France’s rising yields and the misinformed analysis of ‘progressive’ economist Paul Krugman

Ciaran McKenna is a research associate for Resilient Economics Think Tank in Scotland, as well as being a co-founder and board member of Modern Money Lab Europe

On October 8th, Paul Krugman posted a short article on his Substack titled “What’s the Matter with France?”, with the subheading “Is Europe’s #2 economy too big to save?”

In his opening paragraphs, Krugman argues: “What is France’s problem? France is on a fiscally unsustainable path. Debt is already very high as a percentage of GDP, and the French government is adding to that debt by running large budget deficits even though there is no emergency like a war, a severe recession, or a pandemic to justify such deficits.”

Is he living under a rock? There’s no emergency or justifiable reason for deficit spending? There is a war in Europe, a war in the Middle East, a climate catastrophe, rising energy bills, and schools in France are a shambles (which is at the heart of the recent protests). Not to mention that basic accounting shows that government deficits create net financial assets (NFAs) for the private sector. Thus, one can argue that there is always a credible reason for government deficits.

Krugman continues: “You don’t have to be a conservative to see France’s early retirement as unsustainable, especially given that French life expectancy at age 65 is about 87 years of age, 2 years longer than in the US. Thus the fiscal pressure caused largely by France’s very generous government pension plan has led to cutbacks in other spending, notably on education. France is effectively handing over large subsidies to older French at the expense of everyone else. Mass national student demonstrations should come as no surprise.”

So Krugman, a supposedly ‘progressive’ economist, is pitting the elderly against young students. In his money-is-scarce world, someone has to suffer. I mean, they can’t both expect to have well-funded schools and smaller classrooms, and retire with dignity at an age when you can still walk. That would be a little too progressive.

In this money-is-scarce world, Krugman is worried about running out of an artificial social tool (money) that the ECB and national central banks have the capacity to create electronically every day. Not once does he mention the real, physical resources that are actually scarce and that we desperately need to maintain society and care for the elderly: skilled labour, land, energy, and materials.

Finding the money is the easy part. Ensuring that currency issuance to provide for pensioners isn’t inflationary is also relatively easy. Decommodify the essentials. Introduce price caps on energy, food, housing, transport, etc. Use forced-saving certificates. These are some of many policies that national governments can deploy to manage inflation.

A literal laugh-out-loud moment arrived when Krugman insisted that “the implied probability of French default over the next 5 years is still only 1.2 percent – which I think is too low.”

The reasoning he gave for why the probability of default should be higher centred on his scepticism that the ECB would bail out France, as it did for Greece, and other southern European countries. Krugman explicitly states: “The 2010s euro crisis ended when Mario Draghi, the president of the European Central Bank, said three words — ‘whatever it takes’. Markets took this as a signal that the ECB would, if necessary, lend enough money to troubled debtors to avoid default. But it’s questionable whether the ECB could or would similarly rescue France.”

According to Krugman, the ECB would be more reluctant to bail out France because its fiscal deficits are climbing, more fiscally responsible nations like Germany would be angry, and southern European countries that endured painful austerity after 2010 would feel a sense of unfairness.

First, it should be highlighted that if France were abandoned by the ECB and left to default, this would almost inevitably lead to the total collapse of the European Union project itself, which I am sure would be a far bigger concern to neighbouring countries than ECB support.

Now, the next obvious task is to remind Krugman (and readers) that the Outright Monetary Transactions (OMT) programme is still active. This was the programme created shortly after Draghi insisted on doing “whatever it takes”. Under the OMT programme, the ECB announced that it was willing to provide potentially unlimited support in the bond markets. Immediately following this announcement, bond yields across Eurozone member states, particularly those under financial distress, fell.

What’s important to emphasise here is that the ECB only announced that it was willing to act as a buyer of last resort. It did not have to buy a single euro of government bonds under the OMT programme. The announcement alone provided the confidence that private market participants needed, namely that Eurozone countries, heavily indebted or not, would not be left to go insolvent. In other words, there was no default risk, and there is still no default risk.

Following the COVID-19 crisis, the ECB was quick to address any renewed concerns about debt default. The new president, Christine Lagarde, insisted in 2020 that “the ECB will neither go bankrupt nor run out of money” (Reuters, 2020). This was followed in 2022 by the introduction of a new Transmission Protection Instrument (TPI) programme, designed to guarantee liquidity during crises.

And yes, the TPI is still active.

And yes, it also has never been used since its announcement.

Therefore, there are two possible explanations for the rising yields: (1) bond traders have either forgotten about the buyer-of-last-resort guarantees or have started to doubt the ECB’s commitment to them; or (2) yields are rising because of expectations of continued inflation, which will keep base rates higher.

Given that the latter is actually occurring in real time, this seems more plausible. If the former were the case, all that would be necessary is a quick announcement from the ECB reinforcing the status of OMT and TPI.

In the meantime, one has to wonder what ‘progressive’ Paul Krugman (and other mainstream economists) want. Pensioners to work into their 70s? Students to accept class sizes of 30+ and rats scurrying around under collapsing ceilings? Governments to rein in any ambition to address housing, healthcare, or climate catastrophe? To pander to private capital? These are the options we are left with if we accept gold-standard thinking when it comes to fiat money.

In contrast, Modern Money Lab Europe firmly believes that money is a tool societies create to organise real resources (people, skills, infrastructure, technology, and the natural world) in service of the lives people actually want to live. Money is not itself a scarce resource, and treating it as one has cost Europe decades of avoidable unemployment, underfunded public services, and delayed climate action, with all the human suffering that this has caused.

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