The first steps of the Great Recession began with a financial shock that led to coordinated action within the G20 monetary and fiscal authorities. In budgetary matters, all governments amplified the action of the automatic stabilizers by increasing deficits to sustain demand. This strategy was consistent and sustainable for countries that borrowed in their own currency. However, the fast growth of public debt in some countries of the Eurozone, which do not issue debt in their own currency, began to stress their interest rates in view of the uncertainties concerning their repayment capacity and, inclusively, their maintenance in the monetary union. The market starts to question, in some way, the existence of a risk of re-denomination, of breaking the pegged exchange rate, and even of exit of the Eurozone.
Although the coordinated expansionary fiscal action was necessary at a global level, its substantiation in the Eurozone when implemented individually by each of the national governments opened the door to the sovereign crisis that would explode some time later, starting in 2010. For two years, some Eurozone countries suffered a deeper and more structural crisis than the first one, until the European Council in the summer 2012 when the European authorities lead to a turn in the approach of the economic problems. There will be no longer just national solutions, but also the promotion of a common plan, jointly funded, that began with the “banking union” project. Banks would no longer have regulation, supervision and coverage of losses in case of a crisis at national level, but it would be the Union as a whole that would deal with these entities and address the costs in case of a bankruptcy, with the aim of minimizing the use of taxpayer´s money.
Since then, these measures together with others, linked once again to the use of common financing, through different mechanisms, including the creation of the European Stability Mechanism (ESM), helped the crisis to begin to fade together with the internal adjustment process of relative prices, as the only way available in the absence of an genuine Eurozone budget.
It should be noted that, given the length of the crisis, the European fiscal rules were not carefully followed by national governments, because, let’s say it clearly, who really disciplines the issuance of public debt is not the European Commission, but the markets on their day to day transactions. It is important to keep this in mind.
Now we face a new recession, provoked by the COVID-19 virus outbreak, that forces us to assess once again the adequacy of the tools that Eurozone and Member States have available to deal with crisis. In fact, our toolbox remains incomplete, to say the least, to confidently address not only the need for new expansive discretionary fiscal policies, but also the simple use of automatic stabilizers. The road started with the creation of the banking union is not finished and this new crisis reaches us when we do not yet have enough instruments and a common budgetary instrument do deal with it.
In this debate, and taking into consideration the experience of the past crisis, making the application of the Stability and Growth Pact more flexible or expanding the use of State aid support as proposed by the European Commission, is not the solution and it can even be counterproductive. The reaction to the crisis will automatically worsen fiscal balances. The attempt to help contain the fall in domestic demand, it will only work if, and only if, there are no doubts about the ability of Member States to repay their debt. And we must remember that the level of public debt in some countries is already too high. For this reason, political capital should not be wasted fighting over the changing of the rules that, in any case, are not the ultimate restraint of fiscal action. Creditors, who can doubt at any moment in time on the ability of Member States to repay their debt, are.
Therefore, the fiscal action to deal with the new crisis, must be essentially common and in line with other proposals from the European Commission to use the budget of the European Union in a solidary way. However, the displacement of funds already planned for other purposes towards the health sector or small businesses will not have any anti-cyclical effect if the funds available are not increased. An “aggressive” approach is needed, as stated by Ursula von der Leyen on sanitary containment measures, but also in the fiscal but solidary sphere, which does not mean extending the formal margin of the national deficit limits, given the real threat of those who can limit us to, de facto, use such flexibility, the creditors.
A first option could be to increase the acting capacity of the European Investment Bank with an increase in its equity which is already planned under the Green Deal. The funds available in the EU budget need to be leveraged to amplify their effect and the EIB can carry out this mission. However, this capital increase needs to be an urgent and common response from the Member States.
Second, the Commission may submit a review of the European Financial Stabilization Mechanism regulation, launched in 2010 to provide liquidity to the Member States prior to the founding of the ESM. This financial instrument that has a guarantee of the EU budget for a total of 60,000 million euros, still has to execute about 14,000 million euros, which could be leveraged in the market to feed a specific EU program to help the fight against the coronavirus crisis.
And thirdly, we should not fail to analyse what the European Stability Mechanism could do directly. Certainly, its central mission is to provide liquidity to the Member States at risk of breaking the pegged exchange rate, similarly to the role of the International Monetary Fund. Unfortunately, the possibility of allowing the ESM to offer precautionary support through credit lines without the need for financial programs is suspended in face of the impossibility of reaching an agreement last December on the revision of its operational treaty. It is also true that the request for the use of such credit lines carries a reputational risk that nobody wants to incur, without having a direct threat of the market. In any case, it could be envisaged a stimulus package agreed at European level, where all Member States would participate and would be jointly financed through the ESM to face the crisis.
In the monetary area, the ECB will shortly report on its package of measures. In any case, additional problems regarding financial stability have to be avoided. Hopefully, we learned something from the banking crisis of the last decade. As such, the modulation of the anti-cyclical capital requirements of the banking entities should be analysed. These instruments are designed to be used in these cases and it seems clear that we face significant recession risks. We should also expand the purchase of debt in the secondary markets, but carefully analyse any additional interest rate reduction to avoid jeopardizing the fragile financial stability, which could put into question once again the transmission of the monetary policy itself.
In any case, the current oil war offers us, at least, some economic relief that undoubtedly compromises the fulfilment of the ECB’s mandate, but which should help in the recovery of the economy.
Nonetheless, we face a new recession at a delicate moment for the European economy and the institutional design of the Eurozone itself, which continues to suffer from the lack of a fiscal instrument that leaves the bulk of the responsibility to deal with the crisis with the Member States. The sovereign crisis of 2010 urges us to face this situation in a different way from what was done in 2007-08, now demanding a European fiscal response. Wasting time now on trying to make the national fiscal rules more flexible is not worth it. It will not help at all if the Member States budgetary plans are not credible for the market and we will be wasting valuable time to find a solution for a common EU budgetary increase. We are, therefore, faced with a key opportunity for change that will, nonetheless, entail some challenges along the way, especially if some countries focus on trying to find individual solutions to a common problem.