There has been a lot of discussion in recent weeks on whether or not an EU-wide fiscal policy response should include common liability for the additional debt that such a response would imply. Some observers see a replay of similar discussions from a few years ago on Eurobonds, even though the circumstances are very different. Others observe that it would not be the first time such community bonds were issued after a major economic disruption (Horn et al. 2020). In the following, I will lay out the arguments in favour of such an approach – arguments that go beyond economic ones.
Principle of subsidiarity
The principle of subsidiarity, as defined in Article 5 of the Treaty on European Union, is a basic tenet of European decision-making. It aims to ensure that decisions are taken as closely as possible to the citizen and actions on EU level have to be justified in light of the possibilities available at national, regional or local level. Responsibilities for specific policy areas should only be transferred to the EU level if objectives can be better reached at Union level.
One can easily apply this principle to policy actions in the context of coronavirus. Neighbourhood-based WhatsApp groups have mushroomed across London (and I am sure they have so in other cities around the world) to offer help to vulnerable residents. Given differences in the organisational structure of health systems across EU countries, the primary public health response has happened on regional or national levels. Other actions, however, clearly benefit from being undertaken at the EU level. This is the case, for example, for procurement of ventilators and other medical equipment, which is cheaper for the EU than for individual countries given a larger market share on the demand-side if countries act together. Incentives to find reliable tests and a vaccine can benefit from more generous funding on the supra-national level. These public health actions benefit from being taken on the European rather than national level, given scale benefits, strong externalities and the character of a vaccine as public good.
This argument for policy action on the European (or even global) level also applies to the economic policy reaction to the COVID recession. The socioeconomic lockdown made necessary by the COVID-19 virus will damage economies. A quick recovery and limitation of further damage will require fiscal policy actions. While many such actions have been taken already to help firms and households during the lockdown phase, more might be needed in the recovery phase. Given the close interconnectedness of European economies (in the form of supply chains, good and service market integration and labour mobility) it is in every country’s interest that such recovery happens quickly and across all countries in Europe. There are thus strong externalities of national fiscal policy actions, which – without coordination - can result in too little fiscal policy. As important, however, is that some countries have less fiscal space available than others. This is clearly reflected in the fiscal policy measures to-date, which have been much more expansive in Germany than, for example, in Italy or Spain. So, what role can European institutions play in these circumstances?
Why not the ECB?
As has become tradition over the past 12 years, the ECB was the first European institution to step up to its responsibility. The pandemic emergency purchase programme (PEPP) and its flexibility is an aggressive monetary policy step, more effective than pushing interest rates further into negative territory. The PEPP as well as the “no limits” policy announcement (the equivalent to Draghi’s “whatever it takes”) has helped reduce panic on financial markets, including on the sovereign bond markets. There is the suggestion that the use of the OMT programme (announced after Draghi’s “whatever it takes” speech in summer 2012 but never actually used so far) can help reduce pressure on euro area governments that have reached the limit of its fiscal space.
While the ECB is clearly the first line of policy defence in this recession when it comes to financial markets, there are several reasons why it should not bear the main burden of the necessary public support programmes for the recovery. First, the COVID and the consequent government expenditures are clearly fiscal policy tasks; the losses incurred during this crisis will have to be funded and distributed. There are different (non-exclusive) ways of doing so – one is through higher taxes on, for example, income or wealth; another is through higher government debt over the next decades, thus spreading the costs to future generations. In either case, the most transparent way is to do so openly and sanctioned by democratically elected parliaments and governments.
The alternative of using ECB monetary policy tools to keep interest rates and spreads (and thus the cost of such debt) low would also imply that a normalisation of interest rates and reduction of quantitative easing would be even further away. I would not expect any tightening of monetary policy any time soon during the next few years but having the additional task of avoiding runs in the sovereign bond markets would push such a return even more into the future.
A further consideration when burdening the ECB with what is effectively a role for fiscal policies is that it would undermine the standing of the ECB as independent monetary policy institution even further. The ECB has been criticised for keeping interest rates at zero or in negative territory for too long, as often as this argument has been proven wrong; it has also been accused of overstepping its mandate and entering effectively fiscal policy. Forcing the recovery of COVID losses through long-term financial repression is certainly counter to its mandate. While this is what was partly done in many European countries post-WWII (Reinhart and Kirkegaard 2012), central banks were not independent during these times but rather seen as part of democratically elected governments.
Why not the ESM?
The ESM has been established for situations where individual governments are hit by shocks and cannot finance themselves any longer on the market. Similar to the IMF on global level, such a programme comes with conditionality.
There have been suggestions that the easiest way (partly because of existing structures) is for countries at risk of not having sufficient access to market funding to tap ESM funding (e.g Erce et al. 2020). There are several problems with this. First, ESM loans would still be part of national debt and would thus not solve the problem of sovereign debt sustainability. While the idea of using the ESM together with OMT might get around this constraint, this would effectively mix fiscal and monetary policy, as discussed above.
