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Michael Hüther, Peter Bofinger, Sebastian Dullien, Gabriel Felbermayr, Moritz Schularick, Jens Südekum, Christoph Trebesch in NewStatesman Contribution 30. March 2020

In Order to Avoid Economic Disaster: Europe must Demonstrate Financial Solidarity

Seven leading German economists call for €1 trillion of European crisis bonds. As the coronavirus sweeps Europe and societies go into lockdown, the economies of the Eurozone are now confronted with simultaneous supply and demand shocks. As people stay at home, factories are producing less and consumers are buying less.

Healthy companies with sound business models are suddenly finding themselves on the verge of bankruptcy due to acute liquidity problems. Without massive government support, unemployment will soar, consumer spending will collapse, firms will go under and the crisis will escalate.

Now is the time for action. Europe’s governments must mitigate the economic pain by providing liquidity support (like loans and tax deferrals to keep companies from going under) and, where necessary, direct transfers (like payments to the self-employed left without earnings). This will be very expensive, but every country must be able to take the measures necessary to protect its population, stabilise its economy as far as possible, and revive it quickly after the crisis has passed.

Yet not all Eurozone member states have the same budgetary room to do so. And the financial markets are currently uncertain about the will and capacity of states in the currency union to share the burden. The yield on ten-year Italian bonds, the return that investors demand for buying its government debt, has already risen markedly.  

The experience of the last Eurozone crisis hangs over the current moment. The European banking system has been reformed since then and banks are more robust. But we do not know how long the coronavirus will last and there have already been massive drops in income. The risks are enormous. A key lesson from the last crisis is that early and aggressive action is needed to kill off doubts about the stability of the banking system and to stem speculative attacks.

How can this Herculean task be achieved? In the past, European states have assisted one another time and again when faced with serious economic crises. The European Community issued a Community Bond to combat the consequences of the 1974 oil crisis, for example. Now, once more, the time for European solidarity and risk-sharing is upon us. To do “whatever it takes” to steer our economies through this crisis, every country will have to deploy substantial financial resources. And for that, the strong must help the weak. Without common action, the coronavirus could become a second Eurozone crisis.

The strategy we are proposing is based on European crisis bonds - debt issued by Eurozone countries together under shared liability - giving all governments the budgetary headroom they need and spreading the costs of the crisis as broadly as possible. It would see the currency union’s 19 states together issue these community bonds to the value of €1 trillion or €1,000bn (around 8 per cent of Eurozone’s GDP), limited to the current crisis. Member states that risked losing access to capital markets, because investors judged it too risky to lend them money, would receive assistance from this pool.  

How would this help? As the liability for these European crisis bonds would be shared, the debt levels of the most affected states would increase only by a comparatively small margin, helping them to stay solvent. And the bonds would act as a “safe asset”, a low-risk asset that Eurozone banks could use as collateral for other loans (to companies for example). That would reduce the risk of a repeat of the “doom loop” between ailing banks and financially strained governments that was central to the last Eurozone crisis. Europe thus could assist the countries that have been particularly hard hit and prevent them from facing a banking and financial crisis through no fault of their own.

What safeguards would there be? Crucially this would be an emergency fund for crisis management, i.e. a one-off measure like the Community Bond issued during the oil crisis. The maturity of the bonds would be as long as possible, with the interest and repayment obligations of the individual states being based on their share of the European Central Bank’s (ECB) capital. It is probably safe to assume that the bonds could be placed on the market on favourable terms.

And how would they fit into the Eurozone’s institutional architecture? The crisis bonds would involve a strong but complementary role for the ECB as the guarantor of market stability and the setter of the Eurozone’s interest rates. The bank has already responded to the rising risk premiums on government bonds with its Pandemic Emergency Purchase Program. And while the European Stability Mechanism (ESM) - the rescue fund set up in 2012 and a creature of that era, should not take the central role in helping member states through the current crisis - there would be a practical case for mandating it to issue and manage the crisis bonds to ensure prompt, reliable implementation.

The bonds would send a strong signal that Europe stands together in tackling the crisis, a signal that no one could fail to notice. Overstretched countries would not be left alone to beg for help, nor would there be stigma attached to taking on joint debt.

Under our strategy they would be flanked by several additional policy tools. First, the ECB should continue to stabilise government debt markets via the new Pandemic Emergency Purchase Program, thereby preventing any speculation about the stability of public finances and thus the refinancing of existing debt. Second, the stigmatising terms attached to ESM programmes, the bailouts, should be temporarily suspended to ensure governments can roll over their existing debt and to prevent speculation against individual countries, or all countries applying for ESM programmes.  

Third, substantial resources must be put into preventing Eurozone banks from failing. The ESM’s €60bn for bank recapitalisations, infusions of capital enabling banks to keep lending, should be ramped up to €200bn to help to ensure that no doubts arise regarding their soundness. This mechanism must be employed flexibly as a first line of defence and not, as has been the case in the past, only once the resources of the member state concerned have been exhausted. This would help prevent the risky self-reinforcement of bank weakness and declines in market confidence in the stability of public finances.

The dynamics of this crisis are massive and unpredictable, so strong signals of political capacity to act together are needed. The ECB’s emergency measures so far are welcome steps towards stabilising Eurozone markets. But the political will to follow up with bold fiscal measures on the European level must not flag now. In the last Eurozone crisis, ECB interventions all too often led to a complacent sense of stability, and political efforts stalled. This negative feedback loop substantially increased the costs of the crisis for European economies. It must not do so again.

It is now of paramount importance not to lose more time. The longer the coronavirus crisis goes on and the greater the economic impact, the more obvious the existing differences in the fiscal capacity of countries will become. This would disunite Europe - at a time when it must stand together.

To contribution at newstatesman.com

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