Opinion

The European coronavirus response must be a solution, not more stigma

Lagarde needs a different bazooka in responding to a natural disaster like COVID-19.

By: Date: March 18, 2020 Topic: European Macroeconomics & Governance

When European Central Bank President Christine Lagarde said that closing sovereign borrowing spreads wasn’t her job, she was fighting the last war. The financial challenge posed by the coronavirus will require the European Union to jettison the rescue model developed in its debt crisis in favor of aid measures that bring the continent together, instead of driving it apart.

Italy will be an early test of political will. The coronavirus has hit it first and hardest, laying waste to an economy already struggling with slow growth and weak prospects. It will surely need help to recover. But how?

The euro area rescue tools assembled during the last economic crisis were designed to force good behavior out of the fiscally irresponsible, not to make repairs in the aftermath of a natural disaster. In trying to assuage the “moral hazard” concerns of the old guard, Lagarde opened the door to additional panic about the new.

Financial markets know the coronavirus is a universal threat, and they want to see a universal response. Singling out Italy, or any other country, as uniquely weak and isolated sends a message of fragmentation and political stigma that undermines other efforts to contain the damage.

The European Commission acknowledged the new reality in the coronavirus response package it unveiled on Friday. The EU plans to offer small-business loan guarantees, unemployment supports and leeway on centrally funded projects, as direct ways to ease the financial burden on its 27 member states.

On top of that, the Commission signaled willingness to waive many of the fiscal constraints it has spent so long trying to establish by offering extended “flexibility” in its budget rules and promises to rapidly approve national bailouts for beleaguered sectors. Italy has already reached the stage of economic damage necessary to earn broad waivers of the EU’s state aid rules, and other countries may soon join.

ECB actions are following suit, but the communication is lagging. At Lagarde’s press conference Thursday, the central bank unveiled an impressive, if understated, set of measures to support the eurozone and its banks throughout the COVID-19 crisis.

But she also set off fireworks by trying to distance monetary policy from national spending initiatives.

Her divisive comment, which she subsequently rolled back in a CNBC interview, showed the ECB is still leery of the political fallout from the euro crisis, which raged from 2010 to 2015 and threatened the single currency’s very existence.

Conservative politicians in countries like Germany, Finland, and the Netherlands railed against the irresponsibility of their euro-area counterparts and insisted that any aid be pinned to tight constraints. To avoid any whiff of “moral hazard,” they insisted that aid be granted at the last minute, in the lowest possible amounts necessary to do the job at hand.

That kind of just-in-time calibration would be ruinous if tried against 2020’s challenge. The coronavirus won’t respect national borders and neither should rescue budgets. Euro-area countries faced financial contagion in the last crisis, as borrowing difficulties in one country jumped to the others. In this one, the financial flames are being fanned by a literal disease.

This means the EU needs a new “whatever it takes” bazooka — the one unveiled in 2012 by Mario Draghi may not fly. When the ECB rolled out its Outright Monetary Transactions program of unlimited bond purchases, it said any countries wishing to use it would also need a euro-area rescue package from the European Stability Mechanism.

But the ESM only offers programs in exchange for a tough set of economic commitments. As a result, the OMT has never been used, and neither have the ESM’s precautionary programs, which require countries to commit to “corrective measures” and extensive monitoring. While five countries took euro-area bailouts during the last crisis, they only did so when all other options were exhausted. None wanted a follow-on precautionary credit line when their full programs ended.

Lagarde knows all of this. She had two different front-row seats during the euro crisis, first as French finance minister and then as head of the International Monetary Fund. She also knows the importance of acting to calm the markets. But what she forgot is the incredible vocal platform that comes with being ECB chief, and the responsibility to be a financial stability cheerleader as well as a political negotiator.

Like her central banking predecessor, Lagarde wanted to encourage euro-area countries to loosen their purse strings and commit to the kind of government spending that will be required to avoid a severe recession in response to the quarantine measures currently required. Lagarde was tapped largely because of her good relations with German policy makers and her ability to forge deals in the face of steep opposition.

Draghi’s frequent calls for fiscal action were met with strong resistance, and Lagarde hoped to turn the tide.

Hence she made a point of clarifying that the ECB would not engage in monetary financing, presumably to reassure hardliners that the central bank would not willy-nilly buy every bond issued by every country hoping to squeeze the most out of crisis conditions. When it comes to “more debt issuance coming down the road depending on the fiscal expansion” that governments undertake, “we are not here to close spreads. This is not the function or the mission of the ECB. There are other tools for that, and there are other actors to actually deal with those issues.”

In speaking directly to the hardliners, however, she alienated her new constituency, the global bond market.

Lagarde’s mistake echoes the promises made about troubled loans during the height of the U.S. mortgage woes. When the Obama administration took over from President George W. Bush and Treasury Secretary Henry Paulson, they were sure they could quickly solve the problem of pricing and clearing the bad loans clogging banks’ balance sheets. But when they dove in, they quickly ran up against the same technical obstacles.