Second, the ESM was not founded for a crisis like this one but rather to provide liquidity support for individual countries that got into temporary problems. But COVID-19 is not an asymmetric shock hitting one or some countries, but a shock that has hit all economies, though at different points in time. Finally, the tapping of the ESM comes with a stigma, not only in terms of market signals, but also politically, unless all countries commit to tapping the ESM at the same time.
The economic case for COVID debt mutualisation
This leaves the idea of Coronabonds, as suggested for example by Bofinger et al. (2020) or Giavazzi and Tabellini (2020. But why should countries with higher fiscal policy space take on liability for the benefit of countries with lower fiscal policy space? There are several answers to this question. One answer is that of economic self-interest. The countries currently most affected by the virus in human and economic terms are among the countries with the lowest fiscal space even though they are most in need of a fiscal stimulus. On the one hand, a lower fiscal stimulus from these countries dampens the recovery throughout the euro area and the Single Market. On the other hand, a strong fiscal stimulus that turns sovereign debt of these countries unsustainable can result in a vicious cycle of lower growth perspectives endangering access to sovereign debt markets, which in turn lowers growth perspectives further. Such a vicious circle will not only result in more divergence within the currency union, but negatively affect all euro area countries, not even to mention the risk of a possible exit of countries with unsustainable government debt from the euro area.
The experience of the past decade should be a clear warning signal. The Global Financial Crisis and the Great Recession increased sovereign debt burdens throughout the euro area and ultimately resulted in the Eurodebt crisis, deepening social and economic misery and contributing to the rise of populism. There is a clear economic case to avoid that the COVID-recession is followed by a second Eurodebt crisis! Arguing that even a hint of debt mutualisation would result in a further rise of populist parties in Germany, Netherlands and Finland ignores that such a rise would follow from another Eurodebt crisis anyway and underestimates the pan-European spirit of solidarity that can be awoken through right political leadership.
The political case – looking at history
The last global pandemic – the Spanish influenza in 1918-20 – came at the end of WWI. European countries already devastated by the war faced an additional human and economic burden. The next two decades brought nationalistic resentment, authoritarianism and fascism – culminating in WWII and the Holocaust. While I would not for a moment argue that the Spanish influenza had a decisive role in this turn of history, I cannot avoid seeing some parallels in the current circumstances.
The European Union, founded after WWII, has contributed to 75 years of peace in our continent. The current pandemic brings the chance to a common European approach, building on decade-long cooperation and institutional infrastructure, thus ‘updating’ the role of the European Union as peace project. The failure to do so, on the other hand, will undermine the case for Europe even further and will give further impetus to populist if not authoritarian parties. We should have learned over the past ten years (Brexit and a close shave with Grexit) that progress in European integration is not irreversible and not having a common approach to this crisis can have serious political repercussions. The recent open letter by Italian politicians of the centre-left, reminding Germany of the debt rescheduling in 1953 and accusing the Dutch of robbing other European countries of tax revenues (Calenda et al., 2020) gives us a small flavour of what could be the beginning of a slow reversal of decades of European integration.
Finally, the moral case
Finally, there is a moral case: Germany is receiving COVID patients from other countries at the time of writing; a clear sign of European solidarity. But the crisis will not be over once the first COVID wave has receded – rather the public health challenge will be replaced by an economic challenge – why should European solidarity be less important or justifiable for economic recovery than for public health challenges? As many developing countries will struggle with public health and debt challenges in the years to come, global solidarity is the only feasible way forward – starting in Europe is important.
There are arguments that now is not the time to build the necessary institutional framework for Coronabonds or comparable funding structure and that the use of existing structures, including the ESM and the ECB, is preferable. I have argued that this would be the wrong path. While it might help hold off pressure, financial markets anticipate future problems. As important, however, is it to send a political signal of European solidarity now. This is especially important for the younger generation, whose early adult experience will be dominated by the COVID fallout. We do not need another Lost Generation or Depression Babies (Malmendier and Nagel,2011)!
What is needed now therefore is a signal on the highest political level – a signal of fiscal policy solidarity, driven as much by economic self-interest as by historic lessons and the moral case for pan-European solidarity.
Bofinger, P, S Dullien, G Felbermayr, M Huether, M Schularik, J Suedekum and C Trebesch (2020), “Europa muss jetz finanziell zusammenstehen”, Frankfurter Allgemeine Zeitung, 21 March
Calanda, C et al. (2020), “Brief an unsere deutschen Freunde,” 31 March
Erce, A, A G Pascual and R Marimon (2020), “The ESM can finance the COVID fight now”, VoxEU.org, 6 April
Giavazzi, F and G Tabellini (2020), “Covid Perpetual Eurobonds: Jointly guaranteed and supported by the ECB”, VoxEU.org, 24 March.
Horn, S, J Meyer and C Trebesch (2020), “European Community Bonds since the Oil Crisis: Lessons for today?”, Kiel Policy Briefs 136.
Malmendier, U and S Nagel (2011), “Depression Babies: Do Macroeconomic Experiences Affect Risk Taking?”, Quarterly Journal of Economics 126: 373-416.
Reinhart, C and J Kirkegaard (2012), “Financial Repression: Then and Now”, VoxEU.org, 16 March