In designing the EU responses to the coronavirus crisis, the European Commission and European policymakers should be guided by the subsidiarity principle. Action should be taken at the EU level “if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States … but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level”.
So far, very little bang for the buck
This criterion implies that a significant fraction of the €540 billion already committed by the EU is only of limited use.
- The €240 billion of the new ESM credit line is restricted to a maturity of at most 10 years, and ESM loans are senior. But even the weaker member states can already issue debt at this maturity, and this is unlikely to change while the ECB’s Pandemic Emergency Purchase Programme (PEPP) continues. A senior loan with a below-market interest rate would raise the cost of issuing subordinated national debt expiring around the same dates. By the Modigliani-Miller theorem, the average cost of total national liabilities would not be much affected (see also Corsetti and Erce 2020). If another potential benefit of ESM lending is to open the door to Outright Monetary Transactions (OMT) by the ECB, this could be achieved without committing all these resources.
- Another €100 billion are made available through the SURE mechanism (out of an additional guarantee of €25 billion by member states) as loans to support unemployment benefits. The maturity of these loans is still unknown, but it is also unlikely to exceed 10 years. Here, disbursement will be based on needs, and hence there will be some risk sharing. But it will be very limited, since the shock is symmetric and all EU countries will be hit by a severe recession in 2020, ranging from minus 6.5% to minus 9.7% according to the Spring 2020 Economic Forecast of the EU Commission (see also Boone et al. 2020)
What about the Recovery Fund?
In light of this, it is important that the new Recovery Fund be designed so as to achieve something that member states cannot already do on their own. Besides its size and the criteria for disbursements, which will be the outcome of political negotiations, two other aspects will be key:
- The maturity of the resulting obligations for member states. Enabling member states to borrow at very long maturity (longer than they can currently do on their own) could be useful, despite the seniority, because it reduces the risk of a funding crisis when debt is rolled over. As argued by Giavazzi and Tabellini (2020), from an economic point of view the ideal debt instrument in the current circumstances would be a perpetuity. Additional lending to member states at the same maturity at which they can already borrow would be of very limited value.
- Whether the Recovery Fund will be a first (albeit small) step towards remedying the fragilities of the euro area. The single currency is not backed by a fiscal capacity, and its legal foundations prevent explicit monetary and fiscal policy coordination in times of crisis. Moreover, the lack of a common safe asset makes the banking and capital market unions incomplete. The Recovery Fund provides the opportunity to start remedying these fragilities.
Since the EU does not have an independent fiscal capacity, the Commission is working on the idea that the Recovery Fund issues debt backed by resources committed by Member States for the 2021-27 EU budget, in excess of planned expenditures for the same period. This raises the problem of the mismatch between the timing of the committed resources, the next seven years, and the need to issue long-term debt. If the Recovery Fund will not be able to directly borrow at very long maturities, the EU would have to choose between two unpleasant alternatives: either (i) engage in maturity transformation, lending to member states at a longer maturity than it borrows in the markets, thus subjecting itself to a potential interest rate risk; or else (ii) lend at the same maturity of its own liabilities, with little or no benefit to member states.
A step towards completing EMU
The problem of how to enable the Recovery Fund to borrow at long maturities could be reduced if the funding of the EU budget was based on genuinely own EU tax revenue, as proposed by the Spinelli Group (2020). A similar proposal has been made by Garicano (2020). Currently, the EU’s own resources largely consist of transfers from member states. Replacing these transfers with revenue from own EU tax bases would reduce the uncertainty surrounding the seven-year cycle of bargaining on the EU budget. If the revenue from the EU own tax bases were committed by member states for more than seven years, and earmarked for servicing the EU debt, the Recovery Fund could easily borrow at very long maturities. Reasonable proposals on which tax bases to devolve at the EU level abound (e.g. High Level Group on Own Resources, 2016). In normal circumstances, these EU taxes would be used to finance the EU budget; but in exceptional cases, such as the present crisis, they could be used to back the issue of long-term EU debt. Over time, the EU could be allowed to set the tax rates on the devolved tax bases. Of course, this last step would require further and much bigger steps towards political integration, including giving the European Parliament a stronger voice over the EU budget.
Financing the EU budget with genuinely own tax revenue would have other advantages. For example, it would weaken the current incentives for national governments to claim ‘their money’ back. The reason is that EU taxes would redistribute within member states, possibly much more than between states, allowing cross-border political coalitions to form. This could facilitate the funding of truly European public goods, which are currently underprovided, and possibly reduce EU expenditures that primarily redistribute between members states.
A step in this direction would also be a step towards remedying the incompleteness of the euro area. It is well understood that a key fragility of the common monetary policy is that it lacks a solid common fiscal capacity. The recent decision by the German Constitutional Court, although questionable under many respects (e.g. Poiares Maduro 2020), makes it clear that member states cannot keep delegating all macroeconomic policy management to the ECB. The euro area is not equipped to face large crises. Experience also shows that one cannot rely on coordination of national fiscal policies to provide the necessary stimulus. Free-riding, lack of fiscal space by some member states, and other national political distortions typically lead to late and sub-optimal national responses (Blanchard et al. 2020). Building a fiscal capacity at the EU level could be done relatively quickly, and it would provide a way to address these difficulties for the future. Issuing a truly European debt, backed by genuine own EU tax resources, would also create a common safe asset, and it would allow a more effective and transparent coordination between monetary and fiscal policy in times of crisis.
A possible problem with using the EU budget to provide a fiscal basis for the euro area is that not all member states have adopted the common currency. Brexit has reduced the economic relevance of this issue, and all member states (except Denmark) have taken legal obligations to eventually adopt the euro. But solutions could be found to limit this source of funding (and possibly related expenditures) to only euro area countries.
A possible obstacle to exploiting the creation of the Recovery Fund to endow the EU with genuinely own resources is that this could take too much time, and the Fund should be available immediately. This is not a good reason to postpone indefinitely the search for better methods of financing the EU budget, however. Initially, the additional own resources needed to issue EU debt could take the form of government transfers, but member states could commit to immediately starting the preparatory work to replace such transfers with an adequate EU own tax.
Blanchard, O, A Leandro and J Zettelmeyer (2020) “Revisiting the EU fiscal framework in an era of low interest rates”, paper presented at the EFB – CEPR- ACES workshop “Rethinking the European Fiscal Framework”.
Boone, L, D Haugh, N Pain and V Salins (2020), “Tackling the fallout from COVID-19”, in R Baldwin and B Weder di Mauro (eds), Economics in the Time of COVID-19, a VoxEU.org eBook, CEPR Press.
Corsetti, C and A Erce (2020), “Maturity, Seniority and Size: Make Sure the ESM’s Pandemic Crisis Support is Fit for the Purpose”, VoxEU.org, 29 April.
Garicano, L (2020), “Towards a European Reconstruction Fund”, VoxeEU.org, 5 May.
Giavazzi, F and G Tabellini (2020), “Covid Perpetual Eurobonds: Jointly Guaranteed and Supported by the ECB”, VoxeEU.org, 24 March.
High Level Group on Own Resources (2016), “Future Financing of the EU”.
Poiares Maduro, M (2020), “Some Preliminary Remarks on the PSPP Decision of the German Constitutional Court”, Verfassungsblog on Matters Constitutional.
Spinelli Group (2020), “A Federal Europe: the way out of the Crises”.