Stanislas Jourdan – EU: Fake Money but No Real Stimulus

While the health situation in Europe is slowly improving, the economic consequences of the crisis are getting worse. According to EU institutions, the upcoming recession will contract the EU’s GDP by 9 percent and perhaps by as much as 15 percent. This is a far deeper recession than the subprime crisis of 2008.

Positive Money Europe has said since the beginning of the coronavirus crisis that there is nothing governments can do to avoid a short term recession. The lockdown measures are needed to halt the spread of the virus and prevent deadly overcrowding in hospitals.

In this unprecedented context, the overarching priority for governments should be to do everything they can to stop this short term recession becoming a long lasting depression. 

Avoiding a corona-depression

Governments can prevent a long-term recession by using a two phased approach.

In the short run, governments should act to contain the social and economic damage caused by Covid-19 by putting insurance mechanisms in places for businesses and people. Most governments have done this already by unlocking billions in state guarantees for bank loans and partial unemployment programmes in order to safeguards companies and jobs.

While this approach limits damage to the economy by maintaining workers’ incomes and reducing the direct cost for companies, for many sectors the loss of sales and drop in economic activity will not be recouped later on. For example, restaurants will not be able to sell twice as many meals to ‘catch up’ for the loss of income incurred during the lockdown.

This is why a second phase is needed to help the economy recover. Once the health crisis is contained and the lockdown can be lifted, governments should deploy large stimulus programmes to kickstart economic activity. It is critical that the EU coordinates recovery programmes to make sure the cost is shared and minimised between EU countries. It is extremely worrying that the countries most affected by the virus are also those whose economic ability to cope with the crisis have been undermined due to the past decade of austerity. It is therefore critical that the EU develops a fair solution which shares the burden of the crisis and avoids imposing more austerity on these countries afterwards.

What has the EU done so far?

The EU has announced a host of measures to help governments face the crisis, starting with the EU Commission’s decision to suspend the infamous Eurozone fiscal rules, which usually prevent countries from running larger deficits than 3 percent of their GDP. Governments can currently spend as much as they need in response to the crisis.

The European Central Bank (ECB) also jumped in by creating an additional €750 billion money creation programme, through which the ECB will be purchasing governmental and corporate debt. This enables governments to continue borrowing money on financial markets, but does not reduce the amount of debt they have.

Eurogroup finance ministers, after a series of tumultuous meetings, finally agreed to create a special credit line of close to €500 billion for countries to borrow at 0 percent from the Emergency Stability Mechanism (ESM) instead of financial markets. They also agreed to use the European Investment Bank to mobilise guarantees for banks’ lending to small and medium-sized businesses.

The Commission will also unlock €100 billion in loans to soften the cost of national partial unemployment schemes for countries most affected by the crisis.

Finally, the European Commission has been tasked with proposing the creation of a ‘recovery fund’ by the European Council of EU leaders. While preparatory work and negotiations are likely to last for another few weeks, it seems the proposal will involve letting the Commission borrow money from markets to the tune of at least €300 billion through long term bonds, with additional dubious leverage from private investors in the spirit of the Juncker plan. But the funds would mostly be shared through loans and not grants, meaning more debt for the countries using the fund. 

So what’s missing?

Despite the impressive numbers announced, Positive Money Europe has spotted four major issues with the EU’s approach so far. 

1. Size matters. Despite the big headline numbers, most of the plans announced are not direct stimulus spending but insurance mechanisms, made up of subsidised loans. For example, the €500 billion ESM mechanism allows countries to get cheap 0 percent loans, but this would only replace debt which countries would have issued on their own otherwise. The same goes for partial unemployment schemes – they are not stimulus spending but a substitution of corporate wage expenses with public expenditure. Finally, state guarantees for bank loans are also not direct expenditure. 

2. Timeliness. Because the funding provided by the EU is not as generous as it originally appears, many of these programmes will not help to stimulate a recovery anytime soon. The EU’s recovery fund for instance will only be implemented by January 2021, and will be governed within the same governance framework as the very bureaucratic and complex EU budget. Positive Money Europe fears that a social crisis will erupt before this money trickles down to everyday people on the street, with many vulnerable citizens falling through the cracks in social safety nets.

3. Climate change is being ignored. Most of the measures announced, particularly the ones from the ECB do not have any conditions attached to them. For example, the ECB’s new Pandemic Emergency Purchase Programme (PEPP) will allow multinational corporations to access money very cheaply. While urgent action is needed to battle the health crisis, it will be critical to adjust those programmes to ensure that the heaviest polluters and companies most reliant on fossil fuels cannot free-ride on those programmes without being obligated to change their habits and become greener and more sustainable. 

4. The action taken is burdening the economy with even more debt. The EU recovery fund will mostly deliver loans and not grants, piling up debt onto individual countries. Debt creation would not be an issue in itself if its cost was minimal for all countries, and if the spending it generated sustained economic growth. But because of the legacy of the Eurozone crisis, many countries cannot afford to shoulder more debt, and given the small size of the EU plans and their delayed rollout, there is not much chance of generating enough momentum to sustain prolonged economic growth. Ultimately, these higher debt levels will not only overburden public finances after the crisis, but they could be used as a pretext for imposing deadly and self-defeating austerity.

So what else is needed?

If the EU continues to be too slow to respond to the crisis, we will once again need the ECB to use its powerful ability to create money to provide the necessary long-term economic stimulus. 

Positive Money Europe is currently working to develop several alternative proposals to make sure the EU comes up with a comprehensive response which guarantees no one is left behind, and that the measures taken will be both fair and transformative of our economy.

Our proposals, which are complementary and do not exclude other suggestions not listed here, are:

Helicopter money 

As we explained in our recent report, making direct cash transfers to citizens paid for by the ECB would be most effective in stimulating the economy in the second phase of the recovery. Helicopter money may not be the same as universal basic income, but it would still mimic its effects by helping citizens not protected by welfare safety nets – such as freelancers, gig economy workers and those not eligible for partial unemployment schemes. This is not only fair, but it would ensure income support is not withheld from those who need it for bureaucratic procedures.

Monetary financing by the ECB

Following the Bank of England’s lead, the ECB will have to provide direct support for EU-wide stimulus measures, and in particular the EU recovery fund. 

Such support can take many different forms, and proposals have been put to the table already by Paul de Grauwe, Willem Buiter and Sony Kapoor among others. More recently, the Spanish government has put forward an interesting proposal where the EU would issue perpetual bonds. If the ECB were to purchase those bonds under its existing asset purchases programmes, this would effectively be monetary financing.

However, a key aspect in this debate is the fact that Article 123 of the European Treaty formally prohibits direct monetary financing by the ECB to governments and public institutions. In reality, the ECB is already circumventing this prohibition through quantitative easing, so we should be mindful that the range of possible action has already been expanded beyond the initial remit of EU law.

Despite this, we can assume that more direct and radical measures will require top-level agreement between heads of states to relax, suspend or amend Article 123.

From Positive Money Europe’s perspective, two factors could make this possible. Firstly, the limited nature of the EU’s stimulus packages will require additional funding. Given Member States’ inability to agree on pooling more fiscal resources, the ECB’s ability to create money will make it the only option left. 

Will the ECB agree? Undoubtedly. Despite its independence, the bank has signalled recently its desire for the Eurozone to have more budgetary tools. To make this happen, the ECB also has a vested interest in providing financial incentives for Member States to increase the future size of the recovery fund.

Debt cancellation

Positive Money Europe thinks that debt cancellation will likely be needed, both for corporations and governments. As Mario Draghi himself recognised, many companies will not recover sufficiently to be able to repay the loans that states are currently providing them through banks. They will need debt relief. The ECB has already floated the idea of an EU ‘bad bank’ to help with this, but there is a huge risk that such a mechanism will end up offloading risk from the private sector to taxpayers.

If debt cancellation for corporations is going to be on the table, it must also be granted to governments. Today, around 30 percent of all national debts are being held in the ECB and national central banks’ balance sheets as a result of quantitative easing policies. Since central banks belong to governments, this effectively means that a large portion of the public debt is simply owed to ourselves. It could be cancelled at no cost for anyone – central banks can effectively write off those assets without going bankrupt. 

Some argue this is mostly a symbolic gesture, but writing-off governments debts owed by the ECB would immediately reduce the amount of public debt of national governments by 30 percent, equally reducing pressure to resort to austerity in the name of balancing the books. This debate needs to happen.