The COVID Health Crisis and the Fiscal and Monetary Policies in the Euro Area

Abstract

This paper explains the economic policy developed in the euro area to manage the economic effects induced by the COVID health crisis. First, an overview of developments in the euro area is presented. It then explains the fiscal decisions taken by member countries, as well as the monetary policy pursued by the European Central Bank. The final part reflects on the advisability of abandoning the fiscal rules that limit the fiscal capacity of states in order to favor economic recovery once the health crisis has been overcome.

Keywords:

• Euro area
• European Union
• fiscal policy
• monetary policy
• COVID

JEL classifications:

• E5
• E6

Acknowledgments

This is an extended version of the papers presented by each of us at the online XXI Seminar “Monetary and Budgetary Policy: Before and After the Global Crisis 2020” held on March 16–18, 2021 at UNAM in Mexico City and organized by Alicia Girón, Eugenia Correa and Patricia Rodríguez. The authors thank the two anonymous referees for their comments, with the usual caveat applying.

Notes

1 The euro area is the group of countries that belong to the EU and have the euro as their common currency. Of the 27 countries that make up the EU, 19 are in the euro area. The remaining countries, with the exception of Denmark, must adopt the euro when they meet the required conditions.

2 Although the EU budget contributes to reducing the economic differences between the different states and regions that make up the European Union, mainly through cohesion policy, its small size (it cannot exceed 1.2% of the EU's gross national income) limits its capacity to significantly reduce, at least in the short term, the differences in income and development that exist within the European Union. Moreover, the legal prohibition on the budget running a deficit prevents it from playing a stabilising role in mitigating short-term cyclical fluctuations.

3 This clause was approved in 2011 in the “Six Pack.” Although, as noted above, the reforms in fiscal governance within the European Union adopted from 2011 onwards were aimed at strengthening measures to ensure balanced budgets in the medium term, the lesson of the Global Financial Crisis led to keeping a window open to the possibility of not applying the fiscal rules, even temporarily, in the event of serious economic disturbances affecting the euro area and the European Union as a whole.

4 For automatic stabilisers see Bouabdallah et al. (2020) and for discretionary fiscal policy see Haroutunian, Osterloh, and Sławińska (2021).

5 The figures provided in Table 1 are based on the European Commission's estimates of potential output and output gap. Obviously, the existence of errors in the estimation of potential output translates into errors in estimating the output gap and, therefore, the structural and cyclical components of the behaviour of public revenues and expenditures, and, therefore, of the public budget balance. This implies the need to take the necessary caution when assessing the effect of the pandemic on public accounts as well as the size of discretionary budgetary measures and the fiscal stance. In fact, the European Commission itself recognizes the existence of problems arising from the uncertainty about the ability of the output gap to determine the position of an economy in the business cycle, especially in the current context of the COVID-19 crisis (Braz and Carnot 2019, European Commission 2016, 2021b).

6 Liquidity provision measures have mobilised resources equivalent to 16% of GDP (Haroutunian, Osterloh, and Slawinska 2021), to which should be added those mobilised through guarantees granted by the European Investment Bank. By country, the four large euro area countries (Italy, Germany, France and Spain) have mobilised the most resources.

7 In May 2020, the percentage of workers in these employment protection schemes was 21% in the Netherlands, 23% in Spain, 24% in Germany, 44% in Italy, and 47% in France (Dias da Silva et al. 2020).

8 Some of these workers, however, are very likely to end up unemployed. Not all companies that have benefited from these programmes will survive the pandemic, so their disappearance will mean that some of the workers who now remain in a situation of temporary suspension of employment will eventually end up unemployed.

9 These employment maintenance schemes in some countries have also been extended to the self-employed.

10 In the euro area countries, banks are by far the main intermediaries of credit to companies and households. The capital market, although it has gained weight in the intermediation process as a result of the financial crisis, still plays a secondary role. This is the reason why the ECB’s monetary policy focuses on opening credit lines to banks so that they, in turn, can provide liquidity to agents.

11 Although the PEPP was scheduled to be operational until the end of March 2022, the ECB Governing Council at its meeting on September 9, 2021, has agreed that the PEPP will continue “until it judges that the coronavirus crisis phase is over” and that the ECB “will continue to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2023.”

12 . The Next Generation EU programme is a pan-European fiscal programme that aims to facilitate the economic recovery of those countries that have been severely affected by the health crisis. The programme aims to mobilise a total of 677 billion euros and is articulated, on the one hand, through non-refundable funds (46%) and, on the other hand, in the form of credits to member states (54%). The resources will be raised through the issuance of public debt by the European Union. The programme is designed to finance public and private reforms and investments that enhance job creation, strengthen growth potential, social resilience, investments and digital development, support for biodiversity and sustainability (structural transformation and growth potential of European economies).

13 It should be noted that the target of a public debt of no more than 60% of GDP has never been met for the euro area as a whole (although it has been met for some states). This size has grown over time, so that if in 1995 public debt in the current euro area member states as a whole was 71.4% of GDP, in 2019 it was 85.9% of GDP.

14 Assuming a public debt of 100% of GDP, an average interest rate on public debt of 1.5% and nominal growth of 3.5%, in order to reduce public debt by 5 percentage points of GDP each year, it would be necessary to generate a primary surplus of 3% of GDP. It must be noted that in 2019 the primary surplus in the euro area was 1% of the GDP and that the estimated primary deficit for 2021 is 5% of the GDP.

Additional information

Notes on contributors

Jesus Ferreiro

Jesus Ferreiro is a Professor of Economics at the Department of Public Policies and Economic History at the University of the Basque Country UPV/EHU (Spain). He is the author of numerous national and international publications, both in the form of books, articles in indexed journals, and book chapters. His main lines of research are macroeconomic policy, labor economics, and international economics. He is an Associate Member of the Center for Economic and Public Policy of the University of Cambridge, Fellow of the Forum for Macroeconomics and Macroeconomic Policies (FMM), and Trustee of the Association for Social Economics.

Felipe Serrano

Felipe Serrano is a Professor of Applied Economics at the University of the Basque Country UPV/EHU (Spain). He has been Director of the Department of Applied Economics V at the University of the Basque Country UPV/EHU from 2002 to 2020. His preferred areas of research are pension economics, labor market economics, macroeconomic policy, and institutional economics. In these areas, he has published more than 90 works including books, articles, and book chapters, both in national and international journals and publishers. As an expert in pension economics, he has testified before the Spanish Congress of Deputies on the different occasions in which reforms of the Spanish pension system have been addressed. He has been Principal Investigator of the Research Group on “Institutions, Regulation and Economic Policy” from 2010 to 2018.