If it Quacks like a Duck?
Europe was born out of adversity and it is in adversity that it flourishes, particularly when France and Germany agree to lead. Yesterday, both countries crossed the fiscal Rubicon and presented a proposal to provide €500 billion of European Union transfers to sectors and regions most impacted by the coronavirus. The funds will be managed as part as the EU’s multi-annual budget and raised through bond issuance by the European Commission. Budget money is fungible but this is as close to coronabonds as it gets.
The grant nature of the financing is extraordinary in a few ways:
- It represents a significant 3.5 to 4% addition to the €14 trillion EU budget, which is set for a seven-year period and does not tend to rise by more than 1 or 2 percentage points when it is renewed. The budget for 2021–27 is already under discussion and will be determined later this year.
- The €500 billion will be distributed only in grants to sectors specifically impacted by the virus, such as Italian and Greek tourism. While all EU countries contribute to the EU budget, these resources will be distributed according to needs—so this is the first ad hoc, targeted transfer mechanism.
- The transfers will be financed like the EU budget—by the European Commission issuing bonds, which are eligible for the ECB’s QE program.
This spending significantly raises the EU’s fiscal response to the pandemic:
- It adds to the €540 billion loans package, which is comprised of €240 billion ESM credit lines, the €100 billion SURE unemployment loans, and the €200 billion in EIB lending to SMEs.
- This complements about €2 trillion of national fiscal measures, for a total €3 trillion pandemic spending in EU (or $3.3 trillion and 25% of GDP); this is compared with $1 trillion in Japan (19% of GDP) and $2.7 trillion in the U.S. so far (15% of GDP), making it quite a decent effort.
Germany and France presenting a project together is a necessary condition to get it moving—and a sufficient condition to get it supported. The proposal still needs approval by the EU’s 27 Parliaments, and there will likely be several rounds of negotiations. The public announcement is, however, a good sign that it will reach a satisfying outcome. In addition, it will be impossible for reticent member states to argue that these grants should be transformed into loans, as a loan package already exists. The precise plan does not need to be ready before the fall as the spending will start in 2021.
The effort to support vulnerable economies in the Union is significant, and some may see in it a semi-Hamiltonian moment. Markets reacted very positively to the announcement, with Italian and Greek spreads rallying more than 30bps and the euro appreciating one big figure against the U.S. dollar. Common issuance may be the first step toward a common Treasury capacity for the monetary union. Of course, the EU does not yet have the power to raise taxes, but this experience, if successful, could pave the way for further advances in EU architecture and design.