Beyond the immediate threat to public health, the coronavirus has also pushed most European economies onto a slower growth track, all but ensuring a more difficult recovery over the long term. To prevent the worst, EU policymakers must address the looming shortfall in public and private investment.
WASHINGTON, DC/GENEVA – Central banks have learned a lot from previous crises and are now acting on those lessons. But economic policymakers at all levels must avoid the age-old trap of fighting the last war.
To be sure, as has been widely noted, central banks on both sides of the Atlantic met the economic fallout from the COVID-19 pandemic faster and on a greater scale than ever before. Major decisions were made in the space of just days or weeks, rather than months or years, as was the case after the 2008 global financial crisis. This decisiveness has averted a complete economic collapse, and possibly the breakdown of many societies.
But we are still in the rescue phase of the current crisis. Soon enough will come the time for recovery, for envisioning a better world. The precise meaning of “better” will be discussed in due time. But for Europe, the immediate issue is what to do next, after the 2008-2012 playbook has been fully deployed.
The Response Until Now
Following the sudden collapse of two Bear Stearns hedge funds in 2007, it took almost six months for the major central banks to pursue concerted action, and another ten months for the G7 to adopt a plan to guarantee liquidity and restore confidence in the global financial system. Not until November 2008 did the G20 call an emergency meeting.
This time around, central banks and governments reacted almost immediately. On March 3, the US Federal Reserve became the first central bank to lower its benchmark rate, and it has since been purchasing bonds on both the primary and secondary markets – something it did not do in 2008. The Fed has also reactivated its currency-swap lines with other central banks, and deployed additional mechanisms to provide liquidity to commercial banks and companies. For its part, the European Central Bank has abandoned its rules for limiting sovereign and corporate bond purchases, launching a €750 billion ($811 billion) Pandemic Emergency Purchase Program, among other measures.
Meanwhile, in order to limit the indirect effects of the supply and demand shocks resulting from the pandemic, many governments have rolled out stimulus and other programs to support the economy, with three main objectives in mind. Policymakers want to provide companies the liquidity needed to prevent a cascade of bankruptcies and safeguard the economy’s productive capacity. They have also allocated additional aid to prop up sectors whose activities have been halted as a result of lockdowns. And they have disbursed cash and other subsidies to support household incomes, in order to prevent the demand shock that would follow from a sudden and sharp increase in precautionary savings.
Owing to the unprecedented nature of the shock, policymakers have been (understandably) focused on the short term. Official data released since the beginning of the pandemic have confirmed that the global economy, and virtually every national economy, has experienced a nosedive. The massive, sudden decline in demand as a result of the lockdown is having especially adverse effects on developing and emerging economies, where there are growing fears of food shortages, or even famine. For the first time in two decades, poverty is rising globally.
Given these developments, it is clearly time to launch the next phase of the crisis response, so as to limit the negative hysteresis of the pandemic and prevent a further increase in poverty. Phase I has been implemented – the pandemic’s direct short-run economic impact has been absorbed. Now, governments must start planning for the recovery.
The Investment Crisis
Beyond the short-term objective of preventing bankruptcies and limiting the blow to disposable incomes, policymakers also need to consider the implications of declining public and private investment, which will weigh on per capita GDP growth well into the future. The suspension of investment plans will postpone industrial upgrading and modernization, and accelerate capital depreciation, including in the service sector, which has been hit especially hard. Worse, reduced investment will jeopardize the transition to a low-carbon economy, which itself is necessary for ensuring a sustainable and prosperous future.
The risks stemming from slower growth will be felt everywhere, but nowhere more so than in Europe. In the eurozone especially, aging production capacity and infrastructure, weak capital contributions, and declining potential growth are cause for serious concern. So, too, is the lack of European coordination in responding to the pandemic, which has so far been animated by a “me first” attitude. Without closer coordination and a plan for the future, the only lasting legacy of a low-growth decade capped by a crisis will be a higher debt-to-GDP ratio.
To be sure, eurozone member states have devised some remedies, including short-term fiscal stimulus, an extension of existing precautionary credit lines under the European Stability Mechanism, and financial assistance channeled through the European Investment Bank to support workers. But these measures are unlikely to be sufficient. The European rescue package may already be unprecedented in many ways, but that doesn’t mean it will address the specific problem of aging capital stock, which will act as a drag on growth indefinitely.
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As such, it is time to expand the 2008-2012 playbook, by creating a European recovery fund. The point is not merely to announce a trillion-dollar program to calm investors, shore up debtor countries, and ensure eurozone financial stability – though it would do all of those things. Rather, a European recovery fund also must mobilize the right kind of public- and private-sector investment. European Union member states desperately need to halt the decline in living standards, lest that trend exacerbate pre-existing social and political tensions, further undermining Europe’s global leadership.
