Looming Threat of the Coronavirus Epidemic – Europe Should Prepare a Stimulus Package
Comment
No one knows for certain yet what the economic consequences of the coronavirus will be for the German, European, and global economy, though everyone is aware of the potentially severe economic shock the epidemic could cause. The economic risks in this case are particularly high, as the epidemic creates disturbances on both the supply and the demand side, resulting in regions affected by the outbreak likely seeing a sharp drop in services offered by providers that rely on face-to-face interactions. Consequences will not only be felt in the gastronomy sector and the travel and tourism industry but the entire entertainment and cultural sector as well.
The stationary retail sector is also likely to suffer losses in revenue if people start avoiding shopping malls, while the export economy could suffer an adverse shock due to the rapid decline in global economic sentiment. On the supply side, activities in the production sector could be interrupted by workers not being able to come to work due to quarantine measures, or the shutdown of schools and nurseries. Disruptions in global supply chains and logistics could also impact the production industry.
It is therefore not surprising that with the outbreak of the virus in Europe, expectations regarding the interest rate policy of the ECB have changed abruptly, so much so in fact that a further interest rate cutting even deeper into negative territory is no longer being ruled out.
What’s needed here is for fiscal policymakers to step in. After the 2009 financial crisis, the coronavirus could become the second textbook case where a coordinated European stimulus package makes sense. Premature demands for economic stimulus packages, though, are rightly met with scepticism among many German economists. Deeper structural growth weaknesses are too often declared to be a temporary economic problem, if only to continue incurring more debt. The shock from the coronavirus, however, is clearly something different. An epidemic is a classic temporary shock that affects the economy for a certain period of time, being potentially risky for companies in particularly affected sectors. This shock was clearly not caused by mistakes in economic policy either, which is why a corona stimulus package would not be creating false incentives (where economic policy failure is rewarded with a licence to incur debt).
Lowering VAT rates to stabilise consumption
For these reasons and considering the example of 2009, EU countries should now rapidly prepare coordinated fiscal countermeasures which can be quickly activated should the concerns about economic damage become a reality. Especially the critics of the ECB’s negative interest rates shouldn’t leave the central bank alone with this situation; they should be preparing a comprehensive fiscal policy response, the measures being designed in such a way as to allow rapid assistance to the sectors particularly affected. Possible measures include a temporary reduction in VAT rates for stabilising private consumption.
Neither the European Stability and Growth Pact nor the German debt brake forbids such reactions: on the contrary, the exception clauses on “extraordinary situations” have always left open the possibility of responding to non-economic crises such as natural disasters, wars, and epidemics.
The fact that fiscal policy has sufficient leeway for a debt-financed economic stimulus package is demonstrated via the historic lows in bond yields across eurozone countries. Particularly supporters of strict fiscal rules should show in the impending European corona recession that they take the exception clauses of these rules seriously, as this would ultimately strengthen the credibility of these rules, especially in “healthy” times.
