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Οpinion article of Governor Y. Stournaras in Handelsblatt: On Covid-19 and the necessity for common action in economic policy response

06/04/2020 - Articles & Interviews

Yannis Stournaras Governor, Bank of Greece

We are at war against a very formidable, common enemy: the coronavirus. An enemy to public health, society and the economy, especially the productive capacity of the economy. If part of this productive capacity becomes obsolete in the case of corporate bankruptcies, then a serious, albeit short-term, economic problem, will become a long-term one.

There is still very high uncertainty regarding the evolution of the pandemic and thus, the duration of the lockdown and the effects on GDP. No serious forecasts can be made yet, only scenarios depending on assumptions. One fact, however, is now common knowledge: that this shock is worse than the financial crisis of 2008 and the sovereign debt crisis of 2010. This is so because it is an external, symmetric, common shock, affecting the whole planet, on the demand side, the supply side (including international supply chains) and the financial side. To a large extent, this triple shock is due to the lockdown of economies, ordered by governments, in order to protect public health. If this were not the case, the long-term effect on the economy would have been even larger with devastation of the population and the social fabric. We should not allow this to happen.

This is a very large symmetric shock, but with asymmetric consequences, depending on the initial conditions in terms of public health, as well as public debt and available fiscal space. For instance, it will impact very differently a Member State with an ex-ante public debt-to-GDP ratio of 60%, and another one with an ex-ante public debt ratio of 170%. If, on average, public debt-to-GDP in the eurozone increases by between 10 and 40 percentage points, depending on how deep the recession is going to be in 2020 (these are the current estimates – see, among others, Zsolt Darvas, The Fiscal Consequences of the Pandemic, Bruegel, 30/3/2020), The impact will vary greatly across  to Member States, depending on initial public debt conditions. Debt sustainability issues might then resurface once the pandemic is over, which will hamper growth prospects. This is another reason why government bond yield spreads should not start rising, especially for Member States with an already high debt ratio.

Apart from debt sustainability issues, there are also moral issues as well as coordination externalities related to initial conditions: Member States with inadequate fiscal space to tackle the pandemic should not be left on their own for obvious humanitarian reasons as well as due to the risk of spreading  the pandemic if they fail to contain it.

Hence, we need a strong alliance to face this common enemy. An alliance at least of all those who share the common currency: the Euro. Now is the time for common action and solidarity. Moral hazard considerations, although important for asymmetric shocks due, for instance, to economic policy mistakes, should not be the main determinant of our actions today.

Alliance means common action. You may call it a temporary mutualisation of debt issuance or by any other name. It does not matter how we call it, and we should not be trapped in this rhetoric. Common issuance of debt is common action against the common enemy and this may be done using all the firepower of the three European institutions: the European Stability Mechanism (ESM), the European Commission (EC) and the European Investment Bank (EIB).

Common bond issuance is actually not a new activity (800 billion euros have been raised in the past by the ESM and the EC together) and can take place in stages. The ESM has obviously a very serious role to play, but not with ECCL rules under the Covid-19 pandemic we face today. These conditionality rules have been made for other purposes (asymmetric, idiosyncratic shocks) and cannot be applied to current circumstances. Hence, these rules should be properly and temporarily amended for Member States to be able to make full use of ESM resources. At least a total of about 1000 billion euros (approximately 10 per cent of eurozone GDP) should be made available by the abovementioned three european institutions in addition to the Member States’ own fiscal resources, using the flexibility provided by the Treaty for exceptional circumstances.

We need all the flexibility and firepower we may have. Common monetary as well as fiscal policy should be used simultaneously to mitigate the effects of the pandemic on the economy, given the size and nature of the external, symmetric shock. The European Central Bank (ECB) has shown flexibility and common spirit, and is being engaged in a securities purchase programme of about 1000 billion euros in total, as well as in actions to increase eligible collateral in order to assist the transmission of monetary policy under the current extraordinary circumstances. Its supervisory arm, the Single Supervisory Mechanism (SSM), has also acted quickly and provided commercial banks with the necessary, temporary flexibility regarding capital adequacy and liquidity. The same spirit, flexibility and realism have to be shown by the other European institutions as well.

The present crisis should not be wasted: having learnt the lessons from the previous one, we should coordinate our actions in other areas as well. Public debt is not the only area of concern: asset quality is also expected to deteriorate due to the ensuing deep recession in 2020. Despite the fact that commercial banks have, on average, adequate capital to release to provide new credit to corporations and households and a temporary moratorium on loan installments according to European Banking Authority (EBA) guidelines, non-performing loans (NPLs) are very likely to increase substantially. From our past experience, NPLs are a very difficult problem to tackle the day after. Hence, we will need full, albeit temporary, flexibility in state-aid rules in the banking system as well, and the use of Asset Management Companies (AMCs) at a European and/or national level to deal effectively and quickly with NPLs. Otherwise, the recovery of the Member States’ economies will delay. In this context, the completion of the Banking Union will also become an even stronger necessity than before.

We have to take fast, flexible and decisive action now, so that the economies of the euro area can recover quickly from this unprecedented crisis.

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