Moreover, a forward-looking recovery fund offers not only a way to complete the eurozone’s institutional architecture, but also a mechanism for managing the economic implications of an aging population. Despite the weaknesses of a non-optimal currency union, Europe’s policy mix must address sovereign-debt risks, in addition to targeting higher potential GDP growth. To that end, European policymakers could consider some proposals that remain on the table from the 2010 Greek crisis. Among these, one of the most viable options is to establish a European Redemption Fund, as outlined by the German Council of Economic Experts.
Under this plan, a member state could transfer the portion of its public debt that exceeds the 60%-of-GDP limit set by EU rules to a common refinancing platform. In return, that country would enter into a repayment plan, through which it would cover its transferred debts over the course of 20-25 years. The Redemption Fund was primarily meant to provide support in the event of a liquidity crisis. But it also offers a way around the red line that the Germans, Dutch, Finns, and Austrians have drawn at Eurobonds. Now that the pandemic has brought on a twin demand and supply shock, it is time to revive the idea. The clock is ticking.
Breaking Through
As matters stand, the European Council has asked the European Commission to formulate a concrete proposal for a “recovery fund,” and the Spanish government has called for such a program to be financed through the EU budget with the issuance of perpetual bonds. Importantly, the fund would extend not loans but grants. And, given that Europe can scarcely afford a divisive debate about Eurobonds (or Coronabonds) at the moment, a recovery fund probably represents the most realistic proposal on the table.
Under such a scheme, the proposed fund could be used to pool and refinance member states’ sovereign debts that result from public and private investments made over the next two or three years, a variant on the mechanism in the original Redemption Fund proposal. Moreover, the refinancing platform could apply some form of bonus-malus (reward-penalty) provision to promote investments in low-carbon energy and infrastructure, public health, 5G, and so forth. With interest rates near or below zero, such outlays should be considered as cash-flow or opportunity costs, not as additional public debt.
These investments promise higher potential GDP, which is the best way to curb the increase in debt. Such a fund also would signal that Europe has opened a new chapter in its development. But first, we must avoid a repeat of 2013, when the earlier proposal for a Redemption Fund was smothered in its crib. The theoretical and practical difficulties of the task at hand should not be underestimated, but nor should we ignore the lessons from previous crises, or the benchmarks established in earlier debates about quantitative easing, negative interest rates, or the unlimited provision of low-rate credit. Past experience shows that Europe is perfectly capable of updating its playbook quickly.
European policymakers must recognize that neither the rescue nor the recovery will succeed without the necessary financial plumbing. At the same time that governments are extending support to hundreds of thousands of companies and institutions, they must lay the foundation for financing renewed investment. The first effort should be guided by principles of fairness and efficiency, the second by forward-looking strategic thinking.
Though the COVID-19 crisis is unprecedented in so many ways, Europe has been here before, most recently during the debates over the Juncker Plan. That investment program has since chalked up notable successes, while also revealing certain limitations. It has shown that Europe now needs investment an order of magnitude larger than anything that has come before.
Beyond quantity, the quality of investment will determine Europe’s long-term economic prospects. To succeed, any recovery plan must transform billions into trillions. It needs to direct investment toward real social needs, while minimizing windfall effects that reinforce existing inequalities. The goal is to build a new future, not merely to restore the past. That will require tough decisions.
Changing the Game
The most obvious “game changer” for Europe is the plan for a Green Deal that the European Commission unveiled last year. Through large-scale investments in renewable energy and other pillars of sustainable development, the Green Deal offers a roadmap for Europe to reposition itself as a global leader after the pandemic.
Moreover, the Green Deal already recognizes that marshaling the necessary resources and spending them the right way will require fundamental changes in how public and private actors operate – and, more important, cooperate. The current crisis has lent further urgency to this task, pointing to the need for a widespread change in norms and rapid standardization of how proposed investments are assessed.
Some commentators have rightly called for something akin to another Marshall Plan. But what is often forgotten is that the original Marshall Plan involved much more than massive financial transfers. It changed how Europe operates, from the level of firm management all the way up to the geopolitical dimension. Now is the time for Europe to make another quantum leap.
Success will depend, above all, on avoiding doubt and maintaining trust between and within countries. The structures put in place during and after the crisis must not raise suspicions or seem obviously unfair. They should come with mechanisms for independent review and oversight, lest we once again set the stage for another crisis ten years from now. In confronting a virus that threatens everyone, European leaders must remember that their duty is to the many, not the few.
