Eurozone – Time for Eurobonds?
Corona Workshop: A summary of the session "Eurozone - is this the time for Eurobonds?" (Video included) during our Corona Economic Workshop on 22 April. Simon Tilford has assembled quotes and analyzes the discussion during the session.
PUBLISHED23. APRIL 2020
READING TIME6 MIN
The corona crisis has exposed the uneven fiscal capacity of eurozone governments. Some are able to spend far more on combating the economic downturn than others, risking further divergence between stronger and weaker economies. The session chair, Christian Odendahl, kicked off by asking whether the “EU risks becoming a machine that enforces asymmetry, rather than one that fosters convergence.” The session panelists – Jakob von Weizsäcker, Moritz Schularick, Silvia Merler and Christian Kastrop agreed what essentially started out as a symmetric shock – that is, one that threatened to affect all economies equally hard – risked morphing into an asymmetric shock that hit some member-states much harder than others.
There was agreement that without transfers of some kind between the stronger and weaker members of the currency union, we would see further economic divergence between the member-states, casting into doubt the political future of the eurozone. As Moritz Schularick argued, “Italy’s ratio of public debt to GDP had probably already risen from around 135% of GDP to over 150% as a result of the collapse of economic activity and could easily exceed 180% next year.” No Italian government would agree to anything that relied on open-ended austerity to bring down that deficit; any attempt to enforce this on Italy would backfire, bringing Salvini to power, and ultimately lead to an Italian exit from the eurozone.
Silvia Merler confirmed that Italy’s already Eurosceptic politics had shifted further against the EU as a result of the corona crisis. There was a widespread popular perception in Italy that the EU had shown the country too little solidarity in its hour of need. The ESM had become especially toxic in Italian politics – any strategy that relied on lending Italy money rather than transferring funds would be met with stiff resistance. Silvia argued that the reasons for Italy’s poor economic performance within the eurozone were complex, and owed much to previous policy mistakes, such as the build-up of public debt in the 1980s. But that this didn’t change the fact that “Italy had been running primary budget surplus since 1995, its economy had barely grown since the introduction of the euro and had now shrunk massively”. The country faced a highly uncertain recovery path, not least because “around 50% of the domestic production of Italian manufacturing sector is driven by consumption abroad”, and the outlook for that consumption was highly uncertain.
There was broad agreement among the panelists that moral hazard was not an issue right now. The challenge was to prevent a dynamic of economic divergence from establishing itself. The longer this dynamic went on, the harder it would become to gain agreement on the steps needed to tackle that divergence. The task was to find methods of temporarily transferring funds between member-states in a way that was politically sustainable. While there were de facto transfers of funds between member-states through the ESM – recipients benefited from lower borrowing costs – the ESM was not really a solution to the current crisis, and in particular not to the Italian case; the country’s debt burden was just too high to take on new borrowing.
Ways were needed to transfer funds without increasing the debt burden of the hardest hit countries, and therefore worsening their growth prospects.
This posed a formidable political challenge. For example, the quid pro quo for mutualization and transfers could not be de facto EU control over Italian policymaking. That would be undemocratic but also poison relations between Italy and other member-states. But, as Jakob von Weizäcker argued, “neither was it possible to mutualize debt and transfers without closer political integration.” This was substantiated by Christian Kastrop, who stressed that “Many German opponents of Eurobonds (or coronabonds) were not hostile to them in principle but struggled to see a way through this political conundrum.” Thomas Fricke argued that the debate in Germany was moving rapidly: things that would have been unthinkable as recently as 3 months ago were now being openly discussed.
The economic Recovery Program for the eurozone needed to mutualize the cost of fighting the fallout from the crisis without institutionalizing transfers between member-states. One potential option would be for all member-states to raise 5% of GDP in new borrowing, which would then be pooled and allocated to where it was most needed. An alternative would be for the Commission to borrow the money itself: according to Moritz Schularick, “this would be a “one off instrument and legal under article 122 of the EU.” Jakob von Weizaecker stressed that if the EU is a Schicksalsgemeinschaft there has to be solidarity, but that there are ways and means of providing that solidarity: “The corona crisis may yet be a Hamiltonian moment for Europe. Having a common asset may imply a shift to more competencies at the EU level and something like a fiscal authority”. But, he added, “we have to be careful to avoid taking steps now that could undermine support for essential integrative steps in the future.” For example, an alternative to explicit Eurobonds could be a lower profile move to expand the EU budget by allowing it to borrow more. One advantage of this was that the EU had established structures in place for distributing money among the member-states according to need.
This was a good segue into a discussion of the Recovery Fund proposal put forward by the Spanish government. This foresees a fund of €1.5trillion financed by perpetual debt backed by the EU budget. Countries would receive money as transfers rather than debt. While this was viewed as a useful attempt at addressing the deadlock within the eurozone, there was concern that it would fail to overcome the concerns of the Northern block of countries – as they would lack much say over how the money was to be distributed – or the Italians, who could fear it was not sufficiently open-ended.
Finally, there was broad recognition that whatever is agreed by the Eurogroup, the future stability of the eurozone will require the ECB to carry out its lender of last resort function to the full degree. What would this mean in practice? Would it, as Moritz Schularick asked, involve a commitment by the central bank to ensure that difference in German and Italian government borrowing costs is held to 50 basis points? Such a strategy might ensure the sustainability of Italy debt. Or will the ECB tolerate higher spreads: they are currently 160 basis points? If so, the outlook for Italian solvency would be highly uncertain, and Italy could end up leaving the currency union, with very damaging implications for Europe as a whole.