Europe's debate on fiscal policy: too much yet too little. CEPS Policy Insights

The initiatives taken by the ECB in mid-March 2020 flatten the structure of interest rates and ensure short-term sustainability for the EMU countries with high government debt/GDP ratios. But the challenges posed by the pandemic require a huge amount of public spending and therefore threaten this sustainability in the long term. This paper proposes ‘contractual arrangements’ between high-debt countries and European institutions, namely the Commission and the ESM as financial donor, which transfer grants (a ‘gift’) to high-debt countries to cover the national public expenditures resulting from the impact of the pandemic. In exchange, the beneficiary countries would share the design and implementation of these public expenditures with the European institutions, thereby giving up a portion of their fiscal sovereignty

The current European debate on fiscal policy: Too much and too little

In the last two weeks the European Central Bank (ECB) decided to launch new LTRO and T-LTRO programs to ensure liquidity to the banking sector as well as to small- and medium-sized firms (March 12, 2020) and to temporarily strengthen its \u2018quantitative easing\u2019 policy (March 18, 2020), which is centered on the purchases of government bonds and of a large set of private financial assets (including commercial papers). Moreover, the Single Supervisory Mechanism improved the positive impact of the ECB\u2019s initiatives by temporarily weakening the capital requirements and the assessment of the non-performing exposures of the European banking sector. Finally, the European Commission (EC) decided to suspend the European coordination mechanism of the national fiscal policies, that is, the Stability and Growth Pact (SGP). This last step was considered crucial, since it is commonly agreed that even a generous unconventional monetary policy cannot face the short- and medium-term economic impact of the current pandemic shock. The T-LTRO and the \u2018quantitative easing\u2019 may, at most, provide liquidity to different economic activities and flatten the structure of interest rates; they cannot absorb the \u2018real\u2019 shock on the supply side and transfer income to temporarily unemployed workers and to households. The latter are duties that pertain to fiscal policy

The economy in the time of the coronavirus: The different limits of the monetary and fiscal policies

The dramatic coronavirus pandemic will likely have heavy and prolonged recessive effects on the European and international economic systems. A few weeks ago, it still made some sense to forecast an intense but short-term negative systemic shock that would have given way to a rapid and robust macroeconomic recovery (a so-called 'V-shaped crisis'). Today, this perspective is vanishing. The epidemic peaked or will peak in different times in China, a part of Asia, Italy, the rest of the European Union (EU), and the United States; and these phase displacements risk postponing the return to "normality" in the daily life of the major global economic areas at least until the summer of 2020. The consequence of such a prolonged impact suggests a far more threatening 'L-shaped crisis', that is, a phase of drastic fall in the GDPs of the advanced economic areas, followed by long-lasting economic stagnation

Can the Eurozone countries still live together happily ever after?

After the Greek public debt crisis and the bilateral loans to Greece from the other members of the European Monetary Union (EMU), in May 2010 the Ecofin Council launched the European Financial Stabilization Mechanism (EFSM). In June of the same year the EMU countries instituted the European Financial Stability Facility (EFSF). These two mechanisms, which are charged with providing support to EMU countries in \u201cexceptional difficulty\u201d, received their baptism of fire with Ireland in January 2011 and successfully made their first bond issue on the market. Marcello Messori of the University of Rome argues in this CEPS Policy Brief that the solution to Europe\u2019s sovereign debt problems cannot be entrusted to the two stability funds, not even in tandem with the International Monetary Fund. He constructs a new solution, drawing on various other proposals, which should allow the EMU countries to \u2018live together happily ever after\u2019, but unlike many fairy tales and some policy proposals, it makes no promises of a free lunch

The frying pan burns less than the fire: why Italy should not go out of the euro

Leaving the euro or staying in the area is not an alternative that offers symmetrical advantages and disadvantages to Italy and to other \u201cperipheral\u201d Member States, as it would happen if these countries had to decide to enter or not in a new currency area from outside. First, the opting out which was used by the United Kingdom and Denmark in 1998 at the creation of the single currency, cannot be used by the peripheral countries of the European Economic and Monetary Union (EMU), except by an unlikely revision of the European Treaties. Second, the exit from the euro area requires to manage stocks accumulated in that currency; this problem, often labeled as the legacy problem, would not have risen with an initial opting out. In the following Policy brief, my initial assumption may appear too academic since it refers to the ultimate abandonment of the EMU and, consequently, of the European Union (EU) by the side of a peripheral Member State. In fact, the analysis of the effects of an irreversible abandonment are interesting because they foreshadow the outcome, where more realistic scenarios lead to. In particular, they apply to the case of a temporary exit of a peripheral country that aims at implementing an adjustment period. My analysis is specifically dedicated to Italy; and my conclusion is that, if this country decided to temporarily withdraw from the single currency 'frying pan', it would be condemned to the flames of the sixth circle of Dante's hell. This is not to argue that the current configuration of the EMU reflects the best of all possible worlds. However the severe criticisms that can and must be addressed to the European choices, cannot call into question the permanence of Italy (and that of other peripheral countries) in the euro zone

The flexibility game is not worth the new ESM

The reform of the Treaty Establishing the European Stability Mechanism (ESM) broadens the functions of this mechanism so as to transform its current role of financial manager of sovereign debt crises into an institution for the prevention, control and management of such crises. There is thus the risk that the ESM will also have the power to decide whether a euro area Member State that is forced to apply for a European aid program should restructure its government debt in advance. In this eventuality, euro area countries with a high public debt - such as Italy - would be exposed to heavy and distortionary instability. It is therefore appropriate to prevent the ESM from assuming this restructuring power or, at least, to minimize the risk of Italy having to resort to a European aid program. The repeated use of flexibility in the management of public balance sheets is not going in that desired direction and must therefore be replaced by other strategies

How to Create a New European Plan for Investment

The Greek crisis which began six years ago, is an extreme case that has brought to light deficiencies of the euro area. It was characterized by a series of untimely and vainly punitive decisions on the part of the other member states of the European Economic and Monetary Union (EMU), unbearable and unattainable requests to make macroeconomic adjustments and reforms on the part of European institutions, and encouraging but eventually fruitless commitments on the part of the Greek government. These circumstances ended up maximizing the economic and social costs linked to the preexisting structural fragility of Greece, causing the financial size of the aid programs promoted by EMU members and European institutions to balloon, and resulting in partial and distorted adjustments of the Greek economy. Those adjustments pointed out that the expectations of growth and well-being characterizing Greece at the beginning of the new century were misleading, but they also contributed to lead the Greek economy to depression and Greek society to a state of emergency

The inevitable evolution of European financial markets

This paper pursues a twofold objective: (i) to show that the evolution of European financial markets hypothesized is reflected in a series of empirical descriptive data, which, though not providing clear-cut evidence in favor of our interpretation, make the latter plausible; (ii) to examine, with some detail, the main impacts that the transformation of the role of banks will have on the set-up of financial markets and on financial regulation in the euro area and in other parts of the EU (the so-called \u201cBanking Union\u201d (BU) and the so-called Capital Markets Union (CMU) process)

The potentials and the dangers of the Italian economy in a renewed euro area

Overcoming the political and institutional tensions that have characterized Italy in the last fourteen months opens up new prospects for economic growth and cooperative relations with the European institutions. In this regard, the recent appointment of former Italian Prime Minister Paolo Gentiloni as the European Commissioner of Economy is an important signal. However, these promising prospects will not automatically translate into actual progress. For example, the scope of the Economy portfolio assigned to Gentiloni as designated commissioner is different from the one of Economic Affairs, held in the old (and still operative) Commission by Pierre Moscovici; above all, Gentiloni\u2019s scope is more limited than that attributed to Valdis Dombrovskis as designated executive Vice-President with responsibility for one of the three crucial areas of the new Commission (that is, Economy). In this perspective, the fact that Dombrovskis has a coordinating function also \u2013 but not only \u2013 in relation to Gentiloni\u2019s range of activity shows how important it is that Italy does not force the European constraints and \u2013 at the same time \u2013 takes advantage of the many opportunities provided by the guidelines of the new Commission. These guidelines were clearly specified in the program presented by the new President of the Commission, Ursula von der Leyen, for her election by the European Parliament. Similar and complementary considerations apply to the action of the new Italian government. To increase Italy\u2019s economic growth, the new coalition between the Five Star Movement (FSM) and the Democratic Party must: (i) overcome their latent internal conflict, thus avoiding the reappearance in new forms of the pre-existing climate of political uncertainty; (ii) launch an effective economic policy package that will encourage sustainable development in the short and medium-long term, one that is, at the same time, compatible with Italy\u2019s commitments to the European institutions and with Italy regaining its central role in the European Union (EU). In this Policy Brief I will focus on point (ii), keeping the short-term problems separate from the medium to long-term ones, even if, in the actual way the Italian economy works, the two problems are strongly intertwined