The Pandemic Depression
The Global Economy Will Never Be the Same
On March 18, the European Central Bank announced that it will buy an additional 750 billion euros’ worth of European corporate and government bonds this year. That means the ECB will spend a total of 1.1 trillion euros on eurozone bonds over the next nine months, the most it has ever spent on assets in so short a period of time. These extraordinary measures, intended to offset the adverse economic impacts of the coronavirus outbreak, amount to a monetary bazooka that will increase the European money supply (the ECB prints euros to buy bonds) and channel funds indirectly to the governments that issued the bonds, enabling those governments to bail out ailing businesses and provide for unemployed workers.
In an additional show of force, the ECB relaxed self-imposed restrictions on its purchases of government bonds for the duration of the crisis. Previously, the ECB had promised to buy no more than one-third of any country’s available bonds and to buy those assets in proportion to the size of the country’s economy. These rules—as the Financial Times notes—were intended to “ensure that the ECB does not buy so many bonds that it [could be] accused of directly funding national governments.”
The European countries worst affected by the coronavirus pandemic—Italy and Spain, which have the highest death tolls in the European Union and face the strongest economic headwinds—are also among the principal beneficiaries of the new ECB policies. By purchasing Italian and Spanish bonds, the ECB has given Rome and Madrid leeway to focus on keeping their people healthy, without worrying about a domestic economic collapse. These bond purchases have also made a sovereign debt crisis of the kind the European Union last witnessed in the summer of 2012 less likely.
But the ECB’s recent moves have raised hackles in Germany and the Netherlands, where leaders fear that the bank’s actions will encourage governments to live beyond their means or avoid making painful adjustments once the crisis has passed. These leaders have grudgingly accepted the ECB’s new policies, but they are resisting calls to grant the Italian and Spanish governments additional borrowing power without some guarantee that the money channeled to support countries in need does not result in financially unsound behavior.
Between 2012 and 2015, European leaders created an array of institutions to provide general oversight for banks, insurance companies, and financial markets. They wrote a common rule book detailing how banks can behave responsibly and perhaps more important, how banks can be taken over or wound up when they misbehave. Leaders also created a permanent body to underwrite national public finances when the costs of responding to a crisis become too great for any individual government to manage or too risky for international investors to undertake. Known as the European Stability Mechanism, this body acts as the eurozone’s sovereign bailout fund and can grant precautionary credit to governments in a fix, provided they accept the mechanism’s conditions.
But certain eurozone policymakers wanted to go even further. They thought that the European Union should issue a common bond that financial institutions across Europe could use as collateral when borrowing from each other and from central banks. This so-called eurobond could replace or supplement sovereign bonds issued by individual member states, giving governments an alternative means to raise money and in the process, reduce their risk of default. Comparatively wealthier northern European governments scuttled this idea, however, citing fears that irresponsible governments could use the eurobond to go on a spending spree.
The European Union should look beyond national differences and maintain institutional cohesion.
The debate over this and other policies aimed at strengthening the resilience of European financial markets continues today, albeit in a slightly different form, as the eurozone faces a once-in-a-century pandemic that has brought various sectors of the global economy to a virtual standstill. And the disagreements remain rooted in very real differences at the national level: by the end of 2019, Germany and the Netherlands had debt-to-GDP ratios of 59 percent and 49 percent, respectively; the ratios in Italy and Spain were far higher, standing at 136 percent and 97 percent, respectively.
These disparities reflect differences in government policy. Since 2014, Germany and the Netherlands have made concerted efforts to balance their national accounts, reducing their respective debt-to-GDP ratios by 16 percent and 17 percent. Spain, by contrast, has made only a four percent dent in its debt-to-GDP ratio. And Italy has shrunk the proportion by only one percent. No wonder, then, that investors would move their money from Italy and Spain to Germany and the Netherlands in a downturn such as this one—or that the Dutch finance minister would complain that the strength of public finances in his country was the result of hard work that others would have been wise to emulate.
But when faced with a common shock such as the coronavirus, one that will assail countries both rich and poor if improperly contained, the European Union should look beyond national differences and maintain institutional cohesion. There are good reasons to encourage Rome and Madrid to undertake tough economic reforms, but now is not the time to do so.
At a 2019 hearing before the European Parliament, Christine Lagarde argued that her experience as the French finance minister and the managing director of the International Monetary Fund would serve her well as the future ECB president. She emphasized her ability to speak to politicians at the national level. And she argued that, if European economic performance were to fully recover from the last crisis, finance ministers across the eurozone would have to coordinate their activities with the ECB. A monetary stimulus, after all, is only going to be effective if accompanied by appropriate fiscal measures.
With the European Parliament’s assent, Lagarde assumed the role of president of the ECB last November. But the wounds from the 2012 crisis have yet to heal. And as a result of the coronavirus outbreak, Lagarde’s message is all the more urgent. The measures introduced to combat the coronavirus are going to collapse economic performance by keeping workers and consumers at home. Only a powerful fiscal stimulus can offset the impact on households and firms. But these measures will force eurozone governments to take on tremendous amounts of debt.
Italians and Spaniards refuse to be treated like second-class citizens in the face of a global pandemic they did nothing to deserve.
On March 24, Lagarde recommended that European finance ministers pool their borrowing power together to respond to the crisis. Their governments could jointly issue a one-off eurobond—a so-called coronabond—to raise money and distribute it among themselves, without placing conditions on how the funds are spent. The opponents of this plan recommend that Italy and Spain instead go to the European Stability Mechanism for a bailout. The Germans and the Dutch do not like the idea of issuing coronabonds; the Italians and Spaniards, meanwhile, refuse to be treated like second-class citizens in the face of a global pandemic they did nothing to deserve.
So long as this impasse continues, the ECB will remain the only body capable of keeping the European economy afloat. The European Commission may succeed in offering support with additional funds for unemployment insurance under the SURE program announced by European Commission President Ursula von der Leyen on April 1. The European Investment Bank may provide more resources to small and medium enterprises. And the Dutch government may agree to contribute to some kind of benevolent fund to help alleviate suffering in the countries that are hardest hit, as Dutch Prime Minister Mark Rutte suggested in response to criticism over his country’s opposition to coronabonds. But none of these actions by itself or taken together will have the kind of fiscal firepower necessary to stave off an economic crisis. The European economy needs a coordinated fiscal effort that is big enough to have a macroeconomic impact. The ECB has bought time with its latest measures. But it has not solved the economic problems Europe faces as a result of the coronavirus.
Reviving Europe’s Economy Will Take More Than Monetary Policy