Contrary to popular belief, monetary policy does not lack ammunition. The ECB may lower interest rates, implement a special program of long-term refinancing operations (LTRO) for small and medium-sized enterprises - such a program may be announced this week - and even, if necessary, buy debt of banks or listed funds. The Federal Reserve also has numerous options. Article 14 of the Federal Reserve Act, the wording of which has been clarified after the global financial crisis, includes the possibility of buying almost anything, from "bonds issued under the Law on loans to residential property owners" to "bills of exchange issued as part of actual commercial transactions" (e.g. commercial papers of enterprises), or even "gold coins and bars".
However, monetary policy can only provide temporary relief during a crisis. Banks' main role is to provide markets with liquidity to avoid deteriorating financial conditions. Given the evolution of financial conditions in the euro zone and in the United States, recent Fed moves in monetary policy have not yielded much results. Although further monetary policy efforts may be needed, these measures will by no means be sufficient to address the demand and supply shocks associated with the COVID-19 epidemic.
Now more than ever, fiscal policy is needed to overcome the current crisis and stabilize the economy.
This analysis only deals with the situation in the euro zone and possible fiscal policy measures in the United States in the coming days.
What is the situation at the moment?
- On the occasion of earlier crises, such as the sovereign debt crisis of 2012, we have found that to avoid spreading the problem (so-called infection) and control panic as quickly as possible on the market, the pace of political response is of key importance. The delayed response at fiscal level in the euro zone gives cause for concern and we are afraid that recovery in this region will be slower than in other countries, such as China, which have taken bold steps to control the coronavirus epidemic.
- Europe is still divided in terms of national thinking, and it is doubtful that in the coming weeks the countries of the euro will be able to agree on the adoption of a coordinated fiscal package. The European Union will certainly opt for a minimum approach and can propose a set of basic tools covering a wide range of measures that individual Member States will be able to implement at national level based on an individual assessment of the situation. In addition to this set, the European Commission should also show some flexibility in assessing the 2020 stability program - a topic that should be discussed at the next Eurogroup meeting on 16 March.
- Contrary to popular belief, the euro area has considerable fiscal capacity to implement emergency measures. Even countries with loose fiscal policy according to the euro European standards - eg France - have a lot of room for maneuver. In the case of France, the debt-to-GDP ratio is stable and the effective real cost of borrowing is lower than in the United States (-1.5% for 10-year government bond yields). The euro zone would have made the mistake of not using the most effective policy tool at this time.
How to proceed?
- Fiscal incentives should not be targeted at households (because they would directly benefit savings), but at enterprises. Emergency measures may include tax breaks to guarantee the maintenance of as many jobs as possible. One of the benefits of tax rebates is their relatively quick impact on business (the time from implementation of tax breaks to real impact on the economy is usually estimated at 2 to 18 months). The euro area can use as a reference some of the measures recently implemented in Asia, such as the corporate income tax rebate of 25% adopted by Singapore for 2020. A reduction in social security contributions for all is also possible companies. In general, a fiscal package corresponding to around 1% of quarterly GDP for the countries most exposed to the coronavirus epidemic would be a good start. In the case of the abovementioned France, this would mean that the government should propose EUR 6-7 billion in incentives.
- If the crisis lasts longer than originally anticipated, the second step would be fiscal stimuli in the form of increased public investment. The time from the implementation of public investments to the real impact on business is usually the longest. However, we consider this to be a favorable political solution, as it would ensure greater visibility for enterprises in the context of procurement for the coming quarters, and thus would maintain the confidence of entrepreneurs and the level of investment.