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Raghuram G. Rajan & Rohit Lamba
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WASHINGTON, DC/GENEVA – Central banks have learned a lot from previous crises and are now acting on those lessons. But economic policymakers at all levels must avoid the age-old trap of fighting the last war.
To be sure, as has been widely noted, central banks on both sides of the Atlantic met the economic fallout from the COVID-19 pandemic faster and on a greater scale than ever before. Major decisions were made in the space of just days or weeks, rather than months or years, as was the case after the 2008 global financial crisis. This decisiveness has averted a complete economic collapse, and possibly the breakdown of many societies.
But we are still in the rescue phase of the current crisis. Soon enough will come the time for recovery, for envisioning a better world. The precise meaning of “better” will be discussed in due time. But for Europe, the immediate issue is what to do next, after the 2008-2012 playbook has been fully deployed.
The Response Until Now
Following the sudden collapse of two Bear Stearns hedge funds in 2007, it took almost six months for the major central banks to pursue concerted action, and another ten months for the G7 to adopt a plan to guarantee liquidity and restore confidence in the global financial system. Not until November 2008 did the G20 call an emergency meeting.
This time around, central banks and governments reacted almost immediately. On March 3, the US Federal Reserve became the first central bank to lower its benchmark rate, and it has since been purchasing bonds on both the primary and secondary markets – something it did not do in 2008. The Fed has also reactivated its currency-swap lines with other central banks, and deployed additional mechanisms to provide liquidity to commercial banks and companies. For its part, the European Central Bank has abandoned its rules for limiting sovereign and corporate bond purchases, launching a €750 billion ($811 billion) Pandemic Emergency Purchase Program, among other measures.
Meanwhile, in order to limit the indirect effects of the supply and demand shocks resulting from the pandemic, many governments have rolled out stimulus and other programs to support the economy, with three main objectives in mind. Policymakers want to provide companies the liquidity needed to prevent a cascade of bankruptcies and safeguard the economy’s productive capacity. They have also allocated additional aid to prop up sectors whose activities have been halted as a result of lockdowns. And they have disbursed cash and other subsidies to support household incomes, in order to prevent the demand shock that would follow from a sudden and sharp increase in precautionary savings.
Owing to the unprecedented nature of the shock, policymakers have been (understandably) focused on the short term. Official data released since the beginning of the pandemic have confirmed that the global economy, and virtually every national economy, has experienced a nosedive. The massive, sudden decline in demand as a result of the lockdown is having especially adverse effects on developing and emerging economies, where there are growing fears of food shortages, or even famine. For the first time in two decades, poverty is rising globally.
Given these developments, it is clearly time to launch the next phase of the crisis response, so as to limit the negative hysteresis of the pandemic and prevent a further increase in poverty. Phase I has been implemented – the pandemic’s direct short-run economic impact has been absorbed. Now, governments must start planning for the recovery.
The Investment Crisis
Beyond the short-term objective of preventing bankruptcies and limiting the blow to disposable incomes, policymakers also need to consider the implications of declining public and private investment, which will weigh on per capita GDP growth well into the future. The suspension of investment plans will postpone industrial upgrading and modernization, and accelerate capital depreciation, including in the service sector, which has been hit especially hard. Worse, reduced investment will jeopardize the transition to a low-carbon economy, which itself is necessary for ensuring a sustainable and prosperous future.
The risks stemming from slower growth will be felt everywhere, but nowhere more so than in Europe. In the eurozone especially, aging production capacity and infrastructure, weak capital contributions, and declining potential growth are cause for serious concern. So, too, is the lack of European coordination in responding to the pandemic, which has so far been animated by a “me first” attitude. Without closer coordination and a plan for the future, the only lasting legacy of a low-growth decade capped by a crisis will be a higher debt-to-GDP ratio.
To be sure, eurozone member states have devised some remedies, including short-term fiscal stimulus, an extension of existing precautionary credit lines under the European Stability Mechanism, and financial assistance channeled through the European Investment Bank to support workers. But these measures are unlikely to be sufficient. The European rescue package may already be unprecedented in many ways, but that doesn’t mean it will address the specific problem of aging capital stock, which will act as a drag on growth indefinitely.
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Subscribe now to gain greater access to Project Syndicate – including every commentary and our entire On Point suite of subscriber-exclusive content – starting at just $49.99.
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As such, it is time to expand the 2008-2012 playbook, by creating a European recovery fund. The point is not merely to announce a trillion-dollar program to calm investors, shore up debtor countries, and ensure eurozone financial stability – though it would do all of those things. Rather, a European recovery fund also must mobilize the right kind of public- and private-sector investment. European Union member states desperately need to halt the decline in living standards, lest that trend exacerbate pre-existing social and political tensions, further undermining Europe’s global leadership.
