irishtimes.com 22/4/ 2020 Why the European Central Bank can save the euro zone – the only option is for the ECB to do ‘whatever it takes’ by Martin Wolf
The pandemic has raised fears of defaults, financial crises and even exits from the euro zone. The ECB can address all of these issues. Will the euro zone survive Covid-19? If it does, it will be for the same two reasons it survived the financial crisis: fear of a ruinous break-up and action by the one institution able to do so on the scale needed. In July 2012, Mario Draghi told an audience in London: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The ECB is saying this now. It should be enough.
The pandemic is creating an enormous common shock. But it has asymmetric results. Among larger member countries, the brunt of the disease has fallen on Italy and Spain, although France has been catching up. According to the IMF, the euro zone’s gross domestic product will shrink by 7.5 per cent this year; Germany’s GDP will fall 7 per cent, but Italy’s by 9.1 per cent. Its Fiscal Monitor forecasts the euro zone fiscal deficit at 7.5 per cent, Germany’s at 5.5 per cent and Italy’s at 8.3 per cent.
Alas, even this looks optimistic. The “baseline” projection of the IMF’s World Economic Outlook assumes that shutdowns will end in the second quarter of 2020. But it is quite likely that they will not, or that they will need to be repeated. In the baseline scenario, the GDP of high-income countries shrinks by 2 per cent between 2019 and 2021. In the worst alternative – a lengthier shutdown now, followed by another in 2021 – GDP would be almost 10 per cent lower in 2021 than in 2019. Yet, even on its baseline view, the IMF forecasts Italy’s gross public debt at 156 per cent of GDP this year, up from 135 per cent last year. Debt is set to become mountainous for several euro zone members in the years ahead.
This realisation has raised what is euphemistically called “redenomination risk” – fears of defaults, financial crises and finally even exits from the euro zone. So spreads between the yield on Italian debt and the GDP-weighted euro zone average began to rise, helped along by an unfortunate remark of its president, Christine Lagarde, that it was not the ECB’s role to “close the spread”.
With its €750 billion Pandemic Emergency Purchase Programme, launched on March 18th, the ECB undid the harm. Isabel Schnabel, German member of the board, has laid out its rationale. The ECB, she explained, has two overarching objectives, “to restore the orderly functioning of euro area financial markets” and to ensure that “our accommodative monetary policy continued to be transmitted to all parts of the single currency area” (my emphasis).