Concerted stimulus of a significant magnitude is unlikely in the Eurozone for now. Instead, the focus remains on a mix of deliberately lax fiscal rule enforcement and reliance on monetary policy.
There is no majority in Chancellor Angela Merkel’s coalition for bold action at this point. The Organisation for Economic Co-operation and Development (OECD) has warned that German growth could shrink to 0.3% in 2020, but political interpretations will be crucial. Against a backdrop of so far still solid labor market and fiscal data, flat growth might be temporarily acceptable to many in Berlin. Indeed, key policymakers doubt whether the current situation qualifies as a severe crisis.
Among the measures discussed over recent days was subsidizing “short-term work” again, to help employers to retain their often specifically trained manufacturing employees during a downturn. The focus on the supply-side therefore remains strong. Other measures discussed include corporate tax credits and guarantees, and a well-known ingredient to any recent, hypothetical stimulus debate in Germany: bringing forward from 2021 the ca. EUR 10bn reduction in the “solidarity surcharge”. (For the last 30 years, the levy has been added to corporate and income tax, to help finance the cost of rebuilding the country’s formerly communist East.) A serious public investment program, meanwhile, is nowhere in sight.
The cautious German stance was also reflected in the outcome of the 4 March Eurogroup meeting. The focus remains on the new European normal of recent years: deliberately lax enforcement of fiscal rules, while looking to monetary policymakers for anything more tangible. The COVID-19 outbreak therefore constitutes yet another episode in the annual search for reasons to tolerate deviations from fiscal rules, especially in Italy. Rome now appears to be targeting extra measures worth around EUR 6bn (about 0.35% of GDP).
The Eurogroup has insisted on the temporary nature of any deviations – and has instructed its deputies to work towards more detailed proposals until the next meeting on 16 March. All eyes will therefore be on the European Central Bank (ECB), at (or in the run-up to) the 12 March governing council. Further rate cuts could be difficult politically while constituting a double-edged sword given the fragile health of the banking sector; yet a deposit rate cut might still be possible. Targeted longer-term refinancing operations (TLTRO) conditions might be tweaked, but there is concern over the degree to which this could be directed at small and medium-sized enterprises; and expanding quantitative easing could once again raise the thorny issue of the ECB’s capital key.
Following the US Fed’s move, there has been criticism of ECB President Christine Lagarde’s careful positioning, but this overlooks the difficult political context. There may be debate about technical grounds for treading carefully at the zero-lower bound, but there are certainly political incentives for ECB caution so far. Scrutiny of unconventional monetary policy remains strong in the North. In the scenario of a more severe downturn further down the road, ECB credibility in its most skeptical constituencies might be crucial for allowing more decisive action.
In the meantime, the usual caveat attached to every conversation about greater stimulus applies: a real sense of crisis would be required in Germany, perhaps in the labor market, and/or via supply chains and a (partial) stoppage of industrial production. Short of that, the careful approach looks likely to continue for now.