For better and for worse, crises create opportunities for extraordinary politics. European leaders, including the eurozone’s top central banker, Christine Lagarde, would be foolish to think that the ongoing pandemic is different just because it is a public health crisis — and not a political or financial one.
Besides the cost in terms of lives and public health, the pandemic has created an economic shock on a scale that could easily exceed the 2008 financial crisis. While the Great Recession resulted from a financial shock that reverberated through the U.S. and European economies, the entire world now faces a massive downturn across all sectors of the economy.
“Social distancing” invariably means less economic activity for everybody. In the coming weeks, if not months, people will work less, invest less and spend less. Inevitably, balance sheets will deteriorate and otherwise profitable businesses will go under — unless there is a clear commitment from public authorities to stabilize the economy.
The countries hit the worst by the pandemic — Italy, Spain and France — are the ones that have the least amount of fiscal breathing space.
In the United States, the Federal Reserve is moving ahead with a program of quantitative easing, although President Donald Trump is chastising it for being too slow. In the U.K., the Bank of England slashed rates and the government has announced a large fiscal loosening worth £30 billion.
The EU’s response, in comparison, has been pitifully weak. According to Lagarde’s statement last week, there are “no material signs of strains in the money markets or liquidity shortages” and any policy response to the developments should be primarily fiscal — and therefore national.
That is irresponsible. The countries hit the worst by the pandemic — Italy, Spain and France — are the ones that have the least amount of fiscal breathing space, irrespective of the European Commission’s relaxation of fiscal and state aid rules on Friday.
Going into the current crisis, Italy’s debt-to-GDP ratio was 134 percent. Spain’s and France’s were close to 100 percent. With spreads on their bonds skyrocketing, a sizeable fiscal stimulus is out of the question. Greece may have seen relatively few cases of coronavirus, yet the spread on its own 10-year bonds have gone up by over 50 basis points in the past week. It is not enough to simply “count on Germany,” as German Finance Minister Olaf Scholz put it — markets need to see real, macroeconomically significant firepower now in order to regain confidence.
EU countries like Spain will have a hard time absorbing the economic hit that the coronavirus will leave in its wake | Cesar Manso/AFP via Getty Images
And whatever one thinks of Lagarde’s claim that the ECB should not be “the line of first response” to the widening bond spreads on the eurozone’s periphery, a muscular pre-emptive injection of liquidity into the markets by the ECB is now the only thing that can stop the gradual build-up of panic in the financial sector and cushion the impact the pandemic is having on nominal spending.
Worse yet, Lagarde is dramatically misreading the politics of the moment. After the omnishambles of the Brexit negotiations, it has become conventional wisdom that Europeans have been somehow cured of any desire to leave the EU. While that may have been true a few weeks ago, it can no longer be taken for granted in today’s extraordinary times.
The real human cost of the pandemic (over 1,000 people have died in Italy alone) combined with popular anxieties and a sense — justified or not — that European institutions are not helping can easily add to a potent centrifugal force. That will be especially true if Italians reach the conclusion that a devaluation of their currency is their only possible source of economic relief.
Remember that Italy was until recently governed by a populist coalition built around the rejection of austerity supposedly imposed by the EU. In opinion polls in France, French President Emmanuel Macron is tied with the far-right leader Marine Le Pen for reelection in 2022. Even in Spain, the far right made significant gains in the parliamentary election in November 2019. Governments in Warsaw, Budapest and Prague already harbor little affection for the EU. If they conclude that there are political gains to be made from taking things into their own hands — in whatever sense — they will.
If there is one lesson from the Great Depression, it is that when international leadership fails, it is replaced by the destructive, non-cooperative behavior of national governments. When the U.S. failed to provide liquidity to the global financial system and imposed the Smoot-Hawley tariff instead of keeping its markets open, competitive devaluations and tariff hikes ensued.
The EU’s leaders and the European Central Bank’s president in particular face a similar choice today. Either they move boldly to help the periphery, or the periphery is going to help itself in whatever way it can — even if it means the unraveling of the eurozone and the EU.
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