(Bloomberg Opinion) -- Christine Lagarde has told euro-zone politicians that they must take action to stop the coronavirus outbreak from causing a repeat of the 2008 financial crisis. On Thursday, the president of the European Central Bank has a chance to show she can lead from the front.
Lagarde will announce how the ECB intends to combat the virus-caused economic slowdown. The list of possible measures includes a new round of ultra-cheap loans for banks; a cut to the central bank’s deposit rate that would push it deeper into negative territory; and the expansion of quantitative easing. Only a comprehensive package will show that the ECB is serious about protecting the economy and avoiding further disinflation.
The ECB has been slow off the blocks in combating the fallout from a pandemic that’s spreading quickly in Europe. The U.S. Federal Reserve and the Bank of England have both cut rates by 0.5 percentage points — the BoE also introduced cheap funding measures directed especially at hard-pressed small- and medium-sized companies. So far, Lagarde has only issued a statement saying that she stands ready “to take appropriate and targeted measures.”
The ECB president needs to demonstrate some of the fighting spirit of her predecessor, Mario Draghi. In 2012, he said the ECB would do “whatever it takes” to preserve the euro — an action that’s credited with saving the single currency. Lagarde, who took the reins in November, may have hoped for an easier start. Yet she’ll need to sound just as convincing as Draghi when she speaks to anxious citizens and investors.
A central bank cannot solve a medical emergency. But the ECB has a central role in limiting the damaging economic side-effects of the outbreak. A collapse in demand — even if temporary — can lead to a wave of bankruptcies and redundancies if companies cannot access enough liquidity to overcome their credit constraints.
Some countries, including Italy, have put in place draconian measures to try to stop the virus’s spread and to ease some of the pressure on the country’s health care system, including shutting down most shops and asking people to stay at home as much as possible. The public sector must find ways to help affected workers deal with the financial and logistical implications of that; this would make any lockdown more successful by giving people less reason to go out.
Lagarde says governments have a big role to play by using fiscal policy. She’s right about that. Italy has launched a significant spending program — of up to 25 billion euros ($28 billion) — including a boost to the health care system and various income-support schemes. Other countries, including Germany, are still dragging their feet despite the signs that their own outbreaks could quickly spiral out of control.
The ECB still has an important role, however. For a start, it can launch a new round of cheap loans targeted explicitly at SMEs. This scheme, which would mirror the BOE’s, cannot guarantee that banks keep extending their credit, but it would provide some incentives. Such steps are essential to ensure that viable businesses don’t have to shut down for good simply because of the outbreak.
Second, the ECB should cut its deposit rate from -0.5% to, say, -0.6%. This would help contain the rise of the euro, which might otherwise keep strengthening against the dollar after the Fed chose to intervene.
Finally, the ECB should expand its asset purchase program, by removing some of the self-imposed limits that constrain how many bonds it can buy. An extension of QE will bring little extra benefit to countries such as Germany, that can borrow very cheaply already. However, it is crucial for weaker states such as Italy, which need the support of the central bank if they’re to launch ambitious fiscal programs without fearing that markets will turn against them.
These schemes could, in theory, be combined with efforts to relax the prudential standards for banks, to encourage them to loosen up on extending new credit. However, the ECB should use this lever carefully. The euro zone has taken years to reduce a vast pile of bad loans, so it must ensure it doesn’t get out of control again.
The euro zone often fails to act in a timely manner to address its crises. As the human and economic cost of the Covid-19 outbreak rises, governments and the central bank need to come together to show what they can do.
To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net
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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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