- The ECB has shed most of the remaining constraints on purchases. It will be able to support an aggressive expansion of sovereign issuance this year.
- The eurozone’s fiscal response lags behind, but will catch up over the coming weeks as growth deteriorates.
- Eurozone political leaders will likely eventually endorse using the European Stability Mechanism (ESM), but will need to go further.
ECB’s pandemic emergency measures
The ECB has published details of its €750 billion Pandemic Emergency Purchase Programme (PEPP).
When the decision was made last week, the ECB stressed the flexibility of its implementation. This decision is the practical implementation of that:
- Greece is included in the programme.
- The 33% limit on the share of eurozone members’ bonds that the ECB will hold under its existing programmes does not apply to the PEPP.
- The ECB can buy across the yield curve, from very short maturities (down to 70 days) to very long ones.
- The ECB has accepted pari-passu treatment in the event of a sovereign-debt restructuring.
Few constraints remain
The last three points were news, I believe, and demonstrate that the ECB will disregard past constraints in order to respond to the pandemic. The remaining constraint is that the purchase amounts are guided by the ECB’s capital key, which, in turn, reflects the size of the economies, rather than the size of the debt market or the current needs. That said, the ECB can temporarily deviate from that key and lean into specific markets if necessary.
Programme can scale up if necessary
With purchases of more than €1 trillion (>8.5% of GDP) before year end, the ECB has given assurance to the market that the sharp rise in debt issuance that we will see in the coming months will be absorbed. I think that is an important assurance that will keep sovereign spreads in check.
Challenging debt position of many European governments remains
Many European sovereigns will see sharp rises in issuance and in debt-to-GDP as a result of this crisis. Italy has particularly challenging dynamics, but it is not alone. The ECB will end up holding much of that increase on its balance sheet, in all likelihood for a long time. By the end of the year, the ECB will likely hold more than 30% of GDP in its asset purchase programmes. There is no reason why it should stop there.
ECB more aggressive than political leaders
Heads of government have so far failed to reach an agreement on how to approach the challenges facing the fiscally most vulnerable countries (as of 27 March 2020). I expect that they will eventually agree to use the ESM to support EU governments, whereby individual governments can draw up to 2% of GDP on credit lines with light conditionality. Any country can apply, but it is done on an individual basis, so it will still be debt. I don’t think EU leaders are ready to contemplate a ‘joint debt instrument’ that goes beyond the use of the ESM. Although such a solution would provide a helpful backstop, it would be politically challenging for many countries.
Support required beyond Italy
If a broad range of countries draw on the ESM for funding at low rates, that would effectively establish a practice of near-joint issuance of debt. All eurozone countries would be on the hook for much of this increase in debt, either via the ESM or, ultimately, via the ECB. That, I think, is the practical reality. The politics need to catch up.
Does this go far enough?
Speaking only for myself, I think it does, for now. The ECB can act aggressively in the interest of the eurozone as a whole — that is what its mandate says. It is not surprising that the eurozone’s political leaders are focused on their own national crisis, and that they struggle with decisions that have deep political and fiscal implications.
The German and Dutch (and other) governments are not willing to give grants on a large scale. Imagine the politics of handing over hundreds of billions of euros to another rich country at a point of economic crisis. I think they will ultimately be willing to lend their credit and accept that the ECB acts as a backstop, but they are not there yet.
This supports eurozone fiscal response
In comparison to the US, the discretionary increase in fiscal spending may look less impressive so far. But in the eurozone, the automatic stabilisers — the rise in spending that comes about when revenues fall and unemployment rises — are much bigger, particularly when the GDP decline is big. The ECB’s decisions and the ESM measures will ultimately buy some room for this fiscal response.