March 19, 2020
A useful step - but much, much more is needed
This is what they should have done last week. Last night, the ECB’s launched a broad-based €750bn programme of additional asset purchases, and finally agreed to ditch the unnecessary issue and issuer limits for this particular tranche of QE. The capital key stays, but will be applied more flexibly. It is essentially more of the same: same asset classes as before, with more flexibility, bigger volumes and a fancy new name. See below for more details of the programme.
The ECB will now have more headroom to stabilise the Greek and Italian bond markets. We urged them to do exactly this last week when we called for an unlimited programme without the self-imposed constraints. The ECB has been behind the curve on this, and has now essentially caught up with the Fed. But, starting from where we were, this is the right move.
Yesterday we were calling for an ECB-funded eurobond: a mutualised safe asset whose proceeds should be channelled to citizens directly in a classic helicopter drop. During the European Council’s tele-conference on Monday, Lagarde relayed the ECB’s forecasts about the economic fall-out from the crisis. A one-month lock-down of one month would cost 2.1% of GDP, and for three months it would be 5.8%. We think these numbers are oddly precise, and too optimistic because they do not take into account global network effects. But she is certainly right with her warning that the economic contraction will be stronger than in 2009.
As FAZ reports, Lagarde was calling for creative solutions, and talked about a corona-bond. This is unrelated to last night’s decision on asset purchases. The corona-bond would be exactly the same as what we have been suggesting for two weeks now: a mutualised safe asset bankrolled by the ECB. Lagarde said a eurobond would bring relief to the markets in southern Europe, particularly in Italy. FAZ reports that Emmanuel Macron and Giuseppe Conte welcomed the idea, but Mark Rutte rejected it outright. Angela Merkel and Sebastian Kurz were both open in principle. Merkel also made it clear that her guiding principle was to do the minimum that is needed. One had to be realistic given the political realities in the Bundestag, she said. Rutte wants to max out the flexibility clauses of the stability pact, but said it would be premature to talk about Corona-bonds. This is 2012 all over again.
We think that an unconditional ESM facility could emerge as the most likely instrument. This idea has been brought into play by Antonio Tajani, former president of the European Parliament. Conte rejected ESM involvement, but this is primarily because he won’t accept outside interference in Italy’s fiscal policies. FAZ writes that the route through the ESM would be the easiest to do technically, and is thus favoured in Brussels. As so often, the thinking in Brussels is institutional rather than focused on the actual problem.
The problem with ESM loans is that they are debt, not a helicopter drop. Loans are the right instrument to deal with a liquidity squeeze, but not a with a large hit to GDP. A discretionary stimulus is a gift from the heavens, or rather from the central bank. The two are not the same.
The FAZ report of the European Council’s conference reminds us of the discussions held at the height of the eurozone crisis in 2012. There is a sense of crisis, but no crisis is ever big enough to overcome ideological differences. What is different is the nature of the crisis. In 2010-2012, we had a sovereign debt crisis which the ECB could relieve with a promise of unlimited asset purchases. This crisis is different in nature.
In theory it should be possible for national governments to issue discretionary stimulus each on their own, even on the scale we suggested. They could issue national bonds and let the ECB buy them. But if Italy were to launch a stimulus of, say, 10% of GDP, its debt burden would increase accordingly and produce financial instability. We think that, on their own, member states will not go down that route. This is why a mutualised ECB-supported eurobond of sufficient size will be necessary.
And a final observation: According to a poll by Monitor Italia last week, 88% of Italian believe that the EU has not done enough to help their country. And the number of people who believe that EU membership is a disadvantage to Italy has risen from 47% in November to 67% now. That was also different in 2012.