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Lesson 2, Topic 10
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10. How does the vulnerable Eurozone manage the COVID-19 crisis?

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The COVID-19 crisis has created new momentum for changes within the Eurozone, but the longer-term outlook is still unclear. The fundamental rules underpinning the Eurozone have not been changed. But there has been improvisation as well as innovation in order to react to the COVID-19 induced need for higher investment and therefore higher debt levels. Some Eurozone rules, such as the debt ceilings, have been temporarily suspended. The ECB backs the deficit spending of the states. With its Pandemic Emergency Purchase Program (PEPP), the ECB has stabilized the interest rates of government bonds by guaranteeing to buy the country’s bonds from the banking sector. This is a clear break with the policy towards Greece, Italy and others in the euro crisis after 2010. This time there is no risk of default of single states and the spread in interest rates has not proliferated any further. 

Still, there is a spread that disadvantages the already more vulnerable euro-states in fighting the crisis. And as long as interest rates are higher than growth rates, public debt will grow – in relation to GDP as well as in absolute numbers. This is an issue because many states have the substantiated fear that after the acute COVID-19 crisis the Eurozone will go back to punishing high debt levels. So, the already heavily indebted Euro-states do not dare to spend as much as the economic crisis would demand. States such as Germany on the other hand have decided upon releasing huge fiscal stimulus packages in order to save their economy. Under these conditions, however, even greater economic inequality in the Eurozone is the logical consequence. 

The most effective change that would make the vulnerable Eurozone as resilient as any other country with its own fiat currency would have been the introduction of a sole bond, called a Eurobond or a “corona bond”. All the specific Eurozone problems would have been solved once and for all: the loss of trust caused in the euro-project since 2010 when Greece was sent to default, the resulting spread of unsustainable interest rates, a financial system that since then has speculated against certain states, and the necessity of the ECB to stretch its mandate to defend the euro under the conditions named. But politically it has been impossible to implement common debt in the form of common bonds – because of diverging interests in the short term, but also because this fundamental change probably would need more democratic legitimation, potentially including changes in the European contracts, institutional changes, and referendums. 

Thus, instead of resolving the problems on the Eurozone level where they stem from, the European Commission took over and came up with an idea. For the first time ever, the European Union itself would take on a considerable amount of debt. This is how it works: Firstly, the Commission releases bonds that banks and investors can buy with money created by the ECB. Then, the Commission will give this money to the EU governments, partly as non-repayable aid, and partly on favourable credit terms. The states can invest and try to save or restart their languishing economies. In doing so, from a monetary point of view, the European Commission acts as a federal government that creates currency for its states as some of them are no longer able to do so sufficiently for themselves under the euro-regime.

This solution also results in common debt, which the Eurobonds would also cause, but the advantage is that the European Union with its institutions of Council, Parliament and Commission, has more democratic legitimation and can move faster. The disadvantage is that the agreed amount of money is not big enough for the dimension of the crisis and the intervention is meant to be unique. No changes to the architecture of the Eurozone have been made, so the member states still have to find a long-term perspective. 

The institutional problem of the Eurozone is that democratic legitimation, spending and possibly negative results of inflation no longer conform – as would be the case with a national currency. In the Eurozone, national parliaments and governments are still the most legitimate democratic agents and therefore the ones who should decide on spending and money creation. But in case of serious overspending in some of the states, inflation could then also occur in more parsimonious states that did not profit from spending and also cannot vote against the negative consequences of another state’s profligacy. The Eurozone on the other hand, has no governmental institution with democratic legitimation that could decide on direct spending in favour of households and companies. The unproductive solution in the European contracts consisted of restricting spending altogether – which also constitutes an infringement of democratic policy space. 

The latest provisional answer to this dilemma is the European Commission taking on debt. It remains to be seen how the institutions will further adapt. From an economic point of view it is easy; on the national or on a supranational level, some governmental institution has to be allowed to take on the debt, create enough money, and spend it into the real economy, to overcome crisis and at best, make our continent ‘future fit’. 

  • On the topic of future and sustainability, see the article “Climate and Economy” on this website.
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