The economic damage from the coronavirus epidemic has prompted calls for Europe to relax its fiscal rules to allow governments to cut taxes and increase spending. The European Commission seems to agree: Paolo Gentiloni, its economy czar, has hinted that affected governments -- such as Italy -- may enjoy some budget “flexibility” to deal with the emergency.
Granting more leeway is a welcome step, but it’s only a second-best approach. The virus risks affecting some countries much more than others. A centralized eurozone budget would be a better way to address these localized difficulties, since it would allow the channeling of funds to countries where it was most needed. Some governments have much less fiscal space that others -- think of Italy, which is struggling with the continent’s worst coronavirus outbreak. It’s unfortunate that a euro-area pot of money does not exist for this kind of eventuality; instead, some member states will be forced to borrow more even when they have very high levels of public debt.
The impact from COVID-19 on the eurozone isn’t yet visible in the macroeconomic data, but many businesses are warning that the impact will be severe. Chemicals giant BASF was the latest to do so, Friday. Companies face a damaging combination of disruptions to their supply chains and a slowdown in demand -- both from outside the single-currency area and from within. Europe’s stocks are tumbling and are set for their worst week since the region’s sovereign debt crisis in 2011.
The virus has spread across Europe, but some nations are bearing a greater brunt. Italy has had to lock down two areas, home to about 50,000 people, where the country’s outbreak begun. The region of Lombardy, which produces an estimated 22 percent of the country’s gross domestic product, has taken draconian steps to contain the epidemic such as closing schools and other public spaces. Other northern regions have done the same. Ignazio Visco, governor of the Bank of Italy, believes the crisis could shed as much as one-quarter of a percentage point from this year’s growth rate.
Rome is preparing a set of measures to help companies and workers hit by the crisis. The trouble is that Italy faces severe budget deficit limits, given its high public debt -- which stands at about 135 percent of gross domestic product. In 2018, Italy locked horns with Brussels, as it sought to push for borrowing levels that the Commission deemed excessive. The fear is that a fiscal stimulus to counter the slowdown might provoke a similar backlash if the Italians or anyone else are deemed to be spending recklessly.
The Commission appears open-minded about giving Rome -- and other countries in need -- more leeway on their EU-imposed budgetary limits to support the economy. That’s wise. The eurozone has relied heavily on monetary policy to foster a recovery, so the European Central Bank has less room to act than in the past. Governments can tailor fiscal policy to their own country’s needs, depending on how the severity of the economic damage.
However, a country’s ability to react will depend entirely on its own fiscal space. Germany will have greater room to maneuver -- if it chooses to act -- than Spain or Italy because its debt is much lower. This is why the approach has serious shortcomings, since the virus will strike anywhere, regardless of a country’s economic situation (at least within the eurozone). The best tool to respond would be a central fiscal capacity, which distributes resources depending on a country’s needs.
So far, the dream of a euro-area budget has proven elusive because thrifty countries such as Germany have feared other member states would squander the money. The “Budgetary Instrument for Convergence and Competitiveness,” which was agreed to at the end of last year (though is not yet in place) is expected to be tiny, and in any event cannot be used to help countries deal with an economic shock. The coronavirus epidemic shows the limits of not having more meaningful instrument. It would be far better if countries chose to build an insurance mechanism to help each other, as recommended by the International Monetary Fund and Mario Draghi, former European Central Bank president.
It’s still possible that the damage from the coronavirus will prove temporary, and that the eurozone will experience a “V-shaped” recovery. The ECB says it’s ready to step in, cutting rates further into negative territory if the slowdown is worse than feared.
Europe’s politicians should sharpen their fiscal tools. It’s a pity they’re inadequate for this challenge.
Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. -- Ed.