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March 27, 2020

Watch out for the coalition of the south

The most interesting aspect about last night’s European Council is that Italy and Spain, for the first time, have formed a de facto coalition. This time, Portugal is also on board. António Costa criticised Dutch pettiness as threatening the future of the EU. During the eurozone crisis, the periphery never formed a political coalition. This is now different.

Last night’s European Council was a failure. The meeting ended with no agreement, only a perfunctory declaration. The leaders passed the buck back to the eurogroup, but without giving any direction.

Oddly, we think this is good. The absolute worst outcome would have been agreement to use a small ESM credit facility to deal with a large symmetric shock. Our estimate of the fiscal effects of this crisis has been in the range of 20-50pp, probably towards the upper end now. It could be higher. Not only does this go beyond the capacity of the ESM, but it requires a much different instrument than a credit facility or country programme. 

There is no movement from Germany and the Netherlands. Angela Merkel yesterday categorically ruled out what is known as a coronabond, a one-time-only mutualised asset. Mark Rutte said eurobonds were inconsistent with the design of the eurozone.

We noted a revealing comment in FAZ, which said that Germany achieved a partial victory yesterday: it succeeded to frustrate a permanent anti-crisis group at EU level. This tells us that we are at a point where the frustration of crisis resolution is celebrated in the media as a political victory. We note that even the left in Germany is not interested in a European solution anymore. They are celebrating their Keynesian moment. But it is a national celebration. 

What is clear is that the new south-western alliance will not get their eurobond, at least not in the form of a mutualised security underwritten by all 19 members. It would, however, make sense for them to do it among themselves. But, even without a eurobond, they are in a much stronger position now compared to 2012, because of the ECB’s de facto unlimited support. There is nothing much an ESM credit line would do for Italy. Right now, Italy can raise as much cash through the bond market as it requires. The pandemic emergency purchase programme is better than OMT. It is unconditional and, while not officially unlimited, it is de facto unlimited. Even the capital key is ultimately irrelevant, not only because the increase in German debt issuance provides some headroom. None of the limits have ever constituted a real-world constraint to prevent the ECB from doing what it needed to do. They were legal smokescreens, to be broken when expedient.

The only instrument that would make a difference for Italy and Spain right now is one that would reduce the countries’ sovereign debt load. There are various ways in which this could be done. 

On a technical level, a mutualised eurobond would constitute the plain-vanilla tool. It could be technically replicated in other, less transparent ways. But, however you construct a new instrument and no matter what you call it, it has to involve an element of mutualisation. The point is to even out what would otherwise be an asymmetric fiscal effect from the pandemic.

We should recall that the ESM was created because a monetary union transforms balance-of-payments risk into credit risk. That transformation was not foreseen by the monetary union’s founders. The Covid-19 crisis is of a different nature. It is a huge symmetric macro shock for all. But, like the virus itself, it affects some more than others.

A report by the Italian news agency Ansa suggests to us that Giuseppe Conte sees the issues relatively clearly. He is clear in his rejection of an ESM programme. He demands a response that is massive, fast and co-ordinated at eurozone level, and globally. Ansa also pointed out that Italian diplomats had gotten almost everything they were seeking ahead of the summit, yet Conte said no. One suggestion we heard is that the sudden re-emergence of Mario Draghi could have played a role in stiffening Conte’s spine. 

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March 27, 2020

The race to save jobs

Labour markets have been hit drastically by the Covid-19 crisis. Workers have been laid off overnight to an extend not seen before. It is like 9/11 and the 2008 financial crisis together, as someone interviewed by the FT puts it. The International Labour Organisation already warns that globally 25m people could lose their jobs, compared to 22m in the financial crisis.

EU member states offer different schemes for companies and workers to cope with this. Their aim is to either keep workers' competences within the company or allow for lay-offs while guaranteeing workers' income to continue like under a normal unemployment scheme but fast-tracked and targeted. 

Some schemes are limited to sectors that are directly hit by the lockdown like hotels and restaurants. Others include a wider rage of enterprises that have seen a break in supplies, orders or reserves. It is a race against time, as some schemes only become operational only in April and leave workers and companies to deal with the crisis in the interim. Accessibility is not always guaranteed as online platforms are unable to cope with this tsunami of applications.

Here are some of the schemes introduced so far.

France expanded its partial unemployment scheme to more sectors and banned employers from laying off staff. There has already been a surge in demand for partial unemployment scheme, 135,000 enterprises applied for it covering 1.6m employees. And this is just the beginning. The state is paying 70% up  to a maximum of €6,927 per month. Bruno Le Maire already signalled that the initial budget of €8.5bn for two months will not be enough to cover the costs.

Germany is expecting 2.4m to draw from its partial unemployment scheme, the so called Kurzarbeitergeld. This estimate is more than the 1.8m registered during the financial crisis in 2008.  It provides wage subsidies to employees sent home during the pandemic and includes companies that cut working hours as a result of the pandemic.  It pays at the same level as unemployment benefits: Up to 67% of net wages lost due to shorter hours, to a maximum of €6,700 per month.

Italy announced mid March a series of social shock absorbers including a partial unemployment scheme that is paying up to 80% of an employee’s salary for a period of nine weeks to a maximum of €1,130 net per month. Self-employed people have also been awarded a one-off payment of €600.

Portugal unveiled its new scheme yesterday offering all companies experiencing a 40% drop in turnover access to a new and simplified lay-off scheme that allows the reduction of working hours or suspension of the work contract. The state then takes over to continue to pay workers 70% of the gross wage, limited to €1905 a month, while the employer is expected to pay 30%. Whether or not the worker will be subject to taxes is to be clarified yet as well as whether March is the first month of this scheme or April. The scheme is to run for three months and is estimated to cost €1bn per month. 

Ireland sees its near full employment economy last month with only a 4.8% unemployment rate  loosing all the jobs created over the last five years. The Esri think tank warned that the unemployment rate could jump to 18% by June. Under their job protection scheme rolled out this week the government would pay 70% of wages in private companies that are hit by the pandemic, up to a cap of €410 per week, net of tax, which is an equivalent of a worker earning approximately €38,000 gross per annum.  The government estimates €3.7bn in costs over the next 12 weeks. Independents will have access to the basic unemployment pay increased to €350 per month.

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