It is decision time for EU leaders—what should fiscal response to pandemic be?

European leaders have been unable to agree to a joint fiscal policy response to the economic crisis created by the COVID-19 virus, a striking failure in light of the European Central Bank's (ECB) forceful actions. Decision time is approaching for the Eurogroup and EU Council, the representative groups that are the EU's top decision-making bodies. EU governments have put several concrete proposals on the table (see below), as well as have outside economists.¹

EU leaders need to agree because the political future of the "European Project" as a relevant body able to protect Europeans is at stake. If they fail, European populists will target their impotence in Europeans' hour of need. Italy's populist leader Matteo Salvini has already made it clear this will be his strategy.

If EU leaders merely agree to tweak existing European institutions, such as the European Stability Mechanism (ESM) or the European Investment Bank (EIB), they will have squandered an opportunity to innovate, as EU founder Jean Monnet envisioned, during a time of crisis. This could put the EU's long-term future at risk.

A single "big €-number" is also politically necessary to convey a message of EU solidarity to enough Europeans, and EU leaders must not be tempted to settle for a complex patchwork of different European institutions and pet projects.

The ECB's Pandemic Emergency Purchase Program (PEPP) of massive debt purchases and other measures have insulated eurozone member states from the immediate economic costs of fighting the pandemic. But Europe's leaders need to design something to hand over to the ECB before the PEPP expires at the end of 2020. Europe's current pandemic wave is likely to peak in the coming weeks. Some countries have begun to discuss how to reopen their economies after Easter, which falls on April 12. It is not too early to shift the debate from funding crisis-related healthcare costs to forging the economic and financial tools to grow Europe's economies again.

One topic of discussion in Europe is the creation of a common debt instrument, or eurobonds. But there is a risk that the focus will be on the design of the bond rather than the problem that must be funded. Proponents of such bonds cannot fall back on simple slogans like "It's the virus, stupid!" Instead, these advocates should focus on the tasks or problems that a joint debt issuance would address, making the geographic distribution (or net contribution) a matter of secondary importance. Hence European leaders must specify growth enhancing solutions that they want to achieve with a joint debt instrument to boost Europe's economic recovery.

Any financial instrument would have to be worth several percentage points of regional GDP, and the instrument should function over several years. The GDP of the EU's 27 members was €14 trillion in 2019, suggesting that a €1 trillion joint initiative worth 2.5 percent of GDP annually for three years would meet Europe's political and economic requirements. Financial leverage would almost certainly have to be used to reach €1 trillion in the same way that the European Commission's recent so-called "Juncker Plan" leveraged public money for European investments.

Joint public investments in the EU or the eurozone to boost the economic recovery and signal fiscal solidarity is not necessarily the best option to jump-start a recovery. Investments offer less flexibility for member states to spend the money and may therefore not achieve the highest fiscal multiplier (i.e. increase in total economic activity).

Yet the degree to which the use of common resources is restricted to predetermined purposes, such as joint European investment projects, and the willingness of individual member state parliaments to agree to pay for them is clearly politically linked. The right balance between the size of a joint instrument and the discretion recipient countries have to deploy it must be found. A joint European recovery instrument that is focused on funding public investments across Europe strikes that balance, as it will politically enable national parliaments to accept a larger common instrument and help create the additional economic growth necessary to eventually repay the debts incurred.

The term "public investment" should thus be defined broadly to allow member states to rapidly deploy resources, and any recovery investment plan should include the EU's existing priorities in the Green New Deal decarbonization and digital 5G infrastructure projects. In light of the labor market downturn from the pandemic, active labor market policies (ALMPs) and other types of education investments aimed at retraining and upskilling Europe's workforce should also be included.

France's proposal for an earmarked coronavirus rescue fund appears to be one of the best approaches to addressing the EU's political and economic requirements for an adequate joint fiscal response to the pandemic. Such a fund could be established inside one of Europe's existing institutions, such as the Commission, the ESM, or EIB, which would be responsible for issuing earmarked European COVID-19 investment recovery bonds (ECIRBs) to expedite the disbursement of funds. The proposed fund could rely on leverage to achieve the sufficient scale of €1 trillion, while providing member states' parliaments an adequate say in what projects are selected. The fund would be time limited and issue specific and not present a move towards more general debt mutualization in the EU or eurozone. It would be the kind of institutional innovation the European Project needs to remain relevant in combating the economic consequences of COVID-19.

Note

1. See these articles for details: After its COVID-19 emergency, Europe should issue joint recovery bonds, Sharing the fiscal burden of the crisis: A Pandemic Solidarity Instrument for the EU, and COVID-19 economic crisis: Europe needs more than one instrument.