By Professor Andy Mullineux
Lloyds Banking Group Centre for Responsible Business, Department of Finance
The European Union (EU) has relaxed restrictions on aid provided by member state governments to domestically incorporated businesses (‘State Aid’) during the COVID-19 crisis and its aftermath. This is in order to facilitate job protection schemes and protect companies from overseas takeovers at knock-down prices.
This enables the (mainly northern) states with the strongest fiscal positions to provide more support to their businesses. They can afford to contain economic and social damage more effectively than the more highly indebted (mainly southern) member states, without building up potentially unsustainable debt burdens, as Greece had done prior to the 2010-12 Eurozone crisis.
Unlike the USA, Japan and the UK, the Eurozone member countries do not have their own central banks from which they can borrow in their own currencies because they have a common currency (the euro) issued by a shared central bank (the European Central Bank (ECB)) which is not allowed to lend directly to member states.
During the Eurozone crisis, the ECB developed the capacity to conduct ‘Outright Monetary Transactions’ (OMTs), or the purchase of bonds issued by governments needing assistance. It has never been used and its legality has been challenged.
The ECB has, however, engaged in government bond purchases in secondary markets in proportion to the share of each country in the ‘Eurozone economy’ under its Asset Purchase Programme (APR). It has also purchased assets issued by the corporate sector (bonds and commercial paper) and the scale and scope of its APR has been increased in response to the COVID-19 crisis. Some of these extensions, which allow the purchase of lower quality, non-government debt, are also being legally challenged in the German constitutional court.
Short of invoking OMT, the ECB has been encouraging the member states to adopt a coordinated expansionary fiscal response to the crisis. The problem is that true coordination would require fiscal transfers from the ‘northern’ states, which are most able to expand, to the ‘southern’ states, which are less able to expand without suffering increases in their costs of raising. This would increase the ‘spread’ between the yield on Italian bonds relative to the much safer German bonds; which Christine Legarde, President of the ECB, famously said it was not her job to manage.
The German and Netherlands governments have consistently opposed such fiscal transfers, but the Italian government has pointed out that the current conditions allow more state aid in Germany and the Netherlands than is prudently possible in Italy, so transfers would help balance the pain.
The French President Macron has argued in favour of fiscal transfers from funds raised by the issuance of ‘eurobonds’ backed by Eurozone member state governments, but this too is opposed by the Netherlands and Germany. Instead, the European Stability Mechanism (ESM), which imposes ‘conditionality’ on states borrowing from it, could be utilised. Italy does not want to submit to the conditions associated with borrowing from this fund; which was established to deal with a banking crisis and is seeking grants (transfers) not yet more loans (debt).
The EU finance ministers are instead discussing a proposal to create a European Coronavirus Recovery Fund (ECRF) to inject funds into the region’s most stricken economies. This would reduce pressure on the EC, but the idea seems to be for the ECRF to make loans for the purpose of restoring economic activity after the COVID-19 crisis-induced lockdowns, rather than fiscal transfers in the form of grants.
It should be noted that countries with a strong state government structure, such as Australia, Canada, the USA, and Germany, utilise fiscal transfers to foster social and political cohesion; whilst operating with their own common currencies. Increased borrowing by southern EU states is unlikely to reduce their bond yield spreads relative to Germany’s bunds.