Economic policies for the aftermath of COVID-19

In the panel on economic policies in the aftermath of COVID-19 at the 2020 The State of the Union Conference, the Institute brought together Laurence Boone, chief economist of the Organization for Economic Co-operation and Development (OECD); Jeroen Dijsselbloem, former President of the Eurogroup; Ricardo Reis, A.W. Phillips Professor of Economics at the London School of Economics and Political Science (LSE) and EUI Professor George Papconstantinou to discuss the main issues in this regard.

The session launched with  a high-level opening address by European Central Bank President Christine Lagarde who identified the COVID-19 crisis as ‘our generation’s Schuman moment’ and called for bold collective action by governments and the EU. Lagarde was followed by a high-level discussion led by FT editor Roula Khalaf with EU Commissioner for Economic and Financial Affairs Paolo Gentiloni, who stressed the need for a ‘macroeconomically significant recovery fund’.

The panel essentially addressed three main questions.

What type of economic recovery can we expect?

Without doubt, the economic shock from the COVID-19 pandemic will be large; what is more, the outlook is conditioned by the health risks and the advances towards a vaccine. In this environment, rather than projections we should be talking about economic scenarios.

In light of such significant uncertainties, the potential shape of the recovery may not be a choice between a ‘V’ shape indicating a strong rebound, an ‘L’ shape indicating prolonged stagnation, a ‘U’ shape suggesting a bit of both, or a ‘W’ shape reflecting the second wave of infections. We could instead have a three-pronged, ‘ABC’ process: (A) a very sharp fall in economic output, followed by (B) a sharp but limited initial recovery, powered by those who are able to go back to work and spend; and (C) a protracted and slow recovery to pre-crisis levels of economic activity, marked by lasting scars from the recession. Some capacity will have been lost; there will be need for some reallocation of resources across sectors, we are likely to see an increase in precautionary savings, and certainly a debt overhang as a symmetric shock has materialised in an asymmetric way in terms of countries and sectors.

Preventing a financial crisis will be paramount to a faster recovery, in a situation where compared to the sovereign debt crisis, the speed of impact and the disruption have been faster and deeper, the effects in society larger but also where the policy response has been more aggressive.

What should economic policy responses at the national level look like?

All EU member states have attempted to mitigate the impact of the pandemic through unprecedented fiscal measures, including additional public investment, direct transfers, guarantees, tax deferrals and rebates. But has the policy response at national level been appropriate in terms of the size and mix of the measures adopted?

On the whole, national governments have reacted boldly, decisively and with the right measures, but both policy design and fiscal capacity differs significantly, resulting in higher but also highly varied debt levels post-crisis. Addressing sizeable debt overhangs will involve structural reforms and debt reduction policies, though we should avoid a repeat of the mistakes of excessive austerity as in the sovereign debt crisis. Indebtedness however is not only a problem with sovereigns; hence the importance to push forward the capital markets union which will be helpful to finance corporates and the economy, as well as reforming bankruptcy procedures which will help governments deal with firms that face solvency and not just liquidity problems.

In general, after a first phase of broad-based support including extensive help to keep people in jobs, we now need to move to more targeted support, facilitating also reallocation in the labour force so that workers can move jobs where necessary, but in the process avoiding further increase in inequality. In this second phase, the operation of the internal market will be key: following the relaxation of its rules in the first phase, the existing asymmetry in the system needs to be tackled so as to maintain its integrity when supporting corporates, in a manner analogous to common EU rules for bank bailouts by governments in the sovereign debt crisis.

What about the E(M)U-level economic policy response?

At the European level, the bulk of the common response has come from the ECB, where we have witnessed rapid and determined policy action, involving an envelope of around €1 trillion in asset purchases. Such monetary policy operations are appropriate to maintain financial stability and commensurate in terms of magnitude and ambition to that of central banks in other parts of the world. They are also proportional and within the ECB’s mandate of inflation targeting as set out in the European Treaties.

The challenge to the ECB by the German Constitutional Court is economically misplaced, can be market-disrupting, while also putting into question the primacy of EU law. We have also witnessed a relaxation of fiscal rules, several fiscal initiatives based on the ESM, the EIB, and an unemployment re-insurance scheme to be set up under the roof of the European Commission (SURE). Nevertheless, a more sizeable and coordinated fiscal response is called for as some kind of a ‘safe asset’ is required to defend the integrity of the euro and support its role in international markets, while helping countries avoiding excessive indebtedness by involving more grants that loans.

The EU should issue joint debt to finance joint spending including on European public goods to assist the recovery from the pandemic but also the green and digital transition of the EU, to be repaid by means of new joint own fiscal resources in the context of a broader MFF, with the arrangement remaining under EU governance and joint democratic control. Whether it will be able to do so will depend on combining solidarity with responsibility and enlightened self-interest against a political debate that continues to be dominated by significant distrust in many countries.

Dr. Sebastian Diessner is a Max Weber Fellow at the European University Institute.

Professor George Papaconstantinou is a faculty member of the EUI’s School of Transnational Governance.

Video recordings of this session and others are available on The State of the Union 2020 website.