Why has the fall in inflation become a problem for France’s financial balance?

The spectacular fall in inflation and its consequences

The figures published in September 2024 took many economic observers by surprise. With a inflation which is only 1.2% over one yearFrance is experiencing a spectacular decline in price increases after two years of intense crisis. This news, a priori pleasing for the purchasing power of the French, however hides a more complex reality for state finances.

Indeed, this rapid disinflation comes upset the government’s calculations for the development of the 2025 budget. Antoine Armand and Laurent Saint-Martin, respectively Ministers of the Economy and the Budget, find themselves facing a major challenge: how to maintain public finances on course in this new economic context?

The government’s budgetary challenges

The first obstacle facing the executive is the scale of the public deficit. While forecasts were for a deficit of 5.1% of GDP for the current year, the latest estimates are much more alarming. “ The deficit could exceed 6% of GDP this year,” reveals a source close to the matter. This budgetary slippage considerably complicates the government’s task for 2025.

The “weak” price increase also deprives the State of a lever for reducing the deficit potentially powerful. As Mathieu Plane, economist at the OFCE, explains:

“It is much easier to accept an increase in pensions of only 4% when inflation is 5% than not to increase pensions at all when inflation is 1%.”

In addition, disinflation creates a costly squeeze effect on public finances. François Ecalle, founder of the specialized site Fipeco, details this phenomenon: “Recipes, like VAT but also social security contributions react very quickly to a slowdown in inflation. Whereas in the opposite direction, public spending is quite inert.” This asymmetry results, in the short term, in a widening of the deficit.

Public debt: a precarious balance

The issue of the public debt adds to the budgetary difficulties. With a level reaching 112% of GDP at the end of the second quarter of 2024France finds itself in a delicate situation. The return of inflation below 2% further complicates the situation. As Mathieu Plane summarizes: “It is almost impossible to stabilize your debt with prices that increase very little”.

This increase in debt compared to GDP risks sending a worrying signal to financial markets. Investors could demand a higher risk premium to buy French debt, increasing the rate at which France refinances itself. The example of Italy, faced with high interest rates due to its significant debt, looms like a threat over France.

The government’s options for 2025

Faced with these challenges, the government must make decisions for the 2025 budget. cuts in public spending seem inevitable, but their extent and nature remain to be determined. The question of tax increasesalways politically sensitive, could also return to the forefront.

Some economists suggest a different path: raise the inflation target. This option could make debt management easier, but it is subject to strict conditions. Inflation should be driven by wages and corporate income, not imported via energy prices. Moreover, this strategy should be common to the euro zone to avoid competitiveness gaps.

The project of finance law 2025which will be submitted today to the High Council of Public Finances and the Council of State, before being presented to Parliament the week of October 9will be closely scrutinized. The choices made there will have major repercussions on the French economy and the purchasing power of households in the years to come.