Coronavirus in Europe

Phase 3 – acute overall disruption (starting early March in Italy, 1-3 weeks later in other European countries): aggregate supply shock resulting from contagion containment measures with restrained demand and mobility. […] In the event of a one-month lockdown leading to a temporary 50% drop in private-sector activity, we estimate that the cost of exceptional support measures would amount to 0.5% to 1% of annual GDP.

Phase 4 – recovery (starting in May or June): a sharp rebound is likely but may be muted by hysteresis due to confidence effects, lost corporate income in the service sectors, bankruptcies among SMEs and credit constraints resulting from the accumulation of non-performing loans on banks’ balance sheets and the rebuilding of dented savings at the household level. […] The priority in this phase will be on aggregate demand rather than supply-side or sectoral measures. The most appropriate vehicle is likely to be direct transfers to households. There is a need to plan the boost beforehand so that it can be activated at the right moment. Again, the European dimension will be key to internalising externalities.

A Eurozone ‘Coronavirus’ bond would send a strong signal that European countries stand behind the weakest of their member when confronted by a common shock. It will be more powerful than monetary policy contortions in restoring economic confidence and enabling the health authorities in all the affected European countries to fight the real battle. Should a targeted Eurobond issuance prove a bridge too far for European policymakers, there is an alternative. A coordinated jumbo sovereign debt issuance -between 10% to 20% of GDP-coordinated with an expansion of Quantitative Easing by the ECB would provide much needed fiscal space.

Yet, at present, it has no instrument in place to support member countries amid large common shocks. The European Stability Mechanism could be activated in an extreme scenario, but using it as a demand-management tool would be inappropriate. And the EU Solidarity Fund is too small for the job.The COVID-19 pandemic thus represents an opportunity for the EU to create a powerful crisis-management mechanism, which pools member states’ resources and channels them toward a coordinated fiscal policy. The idea of such an “insurance fund” is not new: several economists championed the idea after the last crisis, when discussion of governance reform was in full swing.

The pandemic could trigger a rethink of global economic exposures and production patterns. Will companies decide to increase stocks to be better equipped in the future to deal with supply chain disruptions? Will they reduce the length of value chains to become less vulnerable to such shocks? And how will international travel be transformed? As always, such a crisis is also an opportunity to revisit business models and, perhaps also in consideration of the threat to the climate, to reassess international mobility. […] The EU should also intensify its support to the development of medication and vaccines, true public goods, where the incentives for private pharmaceuticals companies might be insufficient.