EU Fiscal: Plan A, and a Plan B

Published on March 9, 2020

** A teleconference of EU finance ministers last Wednesday to review the coronavirus impact and plan a response did not result in any decision on concerted fiscal policy action, but it did produce the second best result – an effective green light to national governments to individually spend what they need to offset the impact of the epidemic with no fear of disciplinary action from Brussels.

** As we previously flagged (see SGH 3/5/20, “ECB: Coordinating Monetary and Fiscal Measures”), the scope for flexibility to breach the 3% Deficit/GDP target is provided in an emergency spending bill clause of the Stability and Growth Pact, which allows for such outlays if the event creating a need for the spending is outside the control of governments, and clearly an emergency.

** The clause sets no limits on the extra spending, and although Eurozone officials stress the money will have to go to finance only epidemic-related issues, and the European Commission will provide some guidance on what can be considered such in the coming weeks, the scope for “creative bookkeeping” here is large. Since all EU finance ministers have now agreed that coronavirus-related spending should be exempt from normal deficit and debt calculations, the Commission will take that hint and interpret spending accordingly.

** That clearly is a desperately needed lifeline to the ravaged Italian economy already struggling for years to respect EU requirements to cut deficit and debt levels, but which is now one of the hardest hit nations on earth by the virus outbreak, which worst of all from an economic perspective is concentrated in the north, which produces almost one third of the entire country’s GDP.

** Italy has already announced it will spend some 7.5 billion euros, or 0.4% of GDP, to try and offset some of the crushing damage of the epidemic on its economy – a godsend for a country that had already used up all of its other chits with Brussels, including exemptions such as allowing Rome to treat earthquake spending as a structural feature of the Italian economy.

** Of course, this push for stimulus also belies a deeper question that is increasingly being raised in some policy circles – namely that containment of the virus requires a severe and deliberate curtailment of public, and economic, activity – a la Wuhan – and not incentives to get consumers out in the streets to travel or spend more, if that is even possible. Regardless, the need for fiscal support to manage what is already a sharp downturn, and hopefully grease an eventual recovery, still prevails as the priority.

** And along those lines, the EU has also a “Plan B,” and a “first best” policy response for EU economies — an EU-wide concerted fiscal stimulus plan — is not off the table.

** While there are as of yet no concrete numbers or specific measures proposed for an EU-wide fiscal response, sources in Brussels suggest it may yet become a viable option if the overall economy continues to suffer, severely, with a template and point of reference then being the “European Economic Recovery Plan” that was agreed to by EU leaders in December of 2008 in the wake of the Lehman Brothers collapse.

** Under that plan, the EU agreed to pump 200 billion euros, or 1.5% of the EU GDP, into the economy in 2009 to boost confidence and demand. That 200 billion/1.5% of GDP was an aggregate number, meant to serve as a guide for national governments on how much to spend, and in the end many countries spent more than that.

** Unfortunately, that stimulus did not, in the end, prevent a recession in 2009. It may have limited the depth of the slowdown.

** From what we understand, the “concerted stimulus option” has been deliberately left vague for now and would only be fleshed out if the Eurozone economy were to “truly” take a turn for the worse. As of now, the Commission acknowledges that the Eurozone will miss its initial expectations for 1.2% GDP growth in 2020 that was forecast only as recently as on February 13, but by how much it will drop is not yet clear.

** As a historical point of reference, the stimulus package of late 2008 was agreed to only with a clear recession risk in view. And this being 2020, our understanding is that to ensure passage a stimulus package would almost certainly also need to be linked now with the new economic and social priorities of this age – digitalization of the economy, and fighting climate change.

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