Who will foot the bill? Even in these dark times, this call for straightforward realism might not be as incongruous as it seems, given the level of debt governments have accumulated in just a few months. The lifting of lockdown and the unburdening of debt are morphing into the same issue.
Today, countries across the globe are beginning to ease lockdown restrictions, however the question remains what does the future hold for European budgetary and monetary policy? How can there still exist a united monetary zone when Italy’s debt is twice that of Germany’s? Should we go back to the "before" model? Relaunch mass tourism, extreme globalization, uncontrolled production, and investment in oil? Should we adhere to the Maastricht criteria and demand austerity from the Italians for the price of their fight against the epidemic?
Over the next two years, debt spreads between Eurozone countries will widen - spreads of up to 100% are being discussed as a possibility. The countries hit the hardest by the virus - Italy, France, and Spain – have instigated the strictest lockdown policies, and therefore have the greatest increase in debt levels. Conversely, Germany has been less affected and seems better positioned for a rebound.
Therefore, how are we to manage these increased levels of debt? We see four options:
- Reduce deficits and demand austerity from poor countries. This option is not only politically and morally complicated; it is also economically dangerous. The Greek example demonstrated that austerity could paradoxically do more harm than good for public spending.
- Create nominal growth and therefore inflation. Very easy to say ... and very difficult to do, given the demographics and productivity in Europe. With savings rates at an all-time high, a rebound in inflation seems unlikely in the short term.
- Reschedule excessively high debts. This option could certainly lower debt ratios, but would require asking banks and households, whose savings are largely invested in government debt, to dig into their portfolios…Rescheduling would also prove dire for the political sustainability of the euro area.
- Pool debt. This is by far, in our view, the most likely option to have positive long-term effects. The creation of Euro Bonds would make the euro area irreversible and create new fiscal breathing space. This debt could be managed according to a double-stage system: a national stage managed by governments for individual countries’ expenses and a European stage for the new expenses linked to the pandemic as well as any new structural common expenses, for example climate policy or immigration.
As restrictions are eased, inequality will come to the forefront. Remember that the wealth of the richest 1% corresponds to more than twice that of the remaining 7 billion people – therefore if the poorest and most affected countries are made to pay for the consequences of increased debt, we could see a rise in populism.
Furthermore, without the pooling of debt, a return to budgetary austerity would undoubtedly put the Eurozone and European debt in danger. We would also risk a wave of defaults like those witnessed during the 1930’s, which were the tragic consequence of the Versailles moto “Germany should pay”, but this time with even more disturbing political consequences.
The main risk we face today is reverting to old models. There is another way.