Lagarde likewise may have thought she knew how to handle the Germans, only to find it’s more complicated in practice than in theory.

To her credit, Lagarde reversed course immediately, and the transcript of her official press conference remarks now also includes her follow-up statement that high spreads due to the coronavirus are part of the ECB purview after all. “I am fully committed to avoid any fragmentation in a difficult moment for the euro area,” she said. With any luck, the EU governments in charge of the spending spigots will follow her lead.


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
 

Past Event

Past Event

POSTPONED: The Sound of Economics Live: Can the Eurogroup save the day?

In this episode of The Sound of Economics, we analyse the Eurogroup's 'rescue plan' amidst the economic fallout brought about by the COVID-19 health crisis.

Speakers: Maria Demertzis, Giuseppe Porcaro, André Sapir and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 8, 2020
Read article More on this topic More by this author
 

Blog Post

Social distancing: did individuals act before governments?

Using online searches for restaurants as a proxy to assess whether and to what extent individuals were practicing social distancing before strict lockdown measures, we identify substantial differences between countries. In some countries, including Denmark and Portugal, searches for restaurants were considerably down before restaurant restrictions were put in place. Countries where social distancing started earlier, regardless of when policies were enacted, can expect a flatter coronavirus curve.

By: Catarina Midões Topic: European Macroeconomics & Governance Date: April 7, 2020
Read article More on this topic More by this author
 

Blog Post

A green recovery

Government policy faces various challenges. Before the COVID-19 outbreak, the European Union set ambitious targets to reduce carbon emissions. Now in the midst of the pandemic, the EU has temporarily lifted state-aid rules allowing governments to steer companies through the crisis and to minimise job losses using public money. This column suggests combining these policies by attaching green conditions to state aid. In that way, we can aim for a green recovery.

By: Dirk Schoenmaker Topic: Energy & Climate Date: April 6, 2020
Read about event More on this topic
 

Past Event

Past Event

A European response to the coronavirus crisis with Paolo Gentiloni

This is the second event in our series with the Financial Times, where Paolo Gentiloni will discuss the European response to the coronavirus crisis.

Speakers: Paolo Gentiloni, Mehreen Khan and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 6, 2020
Read article More on this topic
 

Opinion

A European approach to fund the coronavirus cost is in the interest of all

We had not seen a common challenge as clear as this pandemic. The sum of national actions and programs is likely to be insufficient.

By: Agnès Bénassy-Quéré, Arnoud Boot, Elena Carletti, Jan Krahnen, Miguel Otero-Iglesias, Lucrezia Reichlin, Dirk Schoenmaker and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 6, 2020
Read article More on this topic More by this author
 

Opinion

A temporary, common fiscal stimulus to answer the mayhem of COVID-19

We are not in normal times and we have to surpass, albeit only for the duration of the COVID-19 shock, the hurdles that did not allow the euro-area to endow itself of a common fiscal policy.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: April 2, 2020
Read about event More on this topic
 

Past Event

Past Event

Find my virus: Mobilising AI and big data to fight COVID-19

At this event, the panellists will discuss the role of AI and big data in the fight against the coronavirus crisis.

Speakers: J. Scott Marcus, Alex Sandy Pentland, Georgios Petropoulos and Marietje Schaake Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 2, 2020
Read about event More on this topic
 

Upcoming Event

Apr
28
18:00

The Sound of Economics Live: On emerging market crisis with Barry Eichengreen

At this online podcast recording, Guntram Wolff and Barry Eichengreen will discuss the impact of the COVID-19 crisis on emerging economies and the corresponding policy responses.

Speakers: Barry Eichengreen, Giuseppe Porcaro and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Opinion

Will the economic strategy work?

Because even thriving companies can be killed in a matter of weeks by a recession of the magnitude now confronting the world, advanced-economy governments have reacted in a remarkably similar fashion to the COVID-19 crisis. But extending liquidity lifelines to private businesses and supporting idled workers assumes a short crisis.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: April 1, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

The macroeconomic policy response to the COVID-19 crisis

From the European Stability Mechanism (ESM) to "coronabonds", the EU seems to be struggling to find an appropriate mechanism to tackle the economic crisis created by the COVID-19 pandemic. What is really the best option? And how do we ensure that, once the pandemic is over, we return to sustainable debt levels and competitive economies? This week, Giuseppe Porcaro is joined by Lucrezia Reichlin, professor of Economics at the London Business School, Grégory Claeys and Guntram Wolff to discuss the macroeconomic policy response to the COVID-19 crisis.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: March 31, 2020
Read article More on this topic
 

Opinion

Why are some stock markets in Asia less affected by coronavirus?

While Asian markets are in a sea of red, mainland China, New Zealand, Hong Kong and Taiwan are all defying the gravity.

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: March 31, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: The macroeconomic policy response to the COVID-19 crisis

Which macroeconomic policy response is the best option to deal with the crisis currently unfolding and will ensure that the recovery will be as quick as possible?

Speakers: Grégory Claeys, Giuseppe Porcaro, Lucrezia Reichlin and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 31, 2020
Load more posts