Chief Economist at ODDO BHF
EU leaders have finally reached an agreement regarding the budget framework for 2021-2027 and the associated € 750bn 'stimulus plan'. This outcome would have been unthinkable a short while ago. Clearly, this marks progress. Relative to the initial proposal, compromises have been made lift the opposition from the self-proclaimed frugal states. The rebate on their contribution to the EU budget has been increased. The share of grants in the stimulus plan is reduced from 66% to 52%. From inception to agreement, two months were needed. The plan’s rollout is scheduled for a start of 2021, with a ramp-up in 2022-2023.
It’s been a hard day’s night (… more precisely, four nights)
The EU does not have a fiscal stabilisation mechanism. When a shock occurs, each country is supposed to act to support its economy. This gives rise to two problems. First, there is no coordination amongst states. Second, the response from some states can by hampered by various constraints, institutional (Stability Pact) or financial (debt ratio). All too often, we then come to hope that monetary policy will be able to overcome the shortcomings of fiscal policy. In practice, the result is that the European policy-mix is unbalanced and therefore sub-optimal1.
As the coronavirus crisis is likely to exacerbate both problems, a common budgetary response to support recovery is a necessity. This is acknowledged, but its practical implications are complex. The meeting between heads of state and government lasted five days and four nights before an agreement was reached on the EU budget and the 'stimulus plan’2. In the present note, we review the major questions shaping this debate.
Why the stimulus? – This question may seem absurd today given what we know about the economic shock, but this was not the case several months ago. At the summit on 26 March, some European leaders saw no point at all in setting up a stimulus fund to help the countries most affected by the pandemic (often those with the least fiscal leeway). Moreover, many saw this idea as nothing more than a ruse to mutualize existing debts. The idea of coronabonds was rejected by the German Chancellor and was described as a mere "slogan" by the European Commission president.
Within a few weeks, GDP has fallen in proportions that are, in some instances, ten times greater than what is observed in a typical recession over several quarters. In its 7 July forecast, the Commission predicts an 8.3% contraction in GDP in 2020 at EU level. Assuming that the pandemic remains under control, the recovery that has just begun would continue and the rebound would be +5.8% in 2021. If this is the case, the level of activity in 2021 would be 6% lower than it would have been in the absence of the pandemic. Such a widening of the output gap requires the mobilisation of as many resources as possible to support the economy. This point is now beyond debate. It is no exaggeration to assume that everyone would have something to gain from this. For example, the German economy, which is so sensitive to foreign demand, has an interest in the EU not only not disintegrating (one Brexit is enough), but also in returning to growth as quickly and durably as possible. Note that the German government, which was often rather reticent on these issues, has become one of those pushing hardest to set up a European stimulus mechanism as rapidly as possible3.
How to do it? – It goes without saying that the EU had not during the last expansion built up the reserves necessary to quickly address the shock caused by the pandemic. One way or another, the stimulus implies additional public debt. The question is who should take on the debt, who should pay it back, and under what terms.
1 See our Eco Note of 28 May 2020: “A one-legged Europe no more?”
2 See: https://www.consilium.europa.eu//media/45109/210720-euco-final-conclusions-en.pdf
3 See our Eco Note of 16 July 2019: “10 questions on Germany”
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