How the ECB Can Fight the Coronavirus Crisis
The European Central Bank was the last large monetary authority to step in. On Monday night, President Christine Lagarde issued a statement saying the central bank stands ready “to take appropriate and targeted measure, as necessary and commensurate with the underlying risks.” While Lagarde could have been more forceful in her choice of words, it’s good she chose finally to intervene. Regardless of what critics say, the ECB can still do a lot to support the euro-zone economy at a time of crisis.
Philip Lane, the ECB’s chief economist, had initially assumed that the impact of Covid-19 on the currency area would probably be “V-shaped.” That forecast is looking optimistic. The epidemic has hit Europe hard: Italy has recorded more than 2,000 cases and numbers are climbing in France and Germany. The OECD expects the euro area to expand by just 0.8% this year, down from 1.2% in 2019 — and that’s in a relatively benign scenario. A sudden shock risks hitting small and medium enterprises especially hard, were they to face liquidity constraints.
A turbulent week in the stock market had already prompted the U.S. Federal Reserve, the Bank of Japan and the Bank of England to say that they stood ready to intervene if needed. The ECB’s response was initially less vocal. Lagarde told the Financial Times last week that she was monitoring the outbreak “very carefully,” but that the situation wasn’t yet at a point where it would have an impact on inflation. The sudden change of tone on Monday night won’t help Lagarde build a reputation as a decisive fire-fighter, but it’s good she changed her mind.
The economic shock from the coronavirus outbreak is certainly hard to assess. We don’t know know how long the epidemic will last, and whether it will cause more damage to global demand or to supply; this would have very different implications in terms of the inflation impact and a suitable policy response. It’s possible too that the ECB wants national governments to announce their budgetary response before it acts. Time and again, countries such as Germany have failed to use their large fiscal capacity to support the euro area and have placed an enormous burden on the central bank. Lagarde might well be acting strategically.
However, the ECB needs to be careful that it doesn’t get back its old crisis-era reputation as the major central bank that’s least willing to act. Policymakers in Frankfurt didn’t launch a scheme of quantitative easing until 2015, several years after the BoJ, the BOE and the Fed. Making the ECB more agile was one of the central achievements of Mario Draghi, Lagarde’s predecessor.
If the situation worsens, the ECB should spell out what it can do to help the euro zone economy. Three tools appear particularly useful. First, it could launch new rounds of targeted refinancing operations for banks, aimed at keeping liquidity flowing to small- and medium-sized enterprises. This would make sure that businesses don’t die simply because of credit constraints. The use of the word “targeted” in Monday’s statement suggests this may indeed be the first line of defense.
Second, Lagarde could cut interest rates further. This would help devalue the euro, which has appreciated recently, further punishing the region’s exporters. Third, in extremis, it could increase the pace of its asset purchase program. This would create additional space for a fiscal response from governments, especially in the more fragile countries. For now, interest rates remain very low, but in Italy they’ve been climbing over fears that a sharp slowdown would add to the country’s large public debt.
The ECB may be right in its cautious choice of words. It’s possible that investors have made yet another display of irrational behavior. Maybe economies in the euro zone will rebound relatively quickly. For once, the fiscal response from government could prove timely and effective.
However, the ECB should be ready for action. The euro zone does not need a shy central bank.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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