Reducing uncertainty to facilitate economic recovery

Elliot Aurissergues (Economist at the OFCE)

As the health constraints caused by the pandemic continue to weigh on the economy in 2021, the challenge is to get GDP and employment quickly back to their pre-crisis levels. However, companies’ uncertainty about their levels of activity and profits in the coming years could slow the recovery. In order to cope with the possible long-term negative effects of the crisis, and weakened by their losses in 2020, companies may seek to restore or even increase their margins, which could result in numerous restructurings and job losses. Economic recovery could take place faster if business has real visibility beyond 2021. While it is difficult for the current government to make strong commitments, on the other hand mechanisms that in the long term are not very costly for the public purse could make it possible to take action.

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What factors drove the rise in euro zone public debt from 1999 to 2019?

by Pierre Aldama

Between 1999 and 2019, the eve of the Covid-19 pandemic, the public debts of the 11 oldest euro zone members had risen by an average of 20 percentage points of GDP. This increase in public debt is commonly attributed to structural budget deficits, particularly those in the pre-crisis period and in the “South”. But how much of the stock of public debt in 2019 can be attributed to structural deficits, and how much to GDP growth, interest payments or cyclical deficits? In this post, we use the December 2020 edition of the OECD’s Economic Outlook to break down the changes in public debt into its main factors: structural and cyclical primary balances, the interest burden, nominal GDP growth and stock-flow adjustments. This shows that the structural deficits generally contributed less than is commonly assumed, and that the increase in public debt over the period was largely the result of the direct and indirect consequences of the double-dip recession in the euro zone.

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Monetary Policy During the Pandemic: Fit for Purpose?

Christophe Blot, Caroline Bozou and Jérôme Creel

In a recent Monetary Dialogue Paper for the European Parliament, we review and assess the different policy measures introduced by the ECB since the inception of the COVID-19 crisis in Europe, mainly the extension of Asset Purchase Programme (APP) measures and the development of Pandemic Emergency Purchase Programme (PEPP) measures.

APP and PEPP have had distinct objectives in comparison with former policies. APP has been oriented towards price stability while PEPP has been oriented towards the mitigation of financial fragmentation.

To this end, we start by analysing the effects of APP announcements (including asset purchase flows) on inflation expectations via an event-study approach. We show that they have helped steer expectations upward.

Then, we analyse the impact of PEPP on sovereign spreads and show that PEPP has had heterogeneous effects that have alleviated fragmentation risk: PEPP has had an impact on the sovereign spreads of the most fragile economies during the pandemic (e.g. Italy) and no impact on the least fragile (e.g. the Netherlands). However, sovereign spreads have not completely vanished, making monetary policy transmission not fully homogeneous across countries.

On a broader perspective, we also show that overall macroeconomic effects have been in line with expected outcomes since the mid-2000s: ECB monetary policy measures have had real effects on euro area unemployment rates, nominal effects on inflation rates and financial effects on banking stability. These results are in line with recent estimates at Banque de France (Lhuissier and Nguyen, 2021).

As a conclusion, an increase in the size of the PEPP program, as recently decided by the ECB, will be useful if financial risks re-emerge. Meanwhile, we argue that an ECB decision to cap the sovereign spreads during the COVID-19 crisis would alleviate the crisis burden on the most fragile economies in the euro area, where sovereign spreads remain the highest.

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Spain: Beyond the economic and social crisis, opportunities to be seized

by Christine Rifflart

Spain has been hit hard in 2020 by the Covid-19 health crisis, which the authorities are struggling to control, accompanied by an economic recession that is one of the most violent in the world (GDP fell by 11% over the year according to the INE)[1]. The country’s unemployment rate reached 16.1% at the end of last year, a rise of 2.3 points over the year despite the implementation of short-time work measures. The public deficit could exceed 10% of GDP in 2020, and the public debt could approach 120% according to the Bank of Spain’s January 2021 forecasts. Europe has enacted large-scale support programmes for affected countries, and as one of these Spain will be the country receiving the most EU-level aid. It will benefit from at least 140 billion euros, with 80 billion of that (i.e. 6.4% of 2019 GDP) taking the form of direct transfers through the NextGenerationEU programme.

