The ECB Has the Wrong Priorities

A lot of generals have the habit of refighting the last war. And faced with the coronavirus, political and monetary authorities give the impression that they’re falling into the same trap. In their minds, they’re dealing with a financial crisis comparable to 2008, when what we’re really going through is an unprecedented public health crisis, hitting the heart of the real economy. And neither public health nor the real economy needs the same responses as the markets do.

You wouldn’t know as much from the actions of the political and monetary authorities. For weeks they have concentrated all their attention on the financial markets. It’s true, there’s been an impressive collapse. Twice in one week, the circuit breakers were pulled out to try to prevent the stock exchanges tumbling spectacularly as soon as they opened. But to no avail. On Thursday, the Paris, Frankfurt, London, Milan, and New York stock exchanges lost between 10 and 16 percent of their value — Wall Street’s worst day of trading since 1987, when it plunged by 26 percent.

If this isn’t a crash, it’s beginning to look awfully like one. Since February 20, when the financial world woke up to the dangers of COVID-19, the various markets have lost between 26 and 35 percent; more than $9 trillion has been wiped off their value.

Nothing has been spared in trying to save the stock markets from collapse and restore confidence among financiers. Already last week the Fed pulled out its monetary weapon and reduced its benchmark rate by 0.5 percent. In a further bid to reassure finance, it pumped vastly increased liquidity into the money (repo) market, which has shown growing signs of difficulty ever since September. The Fed has increased its liquidity injections from $100 billion to over $150 billion a day.

Immediately after this, the Bank of Japan announced that it would also resume its quantitative easing policy and start buying up bond securities on the markets. The Bank of England followed suit, cutting its base rate by 0.5 percent on March 11.

In such a climate, there was a lot of expectation surrounding the European Central Bank’s decision this Thursday, March 12. This was, indeed, considered something of a baptism of fire for Christine Lagarde, who became the ECB president in November. She unleashed the monetary “bazooka” that everyone had been expecting. While the ECB did not change its (already negative) benchmark rate of minus 0.5 percent, it was ready to use all the other tools available to it. Its bond purchase policy (i.e., quantitative easing), previously amounting to €20 billion a month, will be increased by a further €120 billion by the end of 2020. Banks, which already enjoy exceptional refinancing conditions, will be further aided through the TLTRO III (targeted longer-term refinancing operations) program, in order to provide the financial system with unlimited liquidity.

Thanks to these exceptional circumstances, the world of finance has finally got what it’s long been asking for. The prudential and regulatory constraints which had been put in place after the 2008 crisis are now going to be loosened, in order to encourage the banks to lend.

Seeking to boost the impact of these measures, Christine Lagarde called on governments to implement an “ambitious and coordinated fiscal policy response.” Sensitive to criticisms regarding the failure of their policy after the 2008 financial crisis and the subsequent eurozone crisis, Europe’s officials have collectively promised they won’t repeat the same mistakes. This time, they said, they were all ready to act together, to use “all possible tools” to deal with the epidemic and the economic collapse which it risks prompting. In Europe, then, monetary policy and budget policy are going to march hand in hand.

This coming Monday, Europe’s finance ministers are set to outline a common approach to countering the damage caused by the coronavirus epidemic. Even before this meeting, on March 11 Angela Merkel announced her intention to review Germany’s zero-deficit rule, engraved in marble in its constitution and considered one of the main obstacles to a European fiscal stimulus. “We will put in the money necessary to fight the epidemic, and we’ll look at the deficit afterward,” the German chancellor indicated.

All this ought to have pleased or at least reassured financial circles, restoring confidence. Yet after the ECB announcements, the European markets — the only ones open at the time — in fact fell further. It was just like what happened when the Fed lowered its rates last week or when the Bank of England did so on Wednesday. The German DAX index, which had already been well down, lost more than 2 percent within a few minutes of the ECB announcements.

Some analysts explained these reactions by noting that the ECB’s interventions were considered insufficient. Others explained that central bankers’ actions were feeding investors’ worries, already heightened by the decisions taken by Donald Trump. But the malaise doubtless goes rather deeper. For many have come to recognize that having been the world’s great order-givers for over four decades, central banks are today powerless faced with coronavirus. They cannot respond to this any more than five-year stimulus plans or tax breaks for business can resolve the paralysis that has taken over the world economy.

The Need for Public Policy

Reminding us that macroeconomic policy can’t do everything, the economist Barry Eichengreen explained:

monetary policy can’t mend broken supply chains. . . . Fed Chair Jerome Powell can’t reopen factories shuttered by quarantine . . . monetary policy will not get shoppers back to the malls or travelers back onto airplanes, insofar as their concerns center on safety, not cost. Rate cuts can’t hurt, given that inflation, already subdued, is headed downward; but not much real economic stimulus should be expected of them. The same is true, unfortunately, of fiscal policy. Tax credits won’t get production restarted when firms are preoccupied by their workers’ health and the risk of spreading disease. Payroll-tax cuts won’t boost discretionary spending when consumers are worried about the safety of their favorite fast-food chain.

