Monetary Policy No Longer Facing a Crisis Alone

Monetary Policy No Longer Facing a Crisis Alone


by Carlo Altomonte and Gianmarco Ottaviano, Achille and Giulia Boroli Chair in European Studies
Translated by Alex Foti

We accept change only in case of need, and we acknowledge need only in case of crisis. Thus spake Jean Monnet, father of the European unification project. He would therefore not be surprised by what in recent months has been happening in the Old Continent under the effects of the pandemic.

In fact, having faced the financial crisis of 2008-2009 and the sovereign debt crisis of 2011-2012, European countries have already been dealing with the tension between need and change for quite a while now. But even when crises strike, it's not easy to build political consensus and arrive at optimal solutions. The Fiscal Compact of March 2012, the political prerequisite for the agreement on the European Stability Mechanism (ESM) and for OMT operations (Outright Monetary Transactions – Draghi's "Whatever it takes") required the insertion of a balanced budget clause, so dear to "frugal" member states, as condition for having a fiscal policy of the eurozone. The result was de facto fiscal contraction in a period of economic crisis, which led to the widespread perception (especially, but not only, in Italy) of so-called "austerity" as being the right policy at the wrong time. At the end of 2018, also due to structural lags keeping the country behind, Italian GDP per capita was still 6 percentage points below the 2008 value.

With the pandemic crisis, however, the transition from necessity to change seems to have come easier even for Germany, the leading country of the frugal coalition. Previous experience with the euro crisis, and the recent reservations on ECB monetary policy expressed by the German Supreme Court, seem to have generated a rethinking of the "traditional" EU game, according to which crises are managed by granting a modicum of fiscal redistribution between member states, while leaving the bulk of the burden of adjustment on the shoulders of the ECB. The rethinking took place on May 18, 2020, when France and Germany announced, completely unexpectedly, their common proposal for a €500-billion European Recovery Fund endowed with actual funds, meaning fiscal transfers, to be included in the multiannual financial framework of the EU budget and then distributed among member states. The European Commission has then intervened on the original Franco-German proposal, with a detailed proposal for the employment of funds, known as the Next Generation.

Beyond other concomitant measures, such as subsidized loans to support the unemployed (SURE) and the activation of a new temporary credit line for health spending related to the coronavirus emergency (in the ESM context), the Franco-German proposal represents an epochal turning point. In fact, it breaks two of the fiscal taboos that have characterized the single currency since the start. On the one hand, for the first time it accepts the principle that the EU budget can be used in a counter-cyclical way, while so far the consensus was that the EU budget should only cover structural spending, without any role in stabilizing aggregate demand across the economic cycle. Secondly, it designs a common debt instrument (bonds issued by the European Commission based on the guarantees of future national contributions to the EU budget), which is paid by the member states according to their economic weight, but which can be disbursed to the member states in function of financial needs emerging from the pandemic crisis.

By virtue of this sprout of common fiscal policy, for the first time European monetary policy will not find itself alone in dealing with a common crisis, creating a kind of financial support that could also become relevant for key industries and regions of the frugal countries. As Jean Monnet would say, a great privilege of producing cognac is that, more than anything else, it teaches you the virtue of waiting: man decides and organizes, but the seasons must be on his side.

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