COVID-19 update: Euro area policy response
- The flexibility and proactivity of the European Central Bank (ECB) since the beginning of the COVID-19 crisis has been a positive surprise. Generous liquidity measures, easier collateral requirements, increases in asset purchases programmes and the creation of the Pandemic Emergency Purchase Programme, have helped the ECB maintain smooth credit flow to the private sector, stabilise markets and reduce fragmentation risks.
- The Next Generation EU package is also a genuine step forward. Joint debt issuance, fiscal transfers and proposed joint tax revenues are politically meaningful. But the package is too small (around 5% of EU GDP) and slow (peaking in 2023-2024) to be a proper cyclical-stabilisation tool.
- In the meantime, governments will remain on the hook. Fiscal responses should move from damage control to demand stimulus. Here Germany is leading the way, but other governments remain in ‘backstop’ mode.
- Overall, we expect fiscal stimulus of around 4% for the Eurozone this year, far from the 9% needed to offset the COVID-19 induced permanent income loss.
The COVID-19 pandemic has resulted in an unprecedented response from governments and central banks worldwide. In previous papers, we looked into US fiscal and monetary stimulus to alleviate the shock on the economy1 , considered the impact of policy measures in China2 and dissected Japan’s 43% stimulus claims3 . In this piece, we focus on the Eurozone, considering the positive developments that have surrounded intra-governmental stimulus, as well as national measures.
ECB: Swift actions despite hurdles
The European Central Bank (ECB) has reacted swiftly and forcefully to the crisis, deploying multiple policy measures (Exhibit 1). The first line of action was to safeguard liquidity conditions in the banking system and ensure the smooth provision of credit to households and corporates. The highly accommodative pricing of the targeted longer-term refinancing operations (TLTRO) III programme – with interest rate as low as -1% from June 2020 to June 2021, if lending criteria, which have been eased as well, are satisfied – together with collateral easing measures provide strong incentives for banks to maintain credit flows to the real economy. TLTRO III take up in June has been massive, at €1.3tn, adding net liquidity of €548.5bn. Credit is flowing – growth of the broad money supply measure M3 surged to its highest level since 2008, at 8.3% year-on-year (yoy) in April from 5.5% in February. The increase was driven by higher deposits from both non-financial corporates (NFCs) and households, and was matched, in the NFC sector, by stronger provision of loans. Yet, if the ECB’ssupport through ultra-cheap medium-term liquidity provision, was a necessary contributor to a sustained supply of credit, it is not a sufficient condition for its continuation.