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: Date: September 2, 2019 Topic: European Macroeconomics & Governance

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 article More on this topic
 

Blog Post

What should Europe expect from American trade policy after the election?

A Joe Biden Administration would have to decide to what extent to unpick the major United States trade policy shifts of the last four years. A quick return to comprehensive trade talks with the European Union is unlikely and the US will remain focused on its rivalry with China. Nevertheless, there would be areas for EU/US cooperation, not least World Trade Organisation reform.

By: Uri Dadush and Guntram B. Wolff Topic: Global Economics & Governance Date: October 8, 2020
Read article More on this topic More by this author
 

Opinion

Eastern Germany’s New Growth Engine

Eastern Germany has suffered from three decades of deindustrialization since the collapse of communism, largely because of poor policy decisions. But by becoming an electric-vehicle powerhouse, the region can help to drive Europe's green transition and secure its own future prosperity.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: October 7, 2020
Read article More on this topic More by this author
 

Opinion

Trump’s International Economic Legacy

If Donald Trump loses the United States presidential election in November, he will ultimately be seen to have left little mark in many areas. But in the US's relationship with China, the decoupling of economic links could continue, and that could force Europe into hard choices.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: September 29, 2020
Read article More on this topic More by this author
 

Blog Post

The Wirecard debacle calls for a rethink of EU, not just German, financial reporting supervision

The spectacular collapse of Wirecard AG should serve as a wake-up call for the European Union on the need to pool the relevant supervisory mandates at EU level.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: June 30, 2020
Read article Download PDF More by this author
 

Policy Contribution

European Parliament

The European Central Bank in the COVID-19 crisis: whatever it takes, within its mandate

To keep the euro-area economy afloat, the European Central Bank has put in place a large number of measures since the beginning of the COVID-19 crisis. This response has triggered fears of a future increase in inflation. However, the ECB's new measures and the resulting increase in the size of its balance sheet, even if it were to be permanent, should not restrict its ability to achieve its price-stability mandate, within its legal obligations.

By: Grégory Claeys Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: May 20, 2020
Read article More by this author
 

Podcast

Podcast

Rebooting Europe: a framework for post COVID-19 economic recovery

COVID-19 has triggered a severe recession and policymakers in European Union countries are providing generous, largely indiscriminate, support to companies. As the recession gets deeper, a more comprehensive strategy is needed. This should be based on four principles: viability of supported entities, fairness, achieving societal goals, and giving society a share in future profits. The effort should be structured around equity and recovery funds with borrowing at EU level.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: May 15, 2020
Read article More on this topic More by this author
 

Opinion

The message in the ruling

The German Constitutional Court's ruling on the ECB's asset purchase programme is open to much criticism but it can hardly be blamed for raising an important question.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: May 12, 2020
Read article More on this topic More by this author
 

Blog Post

Banking regulation in the Euro Area: Germany is different

Despite progress in recent years towards a single banking policy framework in the euro area – a banking union – much of the German banking system has remained partly sheltered from uniform rules and disciplines that now apply to nearly all the area’s other banks. The resulting differences in regulatory regimes could generate vulnerabilities in the still-incomplete banking union, which is being tested in the context of the COVID-19 pandemic.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: May 7, 2020
Read article More on this topic More by this author
 

Blog Post

Is the United States reneging on international financial standards?

The new Fed rule is a material breach of Basel III, a new development as the US had hitherto been the accord’s main champion. This action undermines the global order without being ostensibly justified by narrower considerations of US national interest.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: April 16, 2020
Read article Download PDF More on this topic
 

External Publication

Facing the lower bound: what will the ECB do in the next recession?

In responding to the global financial crisis, the ECB has pushed its monetary policy into unchartered territories . Today, it appears increasingly constrained by persistently low interest rates. This paper seeks to understand this challenge and assess whether its toolkit would allow the ECB to weather a European recession.

By: Aliénor Cameron, Grégory Claeys and Maria Demertzis Topic: European Macroeconomics & Governance Date: March 27, 2020
Read article More on this topic More by this author
 

Opinion

Why OMT is not the solution for Italy right now

The Outright Monetary Transactions tool is not well suited for Italy right now. Italy needs fiscal support both by itself and by the EU. Italy and the rest of the EU need a fiscal bazooka. We should find a way of backstopping our economies immediately.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: March 16, 2020
Read article More on this topic More by this author
 

Blog Post

To save the Italian economy from the Coronavirus, Rome prescribes a stimulus

Faced with a difficult prognosis, the Italian government has prescribed a three-step strategy to treat the worse economic symptoms of the Coronavirus. The medicine is money and the dosage is €4.5 billion

By: Simone Tagliapietra Topic: Global Economics & Governance Date: March 3, 2020
Load more posts