econ by keralaguest


									   The second largest economy in Europe, the fifth largest economy in the world, and the
fourth most-heavily taxed nation in the EU, France in home to over 63.5 million
residents. France is a member of the G8, OECD, EU, and the EMU and its habitants
enjoy a very high standard of living. France has a mixed economy, in which both
government and business are heavily involved. It has a large public sector, relative to
other industrialized countries: industries, like energy distribution, air-transport, and
telecommunications are under state control (MSN Encarta). Perhaps the greatest
weakness of he French economy is its inflexible labour market, characterized by strong
employment protection legislation (EPL), persistent wage rigidity in the labour market,
largely due to a high minimum wage (the SMIC), early retirement policy at age 55, and to
generous government support programs targeted at the unemployed. All of the above
make it difficult for firms to reduce labour costs in periods of recession, causes a high
level of structural unemployment, and keeps inflation at a higher level during economic
downturns. This paper will analyze the pattern of inflation over the years 1989 to 2004,
the reaction and impact of policy on inflation fluctuations, and the effects of other
macroeconomic factors on the inflation rate (such as foreign demand, exchange-rate,
unemployment rate (u-rate), money supply, and domestic expenditure, for example). In
addition, this paper will assess the impact of labour market, deregulation, and other
measures taken by government to improve the economy and their long-term impact on
the path of inflation.
   Based on inflation data (Diagram 3), inflation was kept low during the entire 16-year
period (below 4%). Furthermore, inflation had been on a downward trend since 1991
through to 1999. The turning point from which inflation began to decline was caused by
an exogenous shock that had a prolonged adverse impact on consumer and business
expectations. After reaching the trough in 1999 (at 0.54%), inflation began to increase
from 2000 onward, initially due to a global rise in oil prices. Based on the data, inflation
variability significantly decreased since the introduction of the euro in 1999 and,
especially, after it replaced the franc in January 2002.
   In 1989, the French economy experienced high economic and employment growth due
to several factors: an improvement in the terms of trade, accelerated growth in the global
economy, decline in real interest rates, depreciation of the franc and a less restrictive
fiscal policy stance. The high level of unemployment (9.4%) restrained real wage
increases and kept inflation at a moderate level of 3.5% (OECD 89/90, p.14). The
acceleration of growth in the global economy and the depreciation of the franc have both
added to the increase in real GDP through an increase in net exports. Inflationary
pressures stemming mainly from export-demand pressures and moderate gains in labour
productivity were suppressed by tight monetary policy adopted by the monetary
authorities (the Bank of France (BF)), which followed a so-called “Competitive
Disinflation” policy. The policy was targeted at reducing the inflation rate below that
seen in France’s main trading partners, in order to enhance the competitiveness of the
French economy (OECD 89/90, p.43). In accordance to this policy, the BF had
decelerated the growth in M3 money supply, which gradually raised short-term interest
rates by 3.25%, starting from the third quarter of 1989. Nevertheless, French firms
increased their investment by 7.6% in response to increased demand from abroad. New
corporate borrowing rose and manufacturing sector investment grew substantially
(OECD 89/90, p.29). Despite he improvement in terms of trade, the trade balance
decreased by 16 billion FF (Table X), largely due o a slowdown in activity in the US and
the UK (OECD 89/90, p.35) and to a smaller extent, to a worsening in French exporting
firms’ competitiveness, as a result of slowing growth in labour productivity.
   Economic activity declined somewhat, with real GDP amounting to 2.75% in 1990,
and inflation was reduced due to the competitive disinflation policy and to the strong
credibility of the BF in achieving its inflation targets. The year 1990 marked a turning
point for budgetary policy, which implemented active tax reductions, after having
attained its targeted reduction in the budget deficit. The decline in aggregate demand,
notably consumption expenditure, was the result of deterioration in business and
consumer confidence, caused by the crisis in the Persian Gulf (OECD 90/91, p.9). As a
result of this event, and also in response o the past monetary policy move to raise interest
rates, inflation fell somewhat to 3.2%. The decrease in demand was partly cushioned by
the achievement of German unification, which, although contributing o the increase in
French exports to that area, had more of a potential long-term effect of “creating a bigger
market for French exports” (OECD 90/91 pp. 12-3). Furthermore, there was upward
pressure on inflation due to a sudden rise in oil prices from $15/barrel to nearly
$40/barrel following the Kuwait invasion (OECD 90/91, p.13). Real investment fell in
the fourth quarter, as businesses became more uncertain about future developments in oil
prices ad as real interest rates remained at their high levels. Overall, consumer prices
remained relatively constant and inflation was lower. Declining inflation, he appreciation
of the franc, and the decline in aggregate demand prompted the BF to lower rates by
0.75% and to lower banks’ required reserve ratios, thereby renewing buoyancy in
corporate sector borrowing (OECD 90/91, pp. 39, 45). However, private sector borrowing
was still low, due to the high level of interest rates, despite the reduction. The enhanced
credibility and the resolve of the BF to fight inflation had caused a decline in inflationary
expectations through 1990-1991 and a decrease in long-term maturity rates. This also
reflects the increased credibility of the BF in achieving its inflation targets. After the
desired government budget deficit reduction was attained, the government implemented
reductions in taxes amounting to 26 billion FF (0.4% of GDP). However, the government
sector deficit was kept in balance, as government expenditure fell markedly by 6.6 billion
FF from the previous year (OECD 90/91, pp. 46-8). Therefore, the impact of the
government sector deficit on inflation was slightly negative and negligible. A more
important factor driving the decrease in the inflation rate was the implemented
deregulation of public air-transport, telecommunications, and road freight sectors:
disentanglement of public monopolies. This improved price competition, due to
undercutting by new firms entering the markets and collectively reducing prices down to
marginal costs (OECD 90/91, pp. 73-5).

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