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The large fiscal packages recently announced by governments aim at stabilization more than stimulus.The goal is not to stimulate investment and consumption (unavailable options when populations are confined) but to: 1/ fund emergency response to the virus situation itself 2/ contain the economic damage so that it does not worsen the recession through two major channels:
A - A collapse of household income and expectations thereof Only part of the amounts recently announced by government are budget-easing measures, strictly speaking.Their order of magnitude is between 1.5% and 4% of GDP for large European economies, with a larger push by Japan (as much as 7%) and the US (more than 10%). Part of the explanation for the lower European numbers (together with the limited fiscal space of a number of countries) is that large pre-existing automatic stabilizers, starting with generous short hour and unemployment insurance schemes, already cushion the damage brought by the crisis to household income.
Other amounts are not strictly budget measures but rather liquidity support, as they are meant, in principle, to be repaid to the state treasuries, although some of them could later be forgiven.
Finally, a large portion of the amounts announced is made up of public guarantees of corporate debt. In this aspect, the push is greater in Europe than in the US, knowing that in the case of the more disintermediated US economy, the Federal Reserve securities purchases programs launched to deal with the crisis also play a very large role in credit easing. These public guarantees will become public spending and debt only if activated by a loan default.
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Within the specific architecture of the Eurozone, European institutions have already played a major part. The EU Commission has first and foremost had an essential role in enabling member states to deploy their national programs, as of the beginning of March, by:
In addition, European-level programs have also been launched.
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Mutualized European fiscal responseDespite their differences, European countries and institutions have agreed, at this point, to the following fiscal measures (together with a number of smaller ones):
- An ESM Precautionary Credit Line program for state budgets, available to all Euro member states for amounts up to 2% of their GDP under the condition that it is used solely for Covid-19-related direct and indirect healthcare, cure and prevention costs. An important feature of an ESM program is that it can open the way to the ECB’s OMT operations (which, unlike the sovereign QEs already launched, is not constrained to respecting the “capital key”, i.e., the ECB could target additional purchases specifically towards a certain country). Whether to request such a program has been a hot political topic in Italy (and remains undecided at the time of writing) - An EIB pan-European guarantee fund of €25bn to support €200bn of financing with a focus on SMEs. - The SURE program, which will provide €100bn to support national short-hour work schemes, in the form of cheap loans granted from the EU to member states.
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The combined effect of the recession and these emergency fiscal programs on deficits and debt could be, very roughly for large advanced economies given the many unknowns, increases of 7% to 15% in deficits (in GDP terms) and 15% to 30% in public debt in 2020.
However, despite deteriorated headline fiscal metrics, the damage caused by these programs to public debt sustainability will be mitigated by their monetization through the large QE programs announced by central banks:
All in all, our view is that this combination of large fiscal programs and debt monetization should be successful in preventing that the unavoidable large “real economy” recession caused by the pandemic and the lockdowns morphs into either a systemic financial crisis or a long-lasting recession extending well beyond the pandemic’s peak.
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Currently announced stabilization-aiming fiscal measures, however, are not the end of the fiscal chapter opened by the crisis. Indeed, they will probably give way to further measures, this time stimulus-oriented, as the confinement measures are gradually lifted. These will be a further addition to public deficits and debt, at least over the medium term.
It is also very probable that some of the crisis-fighting fiscal measures, currently presented as temporary will become more or less permanent, due to demands for a stronger role government role in the economy and stronger social safety nets. If not matched by offsetting revenue raising measures, they may lead to permanently higher structural primary deficits.
All in all, governments of large advanced economies have swiftly and energetically reacted to the crisis with very large fiscal programs. These show cross-country commonalities but also differences in structure and amounts that depend on the magnitude of already existing fiscal stabilizers, political choices (in particular that of letting a large proportion of labour contracts be terminated during the lockdowns) and the interaction of these programs with those announced by central banks. The central bank backstop means that these programs are sustainable over the short term, and can probably even be increased if need be, although politics may complicate things (especially in Europe). It also means that public debt sustainability may be less damaged than meets the eye after the crisis. While these large fiscal programs cannot prevent the collapse in activity that accompanies the pandemic and the lockdowns, they can, in our view achieve their goal of preventing this “real economy” crisis from leading to a systemic financial meltdown or a very prolonged recession. |
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