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Debt monetisation for the emergency, EU bonds for the recovery

Alberto Botta
Senior Lecturer in Economics
Eugenio Caverzasi
Post-Doctoral Researcher
Alberto Russo
Investigador Distinguido senior

The three authors unveil a strategy to fight the COVID-19 emergency and to relaunch the European economy

The global spread of the Covid-19 crisis is now in the headlines worldwide, and it is at the centre of discussions among politicians, policymakers, scientists and common people alike. The spread of the virus has opened a time for major changes in governments’ and central banks’ policies. There is large consensus among economists that the governments of developed countries in Europe and the US – which are currently the epicentres of the pandemic – will have to take extraordinary actions in order to deal with the disruptive economic consequences of this crisis.

In the freshly published FEPS COVID Response Paper, we explain that the current economic crisis consists of a complex mix of supply and demand shocks. On the supply side, the restrictive measures taken by governments in order to implement social distancing and contain the spread of the virus have brought to a stop many activities. Restrictions to people’s mobility and to the functioning of companies have simultaneously induced a tremendous drop on the demand side.

“The contraction in demand is so acute that it is a possible explanation why inflation spikes due to supply constraints do not represent a serious threat at the moment.”

On one side, the steep rise in unemployment, the temporary suspension from work, and the imposed inactivity of self-employed and freelance workers will cause households to cut consumption. On the other side, there is no reason for companies to invest in a context of depressed demand, forced closure and radical uncertainty. Even the more so as many companies risk bankruptcy once they are completely deprived of their expected cash flows. The contraction in demand is so acute that it is a possible explanation why inflation spikes due to supply constraints do not represent a serious threat at the moment, while even more worrisome deflationary trends seem rather likely.

In order to tackle this crisis, we suggest Eurozone governments and European institutions to adopt a two-stage strategy. We first advise a strong emergency action by Eurozone governments covering fixed costs of companies – such as rents and maintenance that enterprises have to cover anyway despite being temporarily inactive – in particular for small and medium enterprises, this way guaranteeing income flows to households in this moment of “suspended” economy. We then suggest the implementation of a Europe-wide recovery plan based on public investment and addressing the not-to-be-forgotten climate crisis, and the now well-understood needs of our healthcare systems.

We propose these interventions to be financed by two sets of bonds. First, national governments will issue public bonds to cover emergency-related expenditures. The ECB will automatically purchase them, giving rise to full debt monetisation and prevent any increase in public debt stocks. This way, the ECB will implicitly finance the extra costs that governments will have to support during the emergency phase of the crisis, acting as a sort of helicopter throwing money into the economy. Second, European institutions will issue recovery bonds – let’s call them European Pandemic Recovery Bonds (EPRB) – to relaunch the European economy in the immediate aftermath of the health crisis.

The first point is indispensable, urgent and might help to overcome the existing different views among Eurozone governments. The second one is equally relevant, and indeed much needed regardless of the current crisis, but there is a little more time for discussion.

“the debate among Eurozone countries is rather disappointing”

In the absence of a common view among Eurozone countries about how to move forwards towards a fiscal union, the ECB should be transformed in a way never imagined before: it should go much beyond the narrow view of some Member States of the ECB as a mere “controller” of price stability. Given the depth of the current health emergency and the challenges it poses to the existence of the euro area, this time “whatever it takes” requires a more radical move. 

Unfortunately, the debate among Eurozone countries is rather disappointing. If even under these exceptional conditions, Member States disagree on the need of acting jointly and use all the possible tools against such a huge shock, single countries will eventually have to monetise emergency-led debts by themselves. It goes without saying that this will imply leaving the Euro and returning to national central banks, or perhaps move towards a smaller group of countries (France, Italy, and Spain, for instance) agreeing on a deeper “sharing” of monetary and fiscal policies in a renewed and more cooperative Europe.

The suspension of the Stability and Growth Pact and the current discussion on a European unemployment scheme, as well as the strong response of the ECB to the crisis through and expanded quantitative easing, give us a hope that something is moving in Europe. But more is needed, especially for fiscal policy.

Copyright Photo: Shutterstock

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