Even though the medical uncertainty still surrounding the developments of the pandemic is still with us, EU leaders are planning the strategies that will hopefully see their countries exiting the economic crisis. Not surprisingly, there are different opinions in northern and southern member states on what shape these strategies should take.
It must be said that the EU already faced some tough challenges before the onset of the pandemic. Countries like Italy and Spain have had to deal with their public debt that many economists argue is unsustainable. Other structural problems faced by southern states include high unemployment and loss of competitiveness.
The rescue measures introduced by the European Commission and member states leaders were generally welcomed and judged as being instrumental in preventing an even worse economic depression in Europe. But withdrawing the support that governments gave to industry to mitigate the impact of the crisis on employment and businesses will be more complicated than most people imagine. Businesses continue to pressure their governments and the ECB to keep pumping in money in the economy. But the day of reckoning will be with us sooner rather than later.
As usual, the Bundesbank officials are taking a more hawkish stance insisting that the fiscal and monetary support provided since the pandemic erupted should start to be scaled back. Jens Weidmann, the president of the German Central Bank, was never happy with the EU introducing a recovery fund of €750 billion and has warned that it risked creating “a kind of debt illusion” because the money would not be included in national debt figures.
The extent of new debt incurred by practically all EU countries to address the effects of the pandemic keeps growing. While this debt has shielded businesses and their workers from a more severe impact of the pandemic, there is no doubt that the ECB cannot keep buying the debt of over-borrowed countries forever. Quantitative easing has helped to keep interest rates low. Still, this tool has its limitations, especially if it is not coupled with the economic restructuring strategies which some member states need.
Fiscal policy should not remain lax after the worst of the pandemic is over. The reduction of the debt ratio should become one of the economic priorities for countries already suffering from a large mountain.
There is no doubt that the ECB cannot keep buying the debt of over-borrowed countries forever
The UK Chancellor Rishi Sunak has already indicated that taxes will have to go up in the next budget to start addressing the cost of government support to businesses during the pandemic. EU leaders have so far been very cautious not to talk about increased taxation to avoid creating an impression that the union will soon be engaging in a programme of austerity.
Even Germany, always considered as an exemplary model of fiscal rectitude, continues to provide cheap loans, equity investment and tax breaks for struggling companies. It also has relaxed rules on when a failing company should declare insolvency. Such measures are undoubtedly welcome but if kept in place for too long could, in the words of Weidmann, “tie workers to companies that have no future and freeze structures that are obsolete”.
The recent appreciation of the euro against practically all other currencies is an added challenge to governments seeking to find the exit route from the crisis. The strong euro is hurting exports and intensifying pressure for more monetary stimulus.
The decision of the US Federal Reserve to take a more dovish approach on inflation has helped in the appreciation of the euro. The currency markets are interpreting the move of the US Central Bank as an indication that interest rates in the eurozone are likely to remain structurally higher.
The creation of the EU recovery fund is another factor supporting the hardening of the euro as is the announcement of the French government, among others, to invest more public money in job creation schemes.
Whether central banks are running out of options to support the return to economic growth remains debatable. Some economists and central bankers believe that there is still significant monetary ammunition to help in the recovery.
Other economic analysts believe that for the time being, the ECB is unlikely to resort to any further cutting of interest rates which already stand at minus 0.5 per cent. But soon they may have to resort to more bond buying to help distressed states find the liquidity they need at a relatively low price.
Ultimately, the normalisation of monetary and policy cannot be postponed forever.