Opinion

Why Europe needs a change of mind-set to fend off the risks of recession

Recession! This is the new worry in Europe and the US. A simple look at google trends shows that in Germany, France and the US, search interest for recession peaked in the last weeks. In Italy, the peak already occurred end of January. Whether a recession is actually occurring is difficult to gauge in real time. But there can be no doubt that significant risks such as the trade war and no-deal Brexit exist.

By: and Date: September 2, 2019 Topic: Macroeconomic policy

Versions of this Op-ed have been published in Le Monde, Handelsblatt, Caixin, Nikkei Veritas, Kathimerini, El Pais and Rzeczpospolita.

Le Monde logo

caixin logo english

nikkei veritas logo

El País logo

Rzecszpospolita logo

 

For European finance ministers, the situation represents a new challenge. When major recessions happened in the past, finance ministers knew that the central bank would be the first line of defence. But with interest rates at zero, room for cutting is very limited for the ECB. Still, the European Central Bank may still push the rate on excess reserves further into negative and restart some sort of asset purchase programme.

All of this ECB action can be somewhat useful, but the reality is that central banks’ ability to control inflation and manage the business cycle may be extremely limited at this stage. The former ECB vice president, Vitor Constancio, recently admitted that it is a “theoretical myth that – in any circumstance – monetary policy alone can control inflation at will”. In the same vain, former US secretary of the treasury and Professor of Economics at Harvard, Larry Summers, argues that structural and fiscal policies are now the key policy tools.

This puts the ball squarely in the camp of European finance ministers. But to succeed, a fundamental change of the finance ministers’ mind-set is needed:

It isn’t enough to rely on automatic stabilisers as Bundesbank President Jens Weidman has just suggested. The problem is that automatic stabilisers kick in late, when workers have already lost their jobs. Automatic stabiliser can only dampen the downturn. Alone, they are insufficient to fend off a recession.

It is time for Europe’s finance ministers to move from reaction to pro-active insurance against downturns. They should prepare concrete spending plans and tax cuts that could be quickly activated should the recession fears materialise. Contingent spending plans should be put in the budget of 2020 already now.

Given the risks to the outlook and the negative real interest rates, some measures should already be put in place to mitigate chronic underinvestment. In fact, recent estimates on the low equilibrium yields suggest that Europe has a weakness in investment and excess savings. Ideally, fiscal policy measures should therefore be targeted at long-standing investment gaps. Two concrete measures come to mind:

First, it would be appropriate for Germany to decide a full depreciation allowance for corporate investments in Germany for a period of say 5 years. This would not only provide an immediate incentive for new corporate investments. It would also tackle a long standing weakness of the German economy: its low rate of corporate investment. Contrary to a corporate tax cut, such as a step would not be a giveaway to companies but a time-limited incentive to invest. And a better capital stock would also help lift salaries.

Second, a significant public investment plan to green the European economy is needed if Europe wants to achieve its goal of climate neutrality. The financing of a sustainable European economy would require very significant investments, hence the name “green new deal”.  In fact, relying only on higher prices for carbon is unlikely to be acceptable. Citizens and companies need to see credible alternatives to their existing ways of life and doing business. Only large, publicly supported, investments could fill this gap. It would also provide a boost to Europe and could be funded literally at zero or even negative costs in the zero interest world.

The question is then how to fund such investments in Europe. Relying only on national budgets is likely going to be insufficient. Not only are some countries’ budgets severely constraint. But countries will also tend to rely on European partner countries to do much of the heavy lifting when it comes to developing the infrastructure. Clearly, climate change deserves a European response with European financing.  The European Investment Bank would be the right institution at the European-level to issue on a large scale sovereign bonds to fund the necessary investments across Europe in green infrastructure.

Many in Europe and Germany such as the for example German savings banks complain about the low interest rates. But those rates are naturally low because so little is invested and so much is saved. The ECB cannot solve this problem. Europe’s finance ministers can. Time to change mind-set from reactive to proactive fiscal policy. Time to provide fiscal insurance against downturns and fund green investments at zero costs.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event More on this topic
 

Upcoming Event

Feb
2
14:00

Towards an inventory of corporate subsidies by China, the EU and the USA

In this event panelists will discuss the latest report of the 28th Global Trade Alert Report, 'Subsidies and market access: Towards an inventory of corporate subsidies by China, the European Union and the United States'.

Speakers: Simon J. Evenett, Denis Redonnet, André Sapir and Reinhilde Veugelers Topic: Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic
 

Opinion

How an open climate club can generate carbon dividends for the poor

The German-led G7 can accelerate decarbonisation while tackling climate justice.

By: Andreas Goldthau and Simone Tagliapietra Topic: Green economy Date: January 11, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Timely measurement of real effective exchange rates

This paper contributes to the measurement of monthly consumer price index-based real effective exchange rates with two main novelties.

By: Zsolt Darvas Topic: Global economy and trade Date: December 23, 2021
Read article More on this topic More by this author
 

External Publication

L’Union européenne et les États-Unis, un an après

Après une année troublée par Kaboul et AUKUS, qu'avons-nous retenu de l'an I de la présidence Biden ? Maria Demertzis revient sur les évènements marquants de l'année 2021 pour la relation entre les États-Unis et l'Union européenne.

By: Maria Demertzis Topic: Global economy and trade Date: December 8, 2021
Read article Download PDF More on this topic
 

Book/Special report

European governance

Instruments of a strategic foreign economic policy

Study for the German Federal Foreign Office produced by Bruegel, the Kiel Institute for the World Economy and DIW Berlin.

By: Katrin Kamin, Kerstin Bernoth, Jacqueline Dombrowski, Gabriel Felbermayr, Marcel Fratzscher, Mia Hoffmann, Sebastian Horn, Karsten Neuhoff, Niclas Poitiers, Malte Rieth, Alexander Sandkamp, Pauline Weil, Guntram B. Wolff and Georg Zachmann Topic: European governance Date: November 12, 2021
Read article More on this topic More by this author
 

Blog Post

What to make of the EU-US deal on steel and aluminium?

While deeply disappointing that the surprise deal maintains aluminium and steel tariffs against the EU beyond a modest quota, it alleviates a major irritant in transatlantic relations and contains interesting and innovative features relating to climate policy and to dispute settlement under WTO rules.

By: Uri Dadush Topic: Global economy and trade Date: November 4, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

The state of trade: the EU's trade policy

A conversation with Member of the European Parliament Bernd Lange on the European Union’s trade policy.

By: The Sound of Economics Topic: Global economy and trade Date: November 3, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

Opinion

European governance

The inconsistency in global strategic relations

All of this talk on strategic retrenchment and autonomy is the language of escalation, not of appeasement and collaboration.

By: Maria Demertzis Topic: European governance, Global economy and trade Date: October 13, 2021
Read article More on this topic More by this author
 

Opinion

The geopolitical conquest of economics

Although economics and geopolitics have never been completely separate domains, international economic relations were shaped for 70 years by their own rules. But the rise of China and its growing rivalry with the United States have brought this era to an end.

By: Jean Pisani-Ferry Topic: Global economy and trade Date: October 4, 2021
Load more posts