Moreover, a forward-looking recovery fund offers not only a way to complete the eurozone’s institutional architecture, but also a mechanism for managing the economic implications of an aging population. Despite the weaknesses of a non-optimal currency union, Europe’s policy mix must address sovereign-debt risks, in addition to targeting higher potential GDP growth. To that end, European policymakers could consider some proposals that remain on the table from the 2010 Greek crisis. Among these, one of the most viable options is to establish a European Redemption Fund, as outlined by the German Council of Economic Experts.
Under this plan, a member state could transfer the portion of its public debt that exceeds the 60%-of-GDP limit set by EU rules to a common refinancing platform. In return, that country would enter into a repayment plan, through which it would cover its transferred debts over the course of 20-25 years. The Redemption Fund was primarily meant to provide support in the event of a liquidity crisis. But it also offers a way around the red line that the Germans, Dutch, Finns, and Austrians have drawn at Eurobonds. Now that the pandemic has brought on a twin demand and supply shock, it is time to revive the idea. The clock is ticking.
Breaking Through
As matters stand, the European Council has asked the European Commission to formulate a concrete proposal for a “recovery fund,” and the Spanish government has called for such a program to be financed through the EU budget with the issuance of perpetual bonds. Importantly, the fund would extend not loans but grants. And, given that Europe can scarcely afford a divisive debate about Eurobonds (or Coronabonds) at the moment, a recovery fund probably represents the most realistic proposal on the table.
Under such a scheme, the proposed fund could be used to pool and refinance member states’ sovereign debts that result from public and private investments made over the next two or three years, a variant on the mechanism in the original Redemption Fund proposal. Moreover, the refinancing platform could apply some form of bonus-malus (reward-penalty) provision to promote investments in low-carbon energy and infrastructure, public health, 5G, and so forth. With interest rates near or below zero, such outlays should be considered as cash-flow or opportunity costs, not as additional public debt.
These investments promise higher potential GDP, which is the best way to curb the increase in debt. Such a fund also would signal that Europe has opened a new chapter in its development. But first, we must avoid a repeat of 2013, when the earlier proposal for a Redemption Fund was smothered in its crib. The theoretical and practical difficulties of the task at hand should not be underestimated, but nor should we ignore the lessons from previous crises, or the benchmarks established in earlier debates about quantitative easing, negative interest rates, or the unlimited provision of low-rate credit. Past experience shows that Europe is perfectly capable of updating its playbook quickly.
European policymakers must recognize that neither the rescue nor the recovery will succeed without the necessary financial plumbing. At the same time that governments are extending support to hundreds of thousands of companies and institutions, they must lay the foundation for financing renewed investment. The first effort should be guided by principles of fairness and efficiency, the second by forward-looking strategic thinking.
Though the COVID-19 crisis is unprecedented in so many ways, Europe has been here before, most recently during the debates over the Juncker Plan. That investment program has since chalked up notable successes, while also revealing certain limitations. It has shown that Europe now needs investment an order of magnitude larger than anything that has come before.
Beyond quantity, the quality of investment will determine Europe’s long-term economic prospects. To succeed, any recovery plan must transform billions into trillions. It needs to direct investment toward real social needs, while minimizing windfall effects that reinforce existing inequalities. The goal is to build a new future, not merely to restore the past. That will require tough decisions.
Changing the Game
The most obvious “game changer” for Europe is the plan for a Green Deal that the European Commission unveiled last year. Through large-scale investments in renewable energy and other pillars of sustainable development, the Green Deal offers a roadmap for Europe to reposition itself as a global leader after the pandemic.
Moreover, the Green Deal already recognizes that marshaling the necessary resources and spending them the right way will require fundamental changes in how public and private actors operate – and, more important, cooperate. The current crisis has lent further urgency to this task, pointing to the need for a widespread change in norms and rapid standardization of how proposed investments are assessed.
Some commentators have rightly called for something akin to another Marshall Plan. But what is often forgotten is that the original Marshall Plan involved much more than massive financial transfers. It changed how Europe operates, from the level of firm management all the way up to the geopolitical dimension. Now is the time for Europe to make another quantum leap.
Success will depend, above all, on avoiding doubt and maintaining trust between and within countries. The structures put in place during and after the crisis must not raise suspicions or seem obviously unfair. They should come with mechanisms for independent review and oversight, lest we once again set the stage for another crisis ten years from now. In confronting a virus that threatens everyone, European leaders must remember that their duty is to the many, not the few.