The EU did what it failed to do last time: monetary and fiscal policy have reacted expeditiously. Unlike in 2012 after the eurozone debt crisis, the bloc is well fortified to survive a deep depression. But is it also prepared for a rapid recovery that helps some people but not others?
This may seem like a first-world problem — literally. But it could be a very big one because of the European habit of overloading policy instruments with multiple demands. The main function of the European Central Bank’s asset purchases is to hit monetary policy targets. But indirectly, they also keep Italy’s bond spreads lower than they would otherwise be. By fortuitous coincidence, quantitative easing becomes a solvency instrument.
That is why financial markets reacted so violently when ECB president Christine Lagarde said in March that it was not her job to close the spreads. To them it was shocking news — and indeed she quickly clarified her remark.
The European Commission’s proposed recovery fund is also overloaded. Its official function is to help raise investment. The pursuit of fiscal targets by cutting government investment was where the eurozone went wrong in the last crisis. The commission has concluded, rightly in my view, that the EU needs to focus its investments in digital and climate change technologies.
But there is a catch. The funding is linked to specific countries. If the commission gets its way, Italy stands to gain the most, in absolute terms, grants of more than €80bn over a period of up to four years. That means the commission is transforming a useful investment programme into a fiscal transfer mechanism. They are hoping to get two instruments for the price of one. It is more likely that they will get none for the price of two. In general, the number of policy goals should not exceed the number of instruments.
A quick recovery would expose the lack of clarity. If inflation rises, the ECB would face a choice. It could control inflation by ending net asset purchases, and even reducing the stock of assets on its balance sheet, or it could prioritise closing bond spreads, continue the purchases and allow inflation to rise.
The recovery fund faces a more existential problem. Unless EU leaders reach agreement at the scheduled summit in mid-July, a rapid recovery would undercut the justification for a recovery fund.
The leaders of the “frugal four” countries that oppose spending too much on coronavirus recovery — the Netherlands, Denmark, Sweden and Austria — would have a field day. They already complain that the commission’s proposal relies too much on backward-looking economic indicators to determine who gets what aid. If the frugal four manage to drag this out until a recovery gathers strength, they would be in a much stronger position.
The fuzzy logic of EU policymaking works much better in a low-growth scenario. By contrast a quick return to growth, however welcome, may end up exposing deep policy conflicts that were hidden by the doldrums that followed the last crisis. In such a bounceback, the EU would still need sustained investment in green energy and technology, but the case for fiscal transfers would become more questionable.
The same issue would also come to a head in the scenario I think is most likely: a strong but uneven recovery. It may be V-shaped for some, U-shaped for others and the most unlucky will never fully bounce back. Compare the future of an over-indebted manufacturer of analogue widgets with a global supply chain to a digital services company. The latter’s revenue and profits may have even increased during the lockdown. In the first quarter of 2020, Apple’s corporate profits were roughly equal to the combined earnings of 300 of the largest quoted EU companies — the subset of the top 500 that reported quarterly results.
I would expect the more digitally-oriented northern European economies to do well, but a 5G-fortified southern Europe could too, especially if tourism were to recover. The old industrial centres in Germany and central Europe could end up as the long-term losers from the lockdown.
Monetary policy cannot address such shifts. Fiscal policy can to some extent. But the EU’s recovery plan with pre-assigned country allocations is not the right instrument. An uneven recovery is clearly much better for most people than a continued depression. But be careful what you wish for. Managing it would require the rarest of qualities in European policymakers: clear thinking and a readiness to solve problems.
munchau@eurointelligence.com
Source: Economy - ft.com
