The Coronavirus has taken the world by storm. Covid-19, a virus that originated in Wuhan, China, has spread around the world and has become a pandemic according to the WHO. As of 29th March, more than 710.000 cases and 33.000 deaths have been confirmed, with the highest number of cases registered in Italy, China and the US.
Containment measures of the virus have led to hundreds of millions of people staying in quarantine in their houses, and schools, Universities and businesses have closed. This will have a devastating impact in the economy, with an expected contraction of the GDP of 2020 in every major economy in the world. The effects of this new crisis can already be seen. A record of 3,28 million Americans filled for unemployment benefits only last week (up from 281.000 the previous week) and the American Secretary of Treasury, Steve Mnuchin, predicted that US unemployment rates might reach 20%, a level not seen since the Great Depression in the 1930’s.
As the Covid-19 spreads around the world and containment measures continue to be implemented, the economic consequences will increase in severity. We do not know how the spread of the virus will evolve and so, we do not fully know the extent of the impact the virus will have in the economy. However, policymakers have to act now to guarantee that firms have the necessary liquidity to survive this period of lockdown, that people don’t lose their jobs and that they have a minimum income available. If governments and central banks are not up to the task, then this crisis will become a full-blown depression and possibly give rise to a financial and banking crisis.
More than ever this is a time of action and pragmatism, and not one of ideological orthodoxy and short-sightedness. Those that do not understand this must quickly change their attitude or regret later.
The situation is especially critical for the European Union. I speak as a staunch Europeanist: either the European Union stands together and implements the necessary measures that permit member-countries to avoid a major economic catastrophe without endangering their fiscal sustainability and credibility with markets or the European Union will cease to exist. After a weak and divided response to the 2008 Financial Crisis and the subsequent Sovereign Debt Crisis, and to the Refugee crisis, followed by a gruelling Brexit, the European Union is losing opportunities to show union and solidarity. An economic depression together with divisiveness between countries wouldbe a deadly blow to the European project.
The European Central Bank is the most effective European institution at counteracting shocks to the European economy. After saving the Euro in 2012, with Mario Draghi’s famous speech in which he said that he “the ECB is ready to do whatever it takes to preserve the euro”, the ECB under Christine Lagarde is facing a tough challenge since it has a limited number of policy tools at its disposable. However, this time the ECB’s actions might not be enough.
After a false start and statements that were criticized in countries like Italy, Lagarde announced on March 18th a €750 billion Pandemic Emergency Purchase Programme (PEPP) with the objective of securing financing to the economy during the Coronavirus crisis. It has now recently been announced that the ECB will put on the side its bond-buying limits that, among other measures, limited the amount of government bonds of a single member-state that the ECB could have in its balance to a third of the country’s total government bonds. This action of the ECB clearly shows its commitment to the survival of the Euro area and to a reduction of the government bond spreads of the most indebted and fragile countries of the Euro Area, like Italy. However, the ECB is limited in its actions by its Statute. Monetisation of government expenditures by the ECB in the context of the Coronavirus crisis, something that other countries can do with their central banks, is hardly possible given the ECB’s current legal framework.
Governments are also doing their part.
In the US, the Senate has passed a historic $2 trillion (around 10% of US GDP) coronavirus aid bill that is the largest economic stimulus in US history. This includes direct payments of $1200 per adult and $500 per child for everyone that earned less than $75.000 last year. Despite being a positive development, a lot of the aid goes to large companies and just $350 billion go to SME’s, many of them severely hit by the crisis. A Coronavirus bailout should not be a bailout to the corporate “establishment”, but a bailout that guarantees people’s jobs and incomes.
Many European governments have already extended tax payment deadlines for firms and families, increased unemployment payments and announced credit lines for firms that need liquidity with the government as guarantee. The announced fiscal aid packages with the objective of helping firms and households amount in some cases to more than 10% of their country’s GDP.
This fiscal injection is necessary. In his article in the Financial Times in March 25th Mario Draghi stated that “It is the proper role of the state to deploy its balance sheet to protect citizens and the economy against shocks that the private sector is not responsible for and cannot absorb.” and that “Much higher public debt levels will become a permanent feature of our economies and will be accompanied by private debt cancellation”.
However, this raises questions regarding the sustainability of the public finances of many countries, especially Southern European countries, that already have high levels of debt and that will certainly see those debt to GDP ratios skyrocket given the expected increase in deficits and contraction of GDP. A further increase in debt levels will likely decrease the market’s confidence in the ability of those countries to pay their debts and so, lead to higher bond yields and to a self-fulfilling default, if no measures to avoid the increase in bond yields are undertaken and no risk-sharing mechanisms at the Euro-area level are implemented.
Therefore, a European response to this challenge is key to guarantee the stability of the Economic and Monetary Union (EMU). Fiscal rules under the Stability and Growth Pact (SGP) have been relaxed and the European Commission has announced €37 billion of investment under cohesion policy in its Coronavirus Response Investment Initiative. It has also been discussed that member-countries might resort to funds from the European Stability Mechanism (ESM) of up to 2% of that country’s GDP. These measures are positive, but clearly insufficient given the Euro Area’s €14 trillion GDP.
In addition, heated discussions around the issuance of common debt at a European-level, known as Eurobonds, or in this case, Coronabonds, have been going on in the European Council. Many countries, including Spain, France and Italy have backed up the issuance of such bonds, but they have faced fear opposition, especially from the Netherlands. In a European Union where decisions are made by unanimity, important actions tend to be delayed or not taken at all.
Economists have come up with a diverse range of measures to tackle the economic challenges in the Euro area. Some of those are a Covid Credit Line (CCL) of the ESM, Perpetual Eurobonds jointly guaranteed and supported by the ECB, the creation of a Euro area fiscal capacity, and “helicopter money”, direct, unrepayable funding by the central bank of the additional fiscal transfers deemed necessary.
The lack of solidarity and understanding of the outstanding social and economic situation that we are living is illustrated by the statement made by the Dutch minister of Finance, Wopke Hoekstra, who argued that the European Commission should investigate countries like Spain for not having accumulated a financial cushion in recent years that would allow it to face the crisis caused by the coronavirus. These statements were received with outrage in Southern European countries, especially by the Portuguese PM, António Costa, who described the statements as “repugnant” and a “recurrent pettiness that completely undermines what the spirit of the European Union”. He added that “Either the EU does what it needs to be done or it will end”.
In conclusion, these are challenging times and in order to move forward we need solidarity and unorthodox policies. This is the time for policymakers to stand up, to ensure that the economy does not collapse and that countries are not doomed to face a cycle of austerity, like in the years after the 2008 crisis. For that, they need to directly channel funds to SME’s and to households, and, in the EMU, to implement bold measures, such as Eurobonds, helicopter money and even private and public debt cancellation.