“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Mario Draghi, President of the European Central Bank (ECB) during the European debt crisis, saved the Eurozone with this improvised sentence during a speech in London in 2012. “Whatever it takes” has been echoed by many European leaders these last weeks, trying to save lives while limiting damages caused by Covid-19 on our economy. Yet, this crisis has different characteristics than the last one.
Covid-19, a globalization’s pandemic, has huge economic impacts. These impacts do not only stem from the costs for our health system but also from all the disruptions caused by the necessary decisions taken by governments, such as lockdown. To say it another way, we are imposing disruptive restrictions on our economies in order to save lives. The first effects seem alarming: each month of lockdown would reduce the annual GDP by three points, the output of businesses is reduced by 40%, that of manufacturing by 50%. The combination of negative supply and demand shocks, reducing our production and partially interrupting the global supply chain, will have an impact on household incomes which will be reduced. Some companies risk bankruptcy, having little or no income with high fixed costs. The example of the aviation sector is particularly significant, the losses being estimated at €250 billion for 2020, or 40% of their revenue in 2019.
The analogy of war, chosen by certain European leaders such as Emmanuel Macron or Boris Johnson, is effective to motivate the population to respect sanitary rules but is difficult to associate with the economy. Indeed, a war maximizes production, while the lockdown puts it at a standstill. In this article, I analyse the monetary and fiscal policies, twin in times of crisis, which have been decided in order to reduce the economic impact of the virus, and the potential stages that I consider necessary for the Eurozone to survive.
Monetary policy of the ECB: fast to react with a limited mandate
The monetary response has been rapid but can still be improved to assure a sustainable future for the Eurozone. The misleading signal sent by Christine Lagarde, current President of the ECB, announcing that the ECB would potentially not intervene to support government debt markets has been quickly corrected. After the sovereign bonds were put under pressure, a first decision was to extend the balance sheet of the ECB by €120 billion and to keep the below-zero policy rates at their current level in order to guarantee loans at low prices for banks, thereby stimulating the real economy by injecting liquidity. On March 18-19, the Pandemic Emergency Purchase Program was launched. It plans to buy €750 billion in government bonds over the next few months to guarantee their stability, especially in view of the complicated situation vis-à-vis southern countries, such as Italy and Spain.
To go further, the ECB could directly finance the debt of the Eurozone countries by buying government bonds directly on the primary market, instead of the secondary market as it is currently the case. The difference being that it would buy directly from sovereigns instead of buying from investors. This practice, called monetary financing, allows member states to monetize newly created debt, meaning that it would not increase the sovereign debt-to-GDP ratios and would then reassure the financial markets on the sustainability of European sovereign debt. Two limits exist for this proposition. The first is legal because the proposal might exceed the mandate of the ECB, but the ECB could interpret it as such as it did during the previous crisis with its Quantitative Easing. Then, this solution could create inflation, in contradiction to the mission of the ECB to keep the price level increase below 2% per year. According to De Grauwe, as the EU is in a “deflationary spiral”, it is unlikely to happen in the short-term. Furthermore, it could be avoided on a longer-term. Andrew Bailey, Governor of the Bank of England (BoE) wrote in the Financial Times that the BoE would not use monetary financing, HM Treasury announced that the BoE will temporarily finance British debt. This solution can be implemented in the Eurozone.
Fiscal policy: politically sensitive but necessary to reach a long-term solution
Monetary policy must go hand in hand with fiscal policy, especially in times of crisis. Since the EU has no common fiscal authority, the responses have hitherto been mainly national: total or partial payment of wages for workers unable to work, support for businesses, deadlines granted in the repayment of credits… These measures, absolutely essential for maintaining the economy in times of social distancing, are also extremely expensive. Some calculations would estimate it at 13% of European GDP, which can skyrocket debt levels: Italy would rise to 158% of GDP this year, 135% for France and 144% for Portugal. To avoid a liquidity crisis or/and a solvency crisis, there must be a coordinate answer at the EU level. An impressive list of scholars, among them Piketty or De Grauwe, have called recently to launch Eurobonds, or Coronabonds on its temporary version. Some can argue that there is the European Stability Mechanism (ESM) that could be activate to help a sovereign facing an urgent financial need, but this system is a temporary “stop-gaps” in this situation as it does not address the long-term problem of unsustainable debt. Many propositions have been made concerning the design of the Eurobonds, the main idea is to issue a common debt at the EU level, which pools the risks associated with unstable national bond markets. In the actual crisis, it would allow the most impacted countries, unlucky to be more impacted than others, to issue debt that does not increase their own debt level, preventing it to become unsustainable. The Coronabonds is a short-term version of the Eurobonds, allowing to issue debt at the EU level in order to finance medical supply and health spending without increasing national debt levels. Politically, nine countries, including France and Italy, have called to launch these bonds. The other group of countries, including Germany and the Netherlands, oppose them, arguing that it could create moral hazard and that the ESM would suffice in the current situation. On the 10th of April, the Eurogroup finance ministers have agreed on a €500 billions package rescue among other measures, but not on Eurobonds. Again, this solution does not address the problem of increasing debt level, which could foster a greater recession, or even the fragmentation of the Eurozone. This package is already politically dangerous for Italy, which sees it as a lack of solidarity in the Eurozone.
The situation we lived these weeks is unprecedented, forcing people to stay at home, stopping the functioning of the economy, with key workers going to work for the common good. Decisions concerning monetary and fiscal policy have been exceptional, but the EU must step-up and reach difficult agreements concerning the unsustainable debt level of important Eurozone countries if we want to stay united. If Jean Monnet has seen right, “Europe will be forged in crises and will be the sum of the solutions applied in these crises”.
Tennessee Petitjean, Master student in Political Economy of Europe at the London School of Economics, and former student in International Relations at the ULB.