Should the Eurozone rely on the US?

by Christophe Blot, Caroline Bozou and Jérôme Creel

The Covid-19 pandemic has led governments and central banks around the world to implement expansionary fiscal and monetary policies. The United States stands out for its substantial fiscal support, which is much greater than that in the euro area. In a recent paper prepared for the Monetary Dialogue between the European Parliament and the European Central Bank, we review these measures and discuss their international implications. Given the size of the US stimulus packages and the weight of its economy, we can indeed expect significant spillover effects on the euro area. However, the impact will depend not only on the orientation of economic policy but also on the precise nature of the measures adopted (transfers, spending and the articulation between monetary and fiscal policy).

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The “modern theory of money” – is it useful?

by Xavier Ragot

A heated debate is currently taking place in macroeconomics. The change in US economic policy following the election of Joe Biden has sparked debate over what to expect from “Bidenomics”. The debate has seen radical Keynesian proposals being promoted by the “modern theory of money” (MMT). This movement advocates massive stimulus packages and the monetization of public debt. This post discusses the MMT proposals through a review of two recent books that have recently appeared in French: Stephanie Kelton, The deficit myth (John Murray, 2020) and Pavlina Tcherneva, The case for a job guarantee (Polity, 2020).

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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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Public debt: Central banks to the rescue?

By Christophe Blot and Paul Hubert

In response to the health and economic crisis, governments have implemented numerous emergency measures that have pushed public debt up steeply. They have nevertheless not experienced any real difficulty in financing these massive new issues: despite record levels of public debt, the cost has fallen sharply (see Plus ou moins de dette publique en France ?, by Xavier Ragot). This trend is the result of structural factors related to an abundance of savings globally and to strong demand for secure liquid assets, characteristics that are generally met by government securities. The trend is also related to the securities purchasing programmes of the central banks, which have been stepped up since the outbreak of the pandemic. For the year 2020 as a whole, the European Central Bank acquired nearly 800 billion euros worth of securities issued by the governments of the euro zone countries. In these circumstances, the central banks are holding an increasingly high fraction of the debt stock, leading to a de facto coordination of monetary and fiscal policies.

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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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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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How to spend it: A proposal for a European Covid-19 recovery programme

Jérôme Creel, Mario Holzner, Francesco Saraceno, Andrew Watt and Jérôme Wittwer[1]

The Recovery Fund recently proposed by the EU Commission marks a sea-change in European integration. Yet it will not be enough to meet the challenges Europe faces. There has been much public debate about financing, but little about the sort of concrete projects that the EU should be putting public money into. We propose in Policy Brief n°72 a 10-year, €2tn investment programme focusing on public health, transport infrastructure and energy/decarbonisation.

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It seems like it’s raining billions

Jérôme CreelXavier Ragot, and Francesco Saraceno

The second meeting of the Eurogroup did the trick. The Ministers of Finance, after having once again laid out their divisions on the issue of solidarity between euro area Member States on Tuesday 7 April 2020, reached an agreement two days later on a fiscal support plan that can be put in place fairly quickly. The health measures taken by the Member States to limit the spread of the Covid-19 pandemic will enjoy better short-term financing, which is good news. The additions to Europe’s tools for dealing with the crisis will be on the order of 500 billion euros – this is certainly not negligible, and note that this comes on top of the efforts already put in place by governments – but this corresponds mainly to a new accumulation of debt by the Member States. The net gain for each of them, as we shall see, is actually quite marginal.

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What do the fiscal stimulus strategies in the United States and Europe reveal?

By Christophe Blot and Xavier Timbeau

In parallel with the decisions taken by the US Federal Reserve and the European Central Bank (ECB), governments are stepping up announcements of stimulus packages to try to cushion the economic impact of the Covid-19 health crisis, which has triggered a recession on an unprecedented scale and pace. The confinement of the population and the closure of non-essential businesses is leading to a reduction in hours worked and in consumption and investment, combining a supply shock and demand shock.

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The transmission of monetary policy: The constraints on real estate loans are significant!

By Fergus Cumming (Bank of England) and Paul Hubert (Sciences Po – OFCE, France)

Does the transmission of monetary policy depend on the state of consumers’ debt? In this post, we show that changes in interest rates have a greater impact when a large share of households face financial constraints, i.e. when households are close to their borrowing limits. We also find that the overall impact of monetary policy depends in part on the dynamics of real estate prices and may not be symmetrical for increases and decreases in interest rates.

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