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Innovation and R&D in Covid-19 recovery plans: The case of France, Germany and Italy

by A. Benramdane, S. Guillou, D. Harrich, and K. Yilmaz

Economies have been dramatically affected by the pandemic of Covid-19 in 2020 (OFCE, 2020). In response, several emergency measures have been undertaken by governments to support the people and the firms that were directly and strongly hit by the lockdowns. After the first shock in spring 2020, which had an international dimension, all economies experienced a decline in their production which jeopardizes their future and the wellbeing of their population. In the near future, bankruptcies and unemployment are expected to increase and the slowdown of private investment will minor both quantitatively and qualitatively the future capacities of production. Meanwhile, the huge rise in public debt will complicate the States’ ability to invest and promote long term growth through public investment. To cope with this dismal future, in addition to emergency measures, many governments have implemented recovery plans to boost and support the economy and to sustain a return to previous levels of wealth. Some governments try, through the recovery measures, to orient their future growth toward specific objectives. In the EU, the Resilience Recovery Facility (RRF), which aims to finance part of EU members’ plan, is adopting this stance by demanding that part of member’s plan will include at least 20% of measures dedicated to digital improvement and 27% dedicated to green investment.

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What more could the central banks do to deal with the crisis?

By Christophe Blot and Paul Hubert

The return of new lockdown measures in numerous countries is expected to slow the pace of economic recovery and even lead to another downturn in activity towards the end of the year. To address this risk, governments are announcing new support measures that in some cases supplement the stimulus plans enacted in the autumn. No additional monetary policy measures have yet been announced. But with rates close to or at 0% and with a massive bond purchase policy, one wonders whether the central banks still have any manoeuvring room. In practice, they could continue QE programmes and increase the volume of asset purchases. But other options are also conceivable, such as monetizing the public debt.

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Central bank asset purchases: Inflation targeting or spread targeting?

by Christophe Blot, Jérôme Creel, and Paul Hubert

Five years after the ECB launched its asset purchase programme (APP), the Covid-19 crisis has put the ECB again at the center of euro area attention, with a new extension of APP and with the creation of the Pandemic Emergency Purchase Programme (PEPP). The simultaneity between APP’s extension and PEPP – they were decided within a two-week interval – could be interpreted as arising from the pursuit of the same objective. This interpretation may be misleading though and may bias the respective appraisal of these policies.

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Europe’s recovery plan: Watch out for inconsistency!

by Jérôme Creel (OFCE & ESCP Business School) [1]

On 27 May, the European Commission proposed the creation of a new financial instrument, Next Generation EU, endowed with 750 billion euros. The plan rests on several pillars, and will notably be accompanied by a new scheme to promote the revival of activity in the countries hit hardest by the coronavirus crisis. It comes on top of the Pandemic Crisis Support adopted by the European Council in April 2020. A new programme called the Recovery and Resilience Facility will have firepower of 560 billion euros, roughly the same amount as the Pandemic Crisis Support. The Recovery and Resilience Facility stands out, however, for two reasons: first, by the fact that part of its budget will go to grants rather than loans; and second, by its much longer time horizon.

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Sweden and Covid-19: No lockdown doesn’t mean no recession

By Magali Dauvin and Raul Sampognaro, DAP OFCE

Since the Covid-19 pandemic’s arrival on the old continent, a number of countries have taken strict measures to limit outbreaks of contamination. Italy, Spain, France and the United Kingdom belatedly stood out with especially strict measures, including lockdowns of the population not working in key sectors. Sweden, in contrast, has distinguished itself by the absence of any lockdown. While public events have been banned, as in the other major European countries, there were no administrative orders to close shops or to impose legal constraints on domestic travel[1].

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Effets contrastés des mesures de confinement au mois d’avril

Magali Dauvin et Paul Malliet

Dans les différents Policy Brief qui ont été publiés par l’OFCE depuis le déclenchement de la Covid-19[1], nous avons fait le choix méthodologique de fonder notre analyse à partir des tables input-output de la base de données entrées-sorties WIOD[2] publiée en 2016. Cette dernière permet de pouvoir évaluer l’impact sur la valeur ajoutée au niveau sectoriel (nomenclature NACE à 17 produits) du choc mondial de confinement que plusieurs observateurs ont qualifié The Great Lockdown.

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