Eichengreen is very much a liberal. But this academic, like many economists (for instance those at the Bruegel think tank), recognizes that the priority is to free up all possible means to treat the ill, hold back the epidemic, and support health systems. In a word, the priority is public policies oriented toward health care, and to make the state take suitable action.

For them, this is the only appropriate response in the immediate. After all, the more the epidemic spreads, the longer it will last, and the more the world economy will be damaged. But given that the coronavirus has already spread across Western countries, the most striking thing has been the public authorities’ lack of response. Doubtless, this is what is making the financial world panic: the mounting paralysis of all activity, the lack of sufficient state responses, and the risk that this will prompt a general collapse — all the more violent and devastating given that the system has built up mountains of debts (and other ills) over the last decade.

Except for Italy — which has accepted that it has to endanger its economy in order to contain the epidemic — European leaders’ main concern has been to keep up economic activity, to support businesses, to ensure everything continues like before — and not to prepare the necessary means for dealing with this public health crisis. Except for Italy — which has directed several billion euros toward fighting the epidemic, buying medicine and materials, and recruiting care staff — the other European states have announced nothing.

Showing its oh-so-great sense of responsibility, the European Commission announced on March 7 that it would take an “understanding” approach toward Italy, even if it did not entirely respect its budget deficit targets. This once again showed the Commission’s dogmatism — and its inability to identify what the real priorities are.

In this COVID-19 crisis European solidarity has once again shown its true colors. Far from bringing aid to Italy in this unprecedented crisis, everyone has preferred to keep their medicine and material to themselves (countries including France and Germany have banned the export of masks). It is China — not Italy’s European partners — which has provided the country with respirators, medication, and other aid.

Who Needs Health Spending?

The Commission explains, in its defense, that health policies are a matter for each individual state. But it’s not as if the Commission has held back from interfering in this field in recent years. In fact, over the last decade health care and hospital spending has been the number one target of European austerity programs. Research budgets have been massacred, from Italy to Spain, France, Greece, and Ireland. In each European Semester (the EU’s budget-review process), the technocrats charged with reviewing member states’ budgets have demanded fresh cuts in health care personnel and in the resources allocated to hospitals. Such spending is considered superfluous or even a luxury in light of the higher demands of Europe’s sacrosanct 3 percent deficit ceiling.

And the approach taken toward health care was equally applied to energy, industry, and other fields: all public policy was considered a distortion of the invisible hand of the market. Thus, in the name of economic “rationality,” having surplus hospital beds was considered mere waste. Thus, in the last few years in France, ten thousand beds have been gotten rid of, together with the staff who went with them. Yet those are ten thousand beds we could do with today.

The coronavirus epidemic shows just how harmful this policy is. For all European countries are under-equipped to deal with the public health crisis it has prompted. All health care systems are showing signs that they’ve reached the breaking point — and this is before the epidemic even reaches its peak. For eleven months hospital personnel in France have been staging strikes to denounce the massacre of public health services and their lack of human, material, and financial resources.

Out of blindness and dogmatism, European officials have shown no sign that they have any intention of changing course and of making public policies part of their plans. The ECB’s decisions show as much. In its new share buyback program, the ECB indicated that it would firstly be buying up equities in private businesses, not state bonds.

But it should be doing things the other way around. In these times of uncertainty, the ECB ought to be taking sides with Europe’s states, helping them to build up their protections against the epidemic by giving them a hand in financing public health care. For that’s the urgent task at hand. We could even imagine that in these exceptional circumstances, the ECB could cancel all the state bonds that it has bought up in recent years, as part of its quantitative easing policy, in order to give relief to states and provide them with more margins of financial maneuver. For once, money would go to the people and not to the banks.

But all the evidence shows that we’re very far from the ECB taking such a bold decision. At her press conference, Lagarde made a faux pas which was highly telling of her inability to change approach and grasp how exceptional this situation really is. She explained that the ECB is “not here to close spreads” (i.e., level out the borrowing costs among states by supporting more vulnerable economies). In short, this means that the ECB doesn’t consider it its business to lessen the growing divergences between German and Italian bond rates and ensure the eurozone’s cohesion. This, even if such a policy means crippling Italy, even as the EU’s third-biggest economy — and its health care system — is under maximum stress.

Financiers immediately concluded from this that the ECB isn’t standing by Italy in its time of trouble. Indeed, immediately after Lagarde made these comments, Italian bonds were pummeled. In a few hours, its ten-year bond rates soared from 1.26 percent to 1.76 percent. And Lagarde’s negative signal could have further major consequences. In moments of tension like these, it wouldn’t take much to set Europe’s smoldering crisis ablaze again. And this time, it would face the full fury of public opinion — having proven that it is incapable of responding to the real priority issues.