Portugal, this is a point I am quite sensitive to, and indeed am finishing a book about.”

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