Europe’s collective and forceful intervention to rescue Italy and other euro area countries at economic risk from the coronavirus (COVID-19) plague has been unprecedented in more ways than one. The €750 billion ($810 billion) to address the pandemic was itself unparalleled, comparable to current estimates of the US rescue. But with its de facto open-ended Pandemic Emergency Purchase Program (PEPP), the European Central Bank (ECB) has brought the continent closer to political and financial unity than was previously imaginable, rescuing a dream that has receded in the last few years.
To understand why, look no further than America’s own “Hamiltonian moment” in 1790.
In the historic constitutional compromise forged by the first US Treasury secretary Alexander Hamilton, James Madison, and Thomas Jefferson in that year, the parties agreed to placing the nation’s capital between Maryland and Jefferson’s home state Virginia. More important, of course, the US federal government assumed all the debt incurred by the US states during the War of Independence, laying the foundation for a strong central federal government in the United States.
In the face of predictions of an 18-month battle against COVID-19, it is difficult to overestimate the potential fiscal costs the euro area could incur from fighting the virus, as some economic forecasts project a 15 percent decline in euro area GDP in the first half of 2020.
Led by French president Emmanuel Macron, Europe has adopted an increasingly martial rhetoric in describing the forthcoming struggle. “We are at war!” said Macron in a televised speech. His choice of language resonates with American history.
What enabled the 1790 compromise, of course, was the imperative to redeem all US states’ debt incurred while fighting a common enemy, forcing a new country to establish a common destiny.
The analogy to the birth of a federal United States is all the more striking because the so-called European project has come close to unraveling in the last decade, under pressure from inherent economic imbalances (a strong North versus struggling economies on the periphery), immigration from the Middle East and Africa, the euro debt crisis, and of course Brexit.
In 1790 the United States was a new country and there was no “legacy debt” from individual US states’ decades of overspending or other issues giving rise to concerns over moral hazard. Quite unlike the political situation facing Europe and the euro area in 2010, when first Greece required rescuing after being hit by a severe fiscal and financial crisis largely of its own making, the situation today from COVID-19 in the euro area is fundamentally different and similar to the United States in 1790.
The war against COVID-19 is a textbook “exogenous shock,” as economists would call it. There are no “legacy issues” associated with the rising fiscal cost of fighting COVID-19 in Italy or other euro area countries. There is no “moral hazard” associated with helping Italy run up huge deficits to avoid a huge death toll and rescue a collapsing economy, because no one “blames” Italy for this crisis the way Greece was blamed for its crisis.
ECB president Christine Lagarde made the universal and shared nature of this crisis clear in her COVID-19 explanatory blog: “The coronavirus pandemic is a collective public health emergency unprecedented in recent history…. Unlike in 2008-9, the shock we are facing is universal: it is common both across countries and across all sections of society. Everyone has to scale back their daily activities, and therefore their spending, for as long as the containment measures last. …Public policies must help them.” This fight against a common enemy has become a shared European experience like nothing else in the last 75 years. Europe set up a range of crisis-fighting tools for the Greek crisis, but they were through the European Stability Mechanism (ESM) contingent on exacting fiscal discipline and structural reform in return for aid.
The PEPP, on the other hand, is unconditional and covers all member states. That is crucial, as the euro area now avoids alienating an already struggling Italian (and other member state) public(s) heroically trying to contain COVID-19. No Italian politician could have contemplated beginning negotiations with the rest of the euro area on the traditional conditions for financial support in the current situation. The ECB’s actions may well have avoided a political path for the euro area ultimately ending in Italian exit from the euro.
Unlike the United States, Europe has no mechanisms for budgetary transfers from prosperous parts of Europe to those less prosperous. There is no single European spending plan comparable to the US federal system. But one must think of the current situation this way: The ECB will be holding on to whatever sovereign bonds it purchases for COVID-19 response (and other purposes) for a very long time. Given the lack of a centralized euro area fiscal capacity and common eurobond, large and long-lasting holdings of euro member states’ debt on the ECB balance sheet take on an important political meaning, beyond the ECB’s crucial financial and economic support function.
In coming weeks, European policymakers could unleash explicitly fiscal assistance from the ESM to fight COVID-19 (see proposals here and here), which would be commendable. But, following the ECB’s bold actions and the European Commission’s suspension of all fiscal rules in the Stability and Growth Pact (SGP), enabling all member states to spend whatever they must to fight the virus, future ESM action is not quite “needed” but would be “nice to have” for the euro area. The ECB has again stepped forward, and this time (unlike in 2010–15) it will be greatly aided by an implicit fiscal partnership with member states. New spending and debt issuance in member states (especially Germany) will work in tandem with ECB actions to stabilize the euro area economy and help prevent the ECB from having to revise its bond purchase rules in the near term.
ECB purchases and bond holdings become the expression of a euro area fiscal solidarity, a shared fight against a common enemy, that the ECB and European political leaders could not otherwise have contemplated out of fear of overstepping national sovereignty of member states. But because Europeans are facing the gravest crisis in anyone’s experience, they will find ways of pledging their lives, fortunes, and sacred honor to save Europe from disaster.
In the time of COVID-19, the euro has in the ECB found its modern-day equivalent of Alexander Hamilton.
1. The €750 billion comes on top of €120 billion announced a week earlier and the ECB’s existing quantitative easing program equaling well over €100 billion/month in asset purchases for the rest of 2020 and beyond that should the public health situation dictate it.
2. As laid out by Frederik Ducrozet, Germany’s new planned borrowing implies that the ECB will not reach its 33 percent issuer ownership limit of German sovereign debt until well after the COVID-19 emergency is over.