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News | Question of the Week, WC 30th March 2020
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Question of the Week, WC 30th March 2020

Q: Covid-19 will be expensive for the Eurozone; who will pay? 

A: The coronavirus is not only spreading in our societies, it is also spreading in the economic data, creating increasingly unbelievable headlines. The scope and cost of fiscal stimulus measures in the Eurozone is a good example. No one knows exactly how this will play out, but experience from the financial crisis suggests that both budget deficits and debt-to-GDP ratios are now set to climb significantly. 

Indeed, we suspect that it could well be much worse on this occasion for EZ government finances. The announced measures and guarantees so far rack up about 12% of GDP, in the major economies. Add in the automatic stabilisers and the fact that the level of GDP itself could decline by around 10% through 2020, and you end up with a bill at nearly 25% of EZ GDP at the end of this year. The reported budget deficit almost surely won’t rise that far. After all, guarantees might not be completely tapped out. Even if they aren’t they ought to add to government debt-to-GDP ratios, unless they’re withdrawn next year, which we doubt. Allowing for cash balances to spare in northern Europe, and extrapolating over the next few years, we reckon that EZ governments face a bill of around €5T over the next three years, which is around 15% of GDP in the same period. Who will pay for this? 

There are effectively three options. Governments can try to fund the bill by increasing taxes and cutting spending, in which case they will need to deliver some very bad news for workers and businesses through 2021 and 2022. They can issue debt, and dump it on the market, or the ECB can buy it, though not, as the rules currently stand, in the primary market. It will be a combination of the last two options with an emphasis on the central bank as a buyer of last resort. The ECB is already ahead of the curve with a pledge to buy a huge amount of sovereign debt between now and the end of the year, which will be a big help. But the numbers still don’t add up and we think the ECB will have to do more. Yield curve control, in effect a cap on long-term yields, is being discussed, and we wouldn’t put it past the central bank to do just. The problem for the ECB, though, is that yield curve control in the Eurozone won’t work unless accompanied by spread control. Eurobonds would help, but that’s a long shot in the very near term. Later on, though, major EZ governments might find that mutualising the cost of Covid-19, via a long-term joint debt issuance purchased by Ms. Lagarde, isn’t such a bad idea. 

Claus Vistesen
Chief Eurozone Economist

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Posted: 3rd Apr 2020

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