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Originally coined by Olivier Blanchard and Jordi Gali in 2005, divine coincidence is a property of New Keynesian economic models and implies, simplifying a bit and under a series of assumptions, that stabilizing inflation at target also implies achieve the optimum level of economic activity. . This is the key to most central bank price stability mandates: hitting the inflation target is enough to maximize sustainable growth. It is a property that makes it possible to separate the macroeconomic tasks, with a monetary policy centered on inflation and a budgetary policy on the stabilization of the public debt.
The problem, of course, is that the conditions necessary for divine coincidence to hold are not always present. For example, in a situation of chronic insufficient demand, such as the one we experienced until recently, monetary policy may not be able to bring inflation back to its target and needs the help of fiscal policy. It is also possible that the economy is facing a large temporary negative supply shock, as is currently the case. In these cases, it is important to recognize the presence of real wage rigidities: wages adjust less, or at least more slowly, than prices. In such a situation, strict compliance with an inflation stabilization regime that does not allow for some wage adjustment is sub-optimal, and generates an excessive reduction in activity: the divine coincidence no longer holds. The solution is to be patient and create the conditions for a gradual adjustment of wages provided, of course, that inflation expectations remain consistent with the objective. The current situation is all the more difficult as the volatility of the supply shock – the rise in the prices of all commodities – is much greater than the volatility of demand: for example, the price of a barrel of Brent has gone from $80 in January to $128 in March to $109 in late April. The reality is that policymakers now have little control over economic variables, and the uncertainty surrounding economic projections is enormous.
Suddenly, energy independence is just as valuable as fiscal discipline
Divine coincidence has been defined in the field of economics, but its logic can also be applied to geopolitics. For decades, it was argued that economic interdependence was the best way to ensure global political stability. For example, Thomas Friedman dared, in 1996, the “theory of conflict prevention of golden arcs”: two countries where McDonalds was established would not enter into an armed conflict. Over time, the idea of ensuring world peace through economic interdependence took hold, and one of the best examples was Germany’s strategy of intense economic relations with Russia: Germany ensured a very cheap energy supply which enabled it to increase the competitiveness of its industries. It was divine coincidence applied to geoeconomics: globalization made it possible to increase economic efficiency and, at the same time, ensure world peace.
But the reality is that the economic relations were hit first, and the political implications were rationalized ex post to justify the economic strategy. After World War II, the United States had a grain surplus and Russia a commodity surplus, and it was in the economic interests of both countries to establish trade relations. Similarly, China’s openness to international trade has generated mutually beneficial economic exchanges for many countries. Pioneer companies lobbied governments, which eventually liberalized trade. The divine geo-economic coincidence has made life easier for those in power: the economic relationship interests us, let us praise the political relationship.
Until the divine geopolitical coincidence ceases to hold. The Chinese (or Russian) economic openness has not led to its democratization, as expected. Subtly, friction between the United States, Europe and China grew and the idea of decoupling Western economies from the Chinese economy took hold. Thus was born the concept of “produce in China for China, outside China for the rest of the world”. And the process was accelerated by the Russian invasion of Ukraine and the sanctions that followed. The McDonald’s theory no longer holds. As a result, energy independence is just as valuable as budgetary discipline. Suddenly, globalization has limits – and that is why Germany, so economically dependent on divine geopolitical chance, is so resistant to this new reality which is shattering its mercantilist economic model and deteriorating its competitiveness.
US Treasury Secretary Janet Yellen recently proposed that supply chains be redirected to allies – “friend-shoring”. The idea of international trade determined by geostrategic relations and political values is far removed from globalization as a strategy for increasing economic efficiency. And what does “ami-shoring” mean in practice? The countries that abstained in the recent United Nations vote condemning Russia represent more than half of the world’s population. Neither the IMF’s Monetary and Financial Committee nor the G20 could agree on a statement at their recent meeting, exposing the huge geopolitical divide between the coalition of developed economies and the rest of the world – especially now that tariffs and sanctions are geostrategic tools and dollar reserves can no longer be considered risk-free assets.
The end of divine coincidence, both economic and geopolitical, reduces economic efficiency, introduces extremely high uncertainty, and makes the design of economic policy extremely difficult. The dilemmas facing policymakers – growth versus inflation, efficiency versus resilience – will not be resolved in the short term, and they feed into each other. Fortunately, these shocks come at a time of strong economic growth, supported by very robust labor markets: the average unemployment rate of the G7 economies is the lowest in decades.
Divine coincidence will return once the impact of these supply shocks dissipates and a new geopolitical model is constructed. But the margin for error in policy-making during the transition period is huge.
