WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

by Hubert Gabrisch
photo: European Council, CC-BY-NC-ND 2.0

Two remarkable events recently burst upon the economic policy agenda of the European Union.

The first was the judgment by the German Federal Constitutional Court on 5 May against the massive Asset Purchase Programme of the European Central Bank (ECB). In direct opposition to the European Court of Justice, the Federal Court ruled that the programme goes beyond the ECB's mandate by involving itself in German fiscal policy, and obliges the German government to demand an explanation with respect to these actions from the Central Bank. The ruling effectively puts an end to Mario Draghi’s ‘whatever it takes’ promise. From now on, highly indebted member states such as Spain, Italy and Greece would be well advised not to risk credit financing for measures to tackle the consequences of Coronavirus. The capital markets may once again not accept an even higher public debt in those countries (just as in 2012). In that case, the monetary union would again run into trouble, if the ECB is not allowed by the German government to protect the common currency using non-standard monetary policies. Hence, a new instrument is needed.

The second event followed on almost immediately: the Merkel–Macron proposal for a EUR 500 billion recovery fund, to be disbursed in the form of non-repayable grants to member countries and regions that have been particularly badly hit by the Coronavirus crisis. The fund would be financed by EU Commission borrowing on the financial markets.

In linking the two events, we might first of all point out that the proposed recovery fund could significantly reduce the need for the exclusive use of non-standard monetary policy measures to combat Europe-wide crises, particularly as the effectiveness of such measures declines as their scale increases. Despite the temporary nature of the fund, the proposal could pave the way for a permanent fiscal crisis mechanism at the European level, as a counterpart to the European Central Bank. Many commentators have seen the lack of such a mechanism as a fundamental in-built weakness of the monetary union that has aggravated the economic downturn on the margins of the euro area and has delayed the recovery of the entire area following the sovereign debt crisis. Hence, the Merkel–Macron proposal offers a way out of an institutional framework, the intellectual foundations of which have ceased to be widely accepted in the academic community. It looks almost like a revolution, born of necessity.

However, before the negotiations at the European level can produce any substantial plan, there are certain problems that need to be resolved, including the intention of raising the proposed EUR 500 billion on the financial markets. Art. 310 (1) of the Treaty on the Functioning of the European Union – an element of the EU’s primary law – requires budget expenditure to be balanced by revenue. Indeed, this is an even more powerful rule than that which the Stability and Growth Pact of 1997, subsequently strengthened by the Fiscal Compact of 2012, imposes on member states. In fact, borrowing requires a change to the EU Treaty, which has to be passed unanimously by the Council. But even that is not the end: a Council decision needs to be followed by various ratification procedures at the national level, which would take time and may result in some unpleasant surprises. The problem could be solved if, instead of being part of the EU budget, the fund were to be made into a legally independent body of the EU member states, according to the Union’s secondary law. There are important precedents for this, such as the European Stability Mechanism or the European Investment Bank. On this point, unfortunately, the Merkel–Macron proposal is silent.

Also unclear are the methods of borrowing, the debt servicing and the burden on the EU budget. The proposal talks vaguely of borrowing and amortisation over 20 years from the EU budget. Amortisation plus interest payments (‘annuity’) are normal for loans from banks. However, bank lending is unusual for public-sector debt in the member countries: they finance deficits almost exclusively by issuing bonds with various maturities and a fixed rate of interest on the capital markets. The amortisation occurs when the bond falls due. The amortisation of shorter-term bonds is usually financed by issuing new bonds. Under the proposals for the recovery fund, final amortisation could take place far beyond the end of the fund’s activities.

In the (preferable) case of bond financing, only interest payments would effectively accrue to the annual EU budget. At a cautious estimate (2%), annual interest payments would amount to about EUR 10 billion. In the case of additional payments of member countries to the budget, Germany would have to contribute about EUR 2.5 billion, and Austria about EUR 250 million. If, as expected, the fund helps to stabilise the economy and tax revenues in the member countries, there should not actually be a financing problem. The EU’s own increased resources, raised via an EU-wide tax, could help with servicing the debt.

A group of countries – the so-called Frugal Four (including Austria) – has now put forward an alternative proposal, which relies exclusively on conditional lending to the recipient countries. Some compromise is necessary; it is Brussels business as usual. Seemingly, the compromise will involve a mixture of favourable credit and non-repayable grants, with the latter clearly predominant. This could be acceptable both to those countries that have been particularly badly hit by the coronavirus crisis but that are in no mood to take on fresh public debt, and also to the ‘Frugal Four’.