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A one-legged Europe no more?
Bruno Cavalier
Chief Economist at ODDO BHF
To move forward, it is preferable to have two legs than one. To stabilise the business cycle, it is better to be able to intervene from two angles - monetary and fiscal. Europe's framework up is such that fiscal policies are decentralised and therefore uncoordinated and suboptimal. EU-wide fiscal stabilisation does not exist. In emergencies, (almost) everything lies on the ECB's shoulders. This can pose problems, as we were recently reminded by Germany's constitutional court. The crisis means that we need to rethink how the EU policy-mix is organised. In this article, we review the fiscal proposals advanced by Germany and France and taken up by the Commission, along with their implications for the ECB.
Rebalancing the policy mix in Europe
We hesitate to start with Jean Monnet’s quotation about Europe being forged during crises1. It has been wheeled out so often over the past ten years that it seems somewhat outworn now. But we must acknowledge that it suits the current circumstances. First, Europe is going through a dire economic crisis, unprecedented in peace time. Next, this crisis highlights the extent to which the policy-mix is incomplete and unbalanced. Everywhere else, in emergencies, fiscal and monetary policies are combined. Europe lacks a central fiscal mechanism designed to stabilise the business cycle, to such an extent that to move forward, it needs to walk on just one leg. In other words, it needs to rely on the ECB alone, which is the subject of much criticism2. Two recent events have prompted the ECB’s role to be reconsidered, and, by extension, Europe's policy-mix. One is the German constitutional court’s ruling of 5 May. The other is the fiscal initiative proposed by Germany and France on 18 May, forming the cornerstone of the Recovery Plan proposed by the European Commission yesterday.
➢ The ECB in the current crisis – the ECB truly grasped the gravity of the situation on 18 March. In an unscheduled meeting, it created the € 750bn Pandemic Emergency Purchase Programme (PEPP) intended to prevent spreads widening within the zone and the fragmentation of financial conditions3. Since the start of March, the ECB’s balance sheet has inflated by almost € 900bn (table lhs). This mainly involves extending liquidity lines for banks and buying securities on the credit markets, principally via the PEPP (chart rhs).
1 "Europe will be forged in crises, and will be the sum of the solutions adopted for those crises." (Memoires, 1976)
2 See our Eco Note of 10 October 2019: “ECB: a critique of the critiques”.
3 See our Eco Note of 19 March 2020: “From Draghi’s big guns to Lagarde’s PEPP-Show”.
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