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 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
Read article Download PDF More on this topic More by this author
 

External Publication

From globalization to deglobalization: Zooming into trade

This article shows some evidence of the decrease in merchandise, capital and, to a lesser extent people to people flows.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: February 3, 2020
Read article More on this topic More by this author
 

Opinion

The US-China trade agreement will not put an end to geopolitical risks

The agreement between the US and China should not be read so positively in Europe, especially in Germany

By: Alicia García-Herrero Topic: Global Economics & Governance Date: January 31, 2020
Read article More on this topic More by this author
 

Opinion

Explaining the triumph of Trump’s economic recklessness

The Trump administration’s economic policy is a strange cocktail: one part populist trade protectionism and industrial interventionism; one part classic Republican tax cuts skewed to the rich and industry-friendly deregulation; and one part Keynesian fiscal and monetary stimulus. But it's the Keynesian part that delivers the kick.

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

Podcast

Podcast

AI in Europe: a conversation with Google's CEO

It seems almost inevitable that Google will be big part of Europe's future. And Europe will be a huge part of Google's too. This week, Alphabet, Google's parent company, hit $1 trillion market cap for the first time. Can Google's AI be socially beneficial? Are big tech companies intrinsically bad? This week, Guntram Wolff talked to Google and Alphabet's CEO, Sundar Pichai.

By: The Sound of Economics Topic: Innovation & Competition Policy Date: January 20, 2020
Read about event More on this topic
 

Past Event

Past Event

Partnering with Europe on responsible AI: a conversation with Sundar Pichai, CEO Google and Alphabet

At this event, Google's and Alphabet's CEO Sundar Pichai will elaborate on his views on Artificial Intelligence.

Speakers: Sundar Pichai and Guntram B. Wolff Topic: Innovation & Competition Policy Location: SQUARE, Mont des Arts, 1000 Brussels Date: January 20, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

Will Iran disrupt the global economy?

Last Friday, Qassem Soleimani, head of the Iranian Revolutionary Guards’ QUDS force, was killed by an American airstrike outside Baghdad airport. The Ayatollah was not pleased and Tehran has promised to retaliate. At the time of recording, the world is still waiting to see how Iran might respond. Some of have speculated that they could disrupt the world’s oil markets by closing the Strait of Hormuz, which acts as a vital artery for around a third of the world’s liquefied natural gas and almost a quarter of the world’s oil. Today, oil prices surpassed $70 and if tension escalates the price is bound to grow. How dependent is the global economy on affordable Middle Eastern fossil fuel? This week, Nicholas Barrett is joined by Maria Demertzis and Niclas Poitiers to discuss how the US-Iran hostilities are affecting global economy.

By: The Sound of Economics Topic: Global Economics & Governance Date: January 6, 2020
Read article More on this topic More by this author
 

Opinion

Could the U.S. economy be experiencing a hidden tech-driven productivity revolution?

In the last decade, most advanced economies have grown more slowly than before. Slower growth has frequently been seen as a legacy of financial crises, especially that of 2007–2009.

By: Marek Dabrowski Topic: Innovation & Competition Policy Date: January 6, 2020
Read article More on this topic
 

Blog Post

Lessons from the China-US trade truce

The tentatively agreed deal between China and the United States temporarily stops a dangerous dynamic, yet it falls far short of the negotiating objectives of both sides. US trade policy has become a dominion of the executive branch guided principally by the President’s electoral interests. Meanwhile, China demonstrates its capacity to resist pressure: it will enact structural reforms at its own pace in line with its interests. Sadly, the deal confirms that the United States no longer feels obligated to follow WTO rules, and can induce others to do the same.

By: Uri Dadush and Marta Domínguez-Jiménez Topic: Global Economics & Governance Date: December 19, 2019
Read article More by this author
 

Opinion

Watch out for China’s currency in case of no-deal scenario

The U.S. and China’s negotiations on a phase-one deal seem to have stalled again. The market was already aware of the limited nature of the likely deal, but was still hoping for it. Against this backdrop, the investors have reacted negatively to the increased likelihood of not reaching a deal on December 15. If this is the case, the U.S. will apply additional tariffs on Chinese imports. The obvious question to address, thus, is, what can happen to China under such a scenario?

By: Alicia García-Herrero Topic: Finance & Financial Regulation Date: December 11, 2019
Load more posts