by James Watson*
Even by the standards of the 2008 financial crisis, the economic policy response by governments and central banks across the globe to the present crisis has been rapid and dramatic. Within days of restrictions on personal movement and economic activity being put in place, finance ministries have acted swiftly to try and secure the business eco-systems, upon which long-term growth, prosperity and employment depend.
Within the EU, we have already seen the ECB launch a new Pandemic Emergency Purchase Programme representing over 7% of GDP, a €37 billion “Corona Response Investment Initiative” from the European Commission, and liquidity support schemes by member states covering up to 13% of euro area GDP, according to the Eurogroup. The events of September 2008 may have been dramatic, but the financial crisis largely played out more slowly, with for example, the US Federal Reserve already providing huge emergency support to banks as far back as March 2008.
While the last crisis had at it roots the unsustainable build-up of debts in our financial system, the cause of the present crisis is not economic. The present economic crisis is a supply and confidence crisis, the result of sharply reduced demand, particularly in certain service sectors. If we can rapidly put in place, with sufficient magnitude, the measures needed to support cash-flow and demand in our economy, we can ensure that the economic impact of this crisis will be more short-lived than that of the last, and avoid this crisis turning into a financial crisis.
Ensuring that as many companies and their employees as possible survive the crisis ready to drive the recovery, means member states increasingly focussing support not only on availability of liquidity, but on non-repayable support to cover costs and to provide support to households. Many companies, particularly SMEs, however willing to take on further debt, simply cannot survive for a significant period with no revenue, but significant ongoing costs. Substantial support to cover costs incurred by businesses is therefore required if a large number of bankruptcies and a sharp increase in unemployment is to be prevented.
Some EU member states are already rolling out such schemes, particularly around facilitating short-term working or subsidising employment, but these need to be expanded, helping to cover costs such as rent and taxes. Putting such schemes in place as quickly as possible, and ensuring businesses have clarity regarding their eligibility will be key to giving businesses the confidence to retain staff and carry on long-term trading.
And whilst this support may initially be to business, it will of course find its way across the economy. Ensuring businesses stay solvent means more wages are paid, suppliers and creditors are honoured, and consumers actually get refunds for services that had to be cancelled. A stimulus through business is thus likely to be more efficient for public treasuries than broader based “helicopter money” such as transfers to individuals to increase demand.
Schemes to support businesses will need to be large if we are to avoid unnecessary bankruptcies and job losses. It is still early days to start assessing the possible short-term hit to GDP in our economies, particularly given its dependence upon both the depth and the length of the social distancing restrictions, which will in turn impact on the crucial question of to what extent we can keep industry producing. Most commentators are currently suggesting GDP falls in 2020 in the US and EU of between 5% and 10%, giving us a sense of the magnitude of the transfers which will be needed by governments.
Yes, these are large numbers, but again a comparison with the 2008 crisis is revealing. EU debt levels rose by almost 20 percentage points between 2008 and 2010, given the huge costs of not only helping sustain economic activity for a significant period, but also recapitalising banks. This time the intervention can be shorter and targeted at the real economy. Moreover, as Bruegel’s Guntram Wolff has pointed out, a large fiscal stimulus, by rapidly returning the economy to full output levels, is likely to ultimately lead to a similar debt/GDP ratio than a small boost that leads to a delayed rebound.
There is however a risk that the stimulus will be too timid in many member states. Details of the US’s $2trillion (10% of GDP) package are presently patchy, but it is clear that a significant part of the package is grants and not just liquidity support. The EU must not fall behind major trading partners in its ambitions. Direct stimulus measures by member states of 2% of GDP are already in place, according to the Eurogroup. It is however only a first step and we need to go further. The EU may have automatic fiscal stabilisers much stronger than those of the US economy, but much of this support only comes when workers are made unemployed, exactly the scenario we are trying to avoid.
Whilst much of this support needs to come from member states, it is crucial that the EU continues to play a supportive and co-ordinating role, fully using all the tools it has. The measures described above risk being significantly undermined if we are not able to keep the single market properly functioning, maintaining vital supply chains across member state borders for industry and consumers alike. The Ecofin Council has now suspended the Stability and Growth Pact rules and brought in a temporary state aid regime offering full flexibility, at least for support up to €800,000 per company (further flexibility is still required for larger support), following proposals from the Commission. So member states largely have the legal flexibility they need, and with bond yields at historically low levels, they can afford to be bold.
One final lesson from the 2008 financial crisis is that we should not need to rely on the ECB to do whatever it takes to defend our common currency. With debt levels relatively high in some member states, and the depth of the downturn still unknown, it is right that the Eurogroup is looking at further “lines of defence” for the euro. Such action can guarantee that all member states can provide the urgent and significant support to business essential to addressing this economic crisis.
*Chief Economist at BusinessEurope
**first published in: www.businesseurope.eu