Fabio Panetta: Why we all need a joint European fiscal response
Contribution by Mr Fabio Panetta, Member of the Executive Board of the European Central Bank,
published by Politico on 21 April 2020.
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The case for common European economic action in response to the coronavirus crisis has often
been presented as a call for solidarity. As noble as that motivation may be, it's not the only
reason for governments to act together. A strong, symmetric fiscal response that offsets the
economic damage from the pandemic is in the economic interest of all countries in the
eurozone.
The disadvantages of an asymmetric response are self-evident.
In the realm of public health, if countries are forced to lift necessary public health measures (e.g.
lockdowns) prematurely because the economic costs of containment are too high, the virus will
inevitably begin to spread again and will further damage the economy.
When it comes to the European economy, there's a similar risk of contagion. The economies of
the eurozone are tightly interlinked through supply chains, financial connections and trade
relationships. As a result, a slump in a large part of the eurozone will depress growth and
employment across the entire region.
These dynamics were on display a decade ago during the sovereign debt crisis, but today's
crisis exacerbates them in two ways.
First, because of the global nature of the shock, European countries cannot redirect their
production to satisfy demand from the U.S. or China, as they did a decade ago. This makes
member countries dependent on trade within the eurozone, which represents 45 percent of the
currency area's GDP.
Second, the amplification of the shock across supply chains will be greater this time. Eurozone
firms are strongly integrated into global value chains, with participation rates 60 percent higher
than for U.S. or Chinese firms. This integration is today three times tighter within the region than
with the rest of the world.
Analysis by the European Central Bank has found that these supply chain interlinkages will
multiply the economic damage of the coronavirus lockdowns. As an illustration, we estimate that
an initial GDP decline of 5 percent in major eurozone economies would turn into a 7 percent fall
in output for the whole area. A GDP decline of 15 percent would provoke a 20 percent loss
across the eurozone. And this only considers the recessionary phase, not the subsequent phase
of weak trade if the euro area economy remains depressed.
Only if all economies act with the necessary force to contain the recession will the loss in output
for the entire eurozone be minimized.
Then there's the risk of political spillovers if responses are asymmetric. Any perception that
common action is absent in times of desperate crisis would dilute public support for the
European Union - an effect that is already visible in countries on the frontline of the health crisis.
Unchecked, these perceptions will weaken centripetal forces in the union and strengthen
centrifugal ones. Ultimately, they could erode trust in the euro.
So it's clear why a forceful, symmetric European response is needed. Failure to act now will not
insulate taxpayers from the costs of this crisis. Quite the opposite: it will amplify those costs
when they finally come due. It will also weaken the policy responses already being undertaken.
For example, without visibility on future sovereign funding costs and rollover risks, government
guarantees on bank loans will either be priced differently across countries - or fewer such loans
will be extended. Either way, the result will be fragmentation and a more persistent loss of
economic potential.
A European fiscal response must be based around three principles. First, the size of the fiscal
reaction should be proportionate to the magnitude of the shock. Second, it should not aggravate
fragmentation stemming from differences in initial fiscal positions. Third, it should not skew the
playing field within the European single market. Viable firms should be able to withstand this
crisis no matter where in the eurozone they are located.
The fiscal response of European countries has thus far been inconsistent with these principles.
The countries least affected by the pandemic have enacted the largest fiscal responses, while
the worst-affected countries have taken the smallest steps. This appears to be, in part, because
the latter fear being unable to shoulder the debt burden that an optimal response would entail.
The threat to the single market is clear: uneven fiscal support implies that a firm's location, rather
than its business model, will be the decisive factor in determining whether it survives this crisis.
Rather than transfers between member states or a mutualisation of existing debts, what is
needed now is for countries to use their collective strength to ensure that the European response
is commensurate with the size of the shock and that all countries can benefit from low funding
costs and zero rollover risk.
As policymakers debate the proper response, various possible funding models are being
considered. These include making serious use of the eurozone's ability to borrow and spend,
using the financing capacity of the European Stability Mechanism to scale up European
interventions or creating a new facility to finance the reconstruction.
Whichever path is taken, the goal of fiscal policy must be to push the financing costs of this
crisis far - very far - into the future. Debt that is issued at very long maturities becomes more
sustainable over time as growth rates outstrip interest rates. And European issuance today will
create the additional fiscal policy space needed to secure those higher growth rates in the future.
An adequate European response would also facilitate the implementation of the ECB's securities
purchase programmes, increasing the effectiveness of monetary policy.
Once the immediate emergency recedes, countries will have to deal with concerns of
competitiveness and long-term sustainability, in the context of prevailing growth and interest
rates. That's an important and necessary battle, but not for today. In fact, the faster the current
emergency is addressed, the faster countries will be in a position to remedy these concerns and
the faster the single market will return to its normal functioning.
Acting now to create the conditions for a symmetric fiscal response will help all member
countries to shorten the duration of the crisis period, protect the economic base on which their
future production structures and exports rely, and - perhaps most importantly - uphold the
promise of a shared and indivisible European destiny.
Eurozone countries should shoulder the cost of financing this crisis together, because they all
stand to benefit by doing so.