Covid-19 has exposed the rational dysfunction at the heart of European decision making. It is perfectly rational for Finance Ministers such as Hoekstra (EPP – NL) and Kulmuni (RE – FI) to resist measures which are economically sound yet counter-intuitive politically. For them, a recovery fund and common crisis measures comes with immediate political cost and only long-term economic benefits for their countries.
A European Recovery Fund is an economically sound proposition; it is however clear that we won’t solve this crisis by relying on issuing more debt as most Euro countries have already high debt to GDP ratios. If countries are left to deal with the Covid crisis on their own, we can expect debt to GDP ratios to increase in line with the previous crisis, if not considerably more.
The strawman argument of mutualising existing debt is neither on the table, nor helpful or desired as a policy in general. We must understand that this isn’t a “normal” crisis.
Like generals fighting the previous war, we have politicians arguing mistakenly about the previous crisis. They are acting individually in a rational way, but unfortunately, collectively undermining our economy.
This moment calls for political leaders who are strong and committed enough to state: “I do not care only about the wellbeing of my national citizens. I care about the wellbeing of all Europeans.” Unfortunately, it seems that we are not mature enough to understand our interests geopolitically. Yet once again, many countries fall back to narrowly professing their own excellence over their immediate neighbours and natural allies, with whom they share the most.
Failure to act decisively, will cause irreparable human suffering in all EU countries either directly or indirectly. Economically weakened and bitterly divided Europe will succumb to being a wholly irrelevant global player, divided between those who lean more towards the US, Russia or China. The consequences of an economic collapse may drive more countries to follow Hungary in abandoning the principles of democracy.
THERE IS HOPE
Bizarre as it might seem, however, now is the moment to fix the Eurozone for the next 50 years while simultaneously easing the current economic crisis.
The previous economic crisis started the process of turning the ECB into the rightfully formidable global monetary actor it is. Now, it will need to take further steps to complete its evolution and assert that it will do what it takes to defend the Eurozone, without limitations.
The eurozone design is fundamentally unstable. The original designers relied on the explicit idea that necessary, yet politically difficult decisions, would be forced through by the need to survive in a crisis. That failed in the previous crisis by making the crisis longer and deeper and likely the same will happen with the current crisis. In the previous crisis, the EU’s common actions were too little, too slow and too late.
This is no time for despair but for creativity, within the confines of the Treaties. Any solution must be such that short-term political interests do not clash with long-term economics, because politics always trumps economics.
DO THE UNTHINKABLE – DIRECT FINANCING BY ECB
As previously shown, debt to GDP ratios are already high, and it is doubtful that EU countries can implement necessary economic support programmes while tax receipts dramatically fall, and expenses increase.
Austerity would be the worst possible policy to enact in the current situation economically, socially, politically and geo-politically. It would hurt the most vulnerable people and reduce demand dramatically in the short-term, while destroying our long-term growth potential.
We need to accept the unconventional nature of this crisis and the severe fiscal restrictions. Therefore, we must pursue policies that we would not normally even consider. The first measure to allow countries to support the people, would be for the ECB to reinterpret its treaty mandate, and fund Eurozone countries directly to avoid lost decades. It is a highly unusual measure but so is the situation.
Five-year inflation futures are at around 1% and demand is dramatically dropping, meaning that there is a good amount of space before inflation would become an issue.
The second step is for the ECB to effectively forgive a proportionally equal amount of Member States’ sovereign bonds that are held by the ECB. This could be done by extending ECB-held bonds payment terms until 2120 or by explicitly writing down the bonds, as a negative balance sheet would not be an issue for the ECB. The alternative would be issuing perpetual bonds as part of the Recovery Fund.
This move would create breathing space for public investments to boost demand. The alternative, tax cuts, would barely impact demand in this current situation.
FIXING EUROZONE FOR THE NEXT 50 YEARS
After those two immediate steps to avoid economic and social calamity in Europe, we must also take decisions to address the long-term structural problems in the Eurozone. Effectively, most of the toxic economic and political dynamics could be solved through two decisions.
Notably we must impose a risk-weighting on sovereign bonds and drastically cut the ability of banks to hold any single country’s sovereign debts by reforming large exposure rules.
These two decisions would cut the link between banks and sovereigns and ban banks overtly holding the bonds of the country of their domiciliation. This change would mean that if a country would find themselves in economic trouble due to bad politics and economics, there is no need to bail them out because contagion to other countries or to the real economy would be drastically reduced.
In such a circumstance, the country would go through debt restructuring and the EU would not need to impose any rules on a maximum debt to GDP ratio.
The EU’s economic rules are criticised rightfully for being economically illiterate and politically toxic. Let’s give the responsibility for sound public economics back to the capitals so they cannot shift blame for their irresponsible ideas to anyone else again.
By combining short-term measures with long-term measures, we could also remove moral hazard from the equation.
We need a sound and healthy Eurozone, which is a source of strength instead of political division for our continent to be relevant. But maybe even more, we need to mature and expand our understanding of our collective interests from narrow national to geopolitical definitions.