By Einstein’s purported definition, madness would be repeating the errors of the eurozone crisis and expecting a different outcome—eurobonds would break with that.
Given the need to increase public expenditure to cope with the economic and social crisis triggered by Covid-19, eurozone governments face a challenge. How are they going to finance fiscal deficits of at least 10 per cent of their gross domestic product, without the power of issuing the currency in which their public debt is denominated? And, in the longer term, how can we all make the most of this crisis, not repeating the errors of the past?
The eurozone encompasses the largest currency area after the United States. That mere fact makes the euro a trustworthy currency and the European Central Bank the powerhouse of printing money without threatening the value of the euro.
This is how the ECB can announce the Pandemic Emergency Purchase Program (PEPP), which implies a monetisation of 7.5 per cent of all eurozone members’ public debt. At the same time, we see the euro devalue against the dollar by less than 2 per cent.
The ECB enjoys the power of monetising public debts—a privilege most eurozone members would not enjoy if they kept their pre-euro national currencies. The PEPP is a step in the right direction, granting fiscal space to the governments of the euro area.
Given the ECB’s issuing power, it seems appropriate that the central bank monetise increasing public debt during this crisis. In a way, that is exactly what the bank president, Christine Lagarde, and its Governing Council have tried to do with the PEPP.
Yet the ECB is the most politically independent central bank among advanced economies and it enjoys great discretion to implement the monetary policy it considers appropriate, with almost no accountability. Thus, any policy decision made by the ECB can be reversed without the say-so of the eurozone governments—and, if so, could lead to a difficult financial situation (as in 2010) for the weakest member states with high fiscal deficits.
Giving the ECB a legal mandate to guarantee all member states’ public debt would require a renegotiation of the EMU treaties. This is neither up for discussion nor politically feasible right now.
In that context, the invocation of the ‘general escape clause’ of the Stability Growth Pact, halting the structural adjustments countries must implement to meet their fiscal targets, is welcome. But it is insufficient.
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First, as with the ECB, the finance ministers grouped in Ecofin could decide to enforce the SGP after 2020 and thus force countries on to an austerity path of adjustments once again. Secondly, increasing fiscal deficits means increasing bond spreads between eurozone countries. The temporary character (and limited scope) of the PEPP does not guarantee public debts in the long term and it opens the door to solvency problems, as in the 2010-12 crisis, for most eurozone members. What we need is a financing mechanism which guarantees no austerity in the future.
The problem remains the political feasibility of putting together an agreement among European Union members. As a symptom of how quickly events are unfolding in front of us, however, a month ago eurobonds were not even the subject of debate among representative politicians, despite the multiple proposals out there (see here, here, here, here or more recent ones here or here). Now the window of opportunity is opening for a new financing mechanism which would underpin European institutions and integration.
But who would issue eurobonds? And how would the money be handed over to national governments?
Two institutions are already in place. The European Stability Mechanism (ESM) has announced that it has at its disposal €410 billion (3.4 per cent of eurozone GDP), to be lent to euro-area members in amounts up to 2 per cent of their GDP. To finance the rescue packages of Greece or Spain, the ESM has already been issuing de facto eurobonds, guaranteed by all eurozone members, to the extent of their share in the ESM capital. The problem is that countries gaining access to the ESM funds would do so through the Precautionary Conditioned Credit Line, conditioned by a memorandum of understanding (MoU).
MoUs bear the stigma of the crisis of 2010-12. Several countries, including Italy, have already announced that they would refuse to sign another this time around. Yet an MoU is a contract between the ESM—with eurozone governments behind it—and the debt-incurring country on terms which are subject to the balance of political forces in the negotiations. It is not wishful thinking to believe that a favourable, anti-austerity agreement is feasible, given the nature of the current crisis.
A way to avoid the stigma would be to have a collective agreement for all eurozone countries, with an anti-austerity MoU available to all. Of course, if we rely on the ESM, it would have to extend the lending well above the 2 per cent GDP limit and would need to issue (euro)bonds to raise the required funds.
European Investment Bank
The second ready institution is the European Investment Bank. The EIB could issue bonds and spend the funds in each EU country in amounts proportionate to the size of each country’s GDP. The EIB would combine direct expenditure of funds—in which case fiscal deficits would not arise at any moment—and credit lines to EU countries. An increase in the EIB’s capital could be agreed by member states to strengthen its resilience.
If moral hazard is a concern, the European Council could implement conditionality, agreeing in a policy package how that money would be spent to fight the coronavirus crisis. The EIB would disburse the money, contingent on approval by national governments of legislation for the implementation of the package thus agreed.
Ultimately, we need a joint fiscal response, under common conditions, which will allow a rapid recovery after the coronavirus is gone. The issuing of eurobonds would set a positive precedent towards a euro area and a union with the required mechanism in place to deal with the abiding challenges ahead of us—as, for instance, climate change.