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Europe must go big in its macroeconomic response to COVID-19



With more citizens infected than in China, the European Union (EU) is now the world’s COVID-19 epicenter. At the same time, by restricting movement more forcefully, Europe is proving that democracies, too, can take many of the measures China had taken. Targeted and free testing widely available across the EU is part of the reason why Europe has a high number of new confirmed COVID-19 cases. European welfare states also generally provide paid sick leave, and European children do not need to rely on their shuttered schools for their main daily meal.

At the same time, Europe, and noticeably the euro area, is finding it politically challenging to implement timely and comprehensive macroeconomic stabilization measures in a crisis, mainly because of its incomplete institutional framework with no centralized fiscal authority. Will the COVID-19 crisis be any different?

The US Federal Reserve has now rolled out an aggressive macroeconomic stimulus package, but euro area crisis response got off to an unfortunate start, with the new European Central Bank (ECB) president Christine Lagarde undercutting predecessor Mario Draghi’s famous “whatever it takes” dictum referencing the ECB’s willingness to defend the euro area’s stability. Instead Lagarde declared on March 12: “We are not here to close spreads, there are other tools and other actors to deal with these issues.”

Her comment unleashed the worst ever one-day fall in Italian bond prices, as investors suddenly doubted the credibility of the ECB’s commitment to Italy, already struggling under an accelerating COVID-19 crisis. Lagarde walked back her statement in a TV interview, which was followed by the ECB chief economist, Philip Lane, offering a similar clarification in writing, and Lagarde has apologized for her gaffe to the rest of the ECB leadership. The new message is that the ECB would stand behind all euro area government bonds after all.

Yet, the ECB’s credibility as a lender of last resort among market participants considerably hinges on their belief that the ECB president would in fact do “whatever it takes,” so Lagarde’s communication misstep is likely to leave a lasting negative impression and ultimately make it more difficult for the ECB to conduct a stabilizing monetary policy in the euro area.

This is a pity, as the ECB’s anti-COVID-19 crisis package actually consists of the right liquidity tools for the euro area banking system, including a bank-subsidy scheme enabling financial institutions to borrow from the central bank at below the ECB’s deposit rate. Such loans will impose limited financial losses on the ECB, while shoring up euro area banks’ capital position. Functionally such below-the-ECB-deposit-rate loans bestow the full benefits of a rate cut to euro area banks.

On the fiscal side, euro area countries have gotten off to a far better start. Germany has rolled out potentially unlimited fiscal support for German firms and workers. Finance Minister Olaf Scholz made it explicit that Italy and other high-debt euro area members should be able to take the necessary fiscal measures with European support.

Indeed, following Lagarde’s implicit retreat from the ECB’s traditional role as the euro area’s leading crisis fighter, it is worth contemplating if euro area governments should now closely coordinate on fiscal and monetary policies during the COVID-19 crisis. The ECB president’s initial misstatement may lead member state finance and budget officials to curtail the central bank’s independence by taking fiscal policy into their own hands in a manner that might forcefully guide the ECB’s hand as well. Such actions by euro area governments would be necessary, if the ECB proves unable to reverse the full increase in Italian bond spreads witnessed following Lagarde’s communication blunder. To date, Italian bond yields have not returned to their precrisis level, and obviously Lagarde’s actions have been a potent political gift to Italy’s anti-European populists led by Matteo Salvini’s League Party.

Euro area finance ministers’ common response to date has been remarkably timid and really only amounts to giving themselves the ability to take whatever national crisis measures they wish, without worrying about European fiscal rules. This situation, though, is likely to rapidly change, as the economic impact of the crisis in Europe deepens. For example, euro area members could soon compel the ECB to take more forceful action on fiscal stimulus by citing that the principle of “fiscal solidarity” in a crisis is also applicable to the ECB’s balance sheet.

Such a “fiscal action” could lead the ECB to launch a targeted, temporary, and unconditional secondary market sovereign bond purchase program—call it the COVID-19 Purchase Program (CPP). Such a program should cover all euro area member states affected by the virus until euro area finance ministers declare the emergency over. The program would be unlimited and aim to restore the bond yields/spreads of any euro area member back to precrisis levels. ECB resources would be directed to Italy and other member states most affected, leaving German bonds untouched as the euro area’s safe haven asset.[1] The ECB would probably not have to buy massive amounts of securities to get spreads back down. The tool should not impose conditionality to avoid resentment in the countries being helped.

The ECB already has two main asset purchase programs—the Public Sector Purchase Programme (PSPP), the ECB’s main quantitative easing program, which aims to reach its inflation target, and the Outright Monetary Transactions (OMT) program, the ECB’s conditional program enabling it to rescue a member state in a traditional fiscal crisis. These tools should remain focused on their original policy goals to avoid raising legal or operational risk by becoming involved in the COVID-19 stabilization efforts.

The virus emergency is a classic case of an “external threat” menacing a member state through little fault of its own. Accordingly, the traditional “moral hazard” concerns over assistance encouraging bad behavior do not apply. Moreover, euro area politics now is right, as Greece is doing “Europe’s policing” on its border with Turkey and Italy has rolled out a herculean effort to combat COVID-19, in all probability positively aligned[2] with the kind of temporary targeted measures a CPP would create. A CPP would also go a long way in signaling solidarity with Italy and thus begin to undo the political damage Lagarde’s comments and the disappointing initial EU cooperation on medical supplies have likely done to Italian voters.

The COVID-19 emergency calls for bold and timely measures to make Europe and the euro more stable. A CPP could do both.


1. ECB actions would directly aim to bring the level of interest rates back down in any member state facing rising yields during the current crisis. They would not seek to directly counter any market-driven reduction in the yields of some other member states by, for instance, selling German bonds.

2. I am indebted to my colleague Nicolas Véron for pointing out these euro area political factors.

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