The coronavirus has exposed the European Union’s (EU’s) fault lines. For now, European Central Bank (ECB) bond purchases should hold things together. But ultimately, national governments will need to take some tough decisions to secure the EU’s future.
The EU’s internal inconsistencies are often masked when the economic and political backdrop is benign, only to be exposed again as the outlook darkens. The last major example of this was the sovereign-debt crisis almost a decade ago. Now, as we enter a new decade, the coronavirus (officially COVID19) has prompted another potential existential crisis.
Impressive Response Masks Fundamental Issues
The speed and magnitude of Europe’s COVID-19 response have been impressive. Outright fiscal stimulus has reached 3% of euro-area GDP (and rising), while an additional 16% of GDP has been pledged in the form of loan guarantees and tax deferrals. And these measures come on top of existing safety nets, or automatic stabilizers, which are extensive in most European countries—even before the crisis, Germany and Italy had schemes to subsidize the incomes of furloughed workers.
This support is being provided by national governments. But it is being underpinned at the collective level by a suspension of the euro area’s fiscal rules and by a €540 billion (4.5% of GDP) package of liquidity support. The latter includes a facility for governments to borrow up to 2% of their national output from the European Stability Mechanism (ESM) with very light conditionality (i.e., the money must be spent directly or indirectly on healthcare). And the ECB has underwritten all of this, promising to boost its asset purchases by at least €870 billion (7% of GDP) and, if necessary, to deploy these purchases more flexibly to support weaker euro-area sovereigns.
Despite these efforts, the COVID-19 outbreak has exposed deep flaws in the euro area’s political and institutional architecture. Politically, it has reminded us that European solidarity often runs only skin-deep. Institutionally, it has highlighted the absence of a centralized fiscal authority with revenue-raising powers that would allow it to address common shocks and the fact that individual euro-area countries don’t have lenders of last resort (despite the ECB’s valiant attempts to paper over these cracks).
In short, Europe’s monetary union is still missing vital elements of a political and/or fiscal union. This means the region will always suffer extreme stress when the global economy runs into difficulty and funding conditions start to deteriorate. And whatever the rights and wrongs of each country’s past behavior, that stress will always be felt disproportionately by debtor nations (where, of course, populist pressures are already rising).