More monetary-policy easing is still a one-club approachâfiscal support is also needed at EU level.
The coronavirus and its associated illness, Covid-19, have rapidly spread across Europe. From an initial concentration of cases and deaths in northern Italy, all European Union countries are now affected, albeit to greatly varying extents.
Member states have initiated a swath of increasingly stringent public-health policies, including bans on public gatherings and, in consequence or by order, production stoppages. Some countries have banned all non-essential contacts outside the homeâstay at home and read, French citizens were told by their president, Emmanuel Macron. National borders have been closed to various categories of person.
The cost in terms of lost output is set to be very considerable, even if the âsocial distancingâ policies quickly reduce new cases. Combined with the cost of counter-measures, fiscal-deficit and debt ratios are set to increase dramatically.
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In additional to national responses, the European public authorities have responded with a series of announcements. On March 13th the European Commission unveiled a support package. For Italy it activated the treaty provision permitting state aid in case of a âserious disturbance in the economy of a Member Stateâ; this would be extended to other countries as necessary. It also noted that economy-wide support measures offering liquidity support to firms did not fall under state-aid constraints.
The commission similarly declared that the pandemic fell within âunusual events outside the control of governmentâ and thus permitted exemptions for related spending under the fiscal rules. It stood ready to activate the general âescape clauseâ that would permit more general fiscal loosening, subject to approval by the Council of the EU.
These decisions increase the headroom for national measures. Regarding EU-level support, however, the statement was very limited. The commission proposes some reprioritisation of its own budget, although this is unlikely to be decisive compared with national efforts. It also intends to increase spending under the Cohesion Fundâpurportedly by âmobilisingâ â¬37 billion of unspent monies, although the mechanism for achieving this is unclear to say the least. The commission made no mention of facilitating access to the European Stability Mechanism (ESM).
On March 16th the Eurogroup of eurozone finance ministers announced that member states should allow the âautomatic stabilisersâ to play in full and also to permit liquidity support for firms and workers and spending on health measures, without regard to countriesâ current fiscal situation. It affirmed that âthe budgetary effects of temporary fiscal measures taken in response to COVID-19 will be excluded when assessing compliance with the EU fiscal rulesâ.
While this is positive in ensuring no member state is constrained by its debt ratio or current deficit from taking necessary measures, on its own it leaves national government budgets at the mercy of market pressures. Beyond welcoming investment initiatives already announced by the European Investment Bank, the Eurogroup failed to take any decisions regarding joint fiscal support for national budgets from existing EU-level vehicles, such as the ESMânot to mention new initiatives.
Liquidity and lending
Not for the first time, this put the economic-policy ball in the court of the European Central Bank. The ECB initially announced a monetary policy package with three main pillars: support for bank liquidity and lending by offering more favourable conditions for long-term refinancing operations (LTROs) and expanding targeted LTROs (or TLTROs) respectively, as well as an expansion of asset purchases (âquantitative easingâ) to prevent risk premia pushing up interest rates.
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The available volume under the TLTRO programme has been increased by half (â¬1 trillion) and the conditions made even more favourableâthe rate is 25 basis points below the deposit rate (currently -50bp). This should encourage banks to extend lending to cash-strapped firms, not least small and medium enterprises and households. The ECB is right that this is more appropriate than cutting the main policy rates even further into negative territory, the effects of which would be at best dubious.
On QE, â¬120 billion was added to the asset-purchase programme (APP) for 2020. The bankâs chief economist, Philip Lane, said it was âcommitted to use the full flexibility embedded in the APP to respond to current market conditionsâ. He went on: âThis means that there can be temporary fluctuations in the distribution of purchase flows both across asset classes and across countries in response to âflight to safetyâ shocks and liquidity shocks.â So there can be targeted support, to Italy for instance, to offset short-term market pressures.
This was an important clarification, after the ECB president, Christine Lagarde, had at the bankâs press conference disowned responsibility for keeping spreads under control. Although swiftly corrected, this threatened to overshadow the positive effect of the monetary-policy package, as spreads on Italian bonds initially jumped, causing market consternation and a political backlash in Italy.
Signs of stress
Separately, on March 15th the ECB announced, in collaboration with other central banks, an easing of conditions for (currency) swap lines, to reduce the danger of a dollar funding shortage. Its Supervisory Board also eased banksâ capital requirements. These measures serve to avoid dislocation in the financial sector and procyclical tightening of bank lending.
Nevertheless, clear signs of stress on sovereign-bond marketsâin particular a sharp rise in spreads for Italian and Greek government bondsâre-emerged, and on March 18th the ECB offered, under yet another new acronym, PEPP (Pandemic Emergency Purchase Programme), a further intensification of QE. The programme has an envelope of â¬750 billion for the current year but is, in principle, unlimited. A waiver enables the participation of Greek government debt.
Moreover, the ECB has made it clear that its (self-imposed) limits on purchases, as a share of sovereign bond markets, and their proportionality to the capital key (national central banksâ contributions to the ECBâs capital) will be set aside if necessary: âThe ECB will not tolerate any risks to the smooth transmission of its monetary policy in all jurisdictions of the euro area.â This had an immediate calming effect on bond markets.
It was vital that EU-level legal constraints on sensible responses to the crisis by the member states were removed. The recent decisions have achieved this. The member states are launching extensive measures to address the health crisis and stabilise workersâ incomes and corporate finances.
In Germany, for example, the government has announced a package which will provide an additional â¬1billion for the health service and set up a âprotective shieldâ around companies and workers. The latter has three domestic pillars: improved conditions for applying for short-term working allowance, tax deferrals and easier reduction of tax pre-payments, and expanded loans and government guarantees to companies, notably via the Kreditanstalt fÃ¼r Wiederaufbau (the national development bank).
Such measures can be tailored to the specific needs and institutional structures of the countries in question. Of course, for as long as economies remain in lockdown there is a limit to what demand-side support can achieve. But the knock-on effects of the immediate loss of output can be mitigated, preserving productive capacity.
Fiscal support needed
The removal of legal constraints does not however prevent countries running into financial market pressures. Calls for the ESM conditionality to be lifted to permit European support for fiscal measures have so far gone unheeded. An absence of European fiscal support is however unlikely to be sustainable.
The Italian prime minister, Giuseppe Conte, has explicitly called for joint bonds to be issued to finance national anti-corona measures. According to press reports, this is not being categorically ruled out by the German government. This would constitute a major breakthrough, finally introducing eurobonds (whatever they are called)âconfirming the adage of the founding father of European integration Jean Monnet that Europe is the sum of its responses to crises.
For the moment, the burden of shielding government finances has been placed one-sidedly on monetary policy. While there were initial doubts that this would provide the support necessary to stamp out flight to safe-havens and the resulting widening of spreads, the most recent ECB statement appears to have put these to rest.
National governments need immediately to make full and intelligent use of the room for manoeuvre that has been created. And then push open the window of opportunity to establish the eurobonds which the common currency should have embraced from the outset.