The Covid-19 shock has triggered a significant fiscal policy response by European Union member states. Even though it is likely to be short-lived, the 2020 recession will be historic. The fiscal response has therefore been essential in avoiding much more serious and longer-lasting economic consequences. Member states have not all been affected in the same way by the current crisis, and the scale of their fiscal responses varies. The European response has been one of the few positive aspects of the crisis. However, the challenges are not yet over. Levels of risk and uncertainty on both the public health and economic fronts will remain particularly high over the next few months
Corporate sentiment has jumped following the easing of Covid-19 related restrictions. There is a risk of excessive enthusiasm because better business expectations do not tell us where we are in terms of the level of activity and demand. The current phase of the rebound is mechanical. It shows that the supply side starts to function again. The real question however is what happens to the demand side in the coming quarters. Companies and households are confronted with limited visibility, so caution will prevail.
Recent economic data have improved on the back of the easing of lockdowns. This may create a feeling of false comfort. The effects of the severity of the crisis will make themselves felt well into the future. A key factor is the rise in unemployment and in unemployment expectations. Both weigh on household spending, due to related income losses and increased precautionary savings. The major national central banks of the Eurosystem expect unemployment to increase in 2021, despite the economic recovery. When visibility remains limited and the pressure on profits high, many companies have no other option than to reduce their labour force
One of the longer-lasting consequences of this crisis is a forced increase in corporate gearing A high level of corporate leverage can act as a drag on growth. Research shows that firms with higher leverage invest less than others. This reduces the effectiveness of monetary accommodation. Highly indebted companies may also suffer a lasting loss in competitiveness vis-à-vis their better capitalised competitors. It implies that policies aimed at recapitalising companies should have lasting favourable effects on growth.
The European Commission is proposing a comprehensive plan to support growth and achieve the EU ambitions in terms of climate policy and digital strategy. Such an effort is necessary in order to avoid that the current crisis would increase the economic divergence between member states. Such a development would weaken the functioning of the Single Market and weigh on long-term growth. The Commission proposes a combination of grants and loans at favourable terms, funded by debt issued directly by the EU. Given the resistance of certain countries to grants, negotiations on the proposal will be tough.
In the coming decades, the European countries will be confronted with rