Back when the eurozone was in the throes of a crisis, Mario Draghi, then president of the European Central Bank (ECB) responded with a simple, seemingly off-the-cuff phrase; “whatever it takes”. Draghi fundamentally changed the course of events, calming the 2012 eurozone debt crisis and bringing down bond yields of the weaker euro-member governments.
Now, can the same be said for Christine Lagarde? Perhaps not.
Rebuffing suggestions that she sought to emulate the legacy of her predecessor, along with the limited package of measures, to alleviate the economic chaos caused by the spread of coronavirus, certainly didn’t play well. While keeping the key rate unchanged (which disappointed markets), to try mitigate the significant impact set to ensue, the governing council of the ECB boosted quantitative easing, by injecting an additional €120bn into the economy by the end of the year, on top of its €20bn a month asset purchase commitment.
This move was heavily criticized. Rather than reassuring markets, Lagarde’s insufficient response triggered a bond market sell-off. Investors concerned with the significant shock to the growth prospect of the global economy, particularly that of the euro area, which, economically speaking has weaker fundamentals than the likes of the US and China, sought the relative safety of treasuries, sending yields which move inversely to price, to panicky lows.
In addition to announcing the ECB’s latest monetary policy easing measures, former IMF chief urged governments and all other policy institutions within the eurozone to come up with an “ambitious and collective fiscal response”, to cushion the significant disruptions to economic activity, particularly; a slowdown in production and a reduction in domestic and foreign demand. Although, theoretically speaking, enacting expansionary fiscal policy as suggested by Lagarde, is considered to be the ideal course of action at this juncture, employing it is indeed no easy task, particularly when considering that the economic situation of the government in question, which is already subdued and which does not enjoy fiscal space.
To clarify thoughts; fiscal space is the budgetary room that allows a government to raise spending or lower taxes, thus stimulating the economy, without compromising market access and putting debt sustainability at risk. Albeit typically frowned upon, and widely portrayed as irresponsible, instilling an unbalanced budget, one leaning more towards higher expenditure through expansionary fiscal policy, is imperative at this juncture. In a bid to try mitigate the significant impact on economic growth set to ensue, several European countries have already stepped in.
Notably, to soften the impact and thus ensure companies can weather the crisis, Europe’s largest economy; Germany, pledged unlimited cash to businesses hit by the virus through a massive expansion of loans and allowing companies to defer billions of euros in tax payments. For a government that for years has been committed to the ideology of balanced budgets and no new borrowing, this move has caught everyone by surprise as it signifies the enormity of the challenge coronavirus poses for an export-oriented economy like Germany’s, one, which is heavily reliant on global supply chains and the free flow of trade.
Similarly, the Prime Minister of Europe’s worst-hit country Giuseppe Conte announced that his government is going to intervene and spend as much as €25bn to shield the economy. The provisions under discussion include but are not limited to; help for workers facing temporary layoffs, compensation for companies whose revenues plunged by more than 25 per cent since the outbreak and boosting a guarantee fund for loans to small and medium enterprises (SMEs).
Undoubtedly, as more European countries follow suit and thus implement the necessary fiscal measures, the concerted effort to stimulate the economy shall pay dividends. Whether this will be enough to safeguard Europe from another financial crisis is, at this stage, too early to predict.
Disclaimer: This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.