While EU leaders battled over the right collective economic response to the coronavirus crisis on Thursday evening, the significant move had already been made the night before by the region’s central bank.
By throwing off the last shackles restraining its €750bn plan to buy bonds on Wednesday, the European Central Bank positioned itself to soak up an expected avalanche of debt that is needed to finance the region’s response to the coronavirus pandemic.
Yet one of the big debates left to be resolved is how much of this extra debt burden should ultimately be carried by national governments, the central bank or by the EU acting collectively.
Former ECB president Mario Draghi described in an article in the Financial Times on Friday how the “huge and unavoidable economic cost” of the pandemic “must eventually be absorbed, wholly or in part, on to government balance sheets”.
While most economists and policymakers agree with this assessment, the question of how to share the financial burden of coronavirus has opened deep divisions within the ECB and between European leaders.
Mr Draghi’s call for radical action and EU solidarity came after nine member states wrote a letter urging the issuance of joint European debt to finance the fight against the coronavirus ahead of a divisive European Council video conference on Thursday.
The letter argued the move was needed to ensure “stable long-term financing for the policies required to counter the damages caused by this pandemic”. But the arguments met with a frosty response on the video call from a number of northern European states hostile to demands for greater fiscal unity.
Alexander De Croo, deputy prime minister of Belgium, one of the nine signatories, argued before the leaders’ meeting that showing solidarity with fellow member states did not risk “moral hazard” given the extraordinary nature of the crisis.
“Our European interest is linked to our own national interest. It is in our interest that we give a kick-start to those economies that are impacted in a gigantic way,” he added in an interview.
Fabian Zuleeg, chief executive of the European Policy Centre, added that countries could not afford to fall back to pre-crisis orthodoxies given the scale of the challenge ahead. “The most important thing is we overcome the resistance of some national leaders to do something at the European level which is commensurate to the scale of the problem we are seeing.”
For its part, the ECB has made abundantly clear its willingness to act with “no limits”. The size and flexibility of the central bank’s new asset-purchase plan has soothed tensions in sovereign bond markets.
The ECB’s vastly enlarged and enhanced support will be needed in the coming months and years, as most economists agree with Mr Draghi’s declaration that “much higher public debt levels will become a permanent feature of our economies”.
European governments have already announced multibillion-euro rescue packages to support virus-hit companies, workers and healthcare systems. with measures that they estimate to be worth about 2 per cent of gross domestic product.
“If you add up what the EU member states are doing with their national budgets it is really impressive,” said one senior EU diplomat. “This is the hour of the member state, and not so much of the EU.”
Mr Draghi acknowledged this, but said “a more comprehensive approach is needed”. Pernille Bomholdt Henneberg, economist at Citigroup, estimated that a fiscal easing of 5 per cent of GDP was needed “given the accumulating shocks to consumer activity, business investment, and financial volatility”.
For the time being the EU leaders’ debate on joint fiscal action has focused on the use of the European Stability Mechanism as a backstop for countries that are facing deep economic slumps and spiralling borrowing needs.
However, a highly politicised debate still looms on the details of the proposals, including critically how tough the conditions attached to the loans will need to be.
Christine Lagarde, the ECB’s president, has also been urging EU leaders to go further by issuing joint debt instruments — often referred to as eurobonds — to fund the relief effort in areas hit hardest by coronavirus.
Economists say that without joint EU financing the ECB will be condemned to do most of the heavy lifting to avoid a sovereign debt crisis like the one that brought the eurozone to the brink of collapse in 2010-12.
“Whether we go through the ESM or the balance sheet of the ECB, a lot of the extra debt will end up with the central bank and that shouldn’t lead to a sovereign debt crisis,” said Guntram Wolff, director of the Bruegel think-tank in Brussels.
There are already signs that conservative voices in Germany are uncomfortable with how far the ECB is going, fearing it is straying into monetary financing of governments, which is against EU law.
Otmar Issing, the former chief economist of the ECB who is now head of the Centre for Financial Studies in Frankfurt, wrote in the Frankfurter Allgemeine newspaper this week in response to the central bank’s new €750bn bond-buying programme: “What is it other than monetary government funding that the ECB is prohibited from doing by the [EU] treaty?”
The most serious worry for economists is Italy, which has been the hardest hit by coronavirus and entered the crisis in an already weak position. Italy has the highest debt levels of any main European country, an economy that has not grown for a decade and a banking system that is still clearing up the bad loans left from the last crisis.
Economists at Goldman Sachs have predicted that Italy’s economy will shrink by 11.6 per cent this year and the extra spending required to shield companies and workers from the virus will inflate its national debt from 135 per cent of GDP to above 160 per cent.
“I want to beat the coronavirus but I don’t want to have a gigantic debt hangover afterwards. That is the big risk if I look at some of the schemes through Europe,” said Belgium’s Mr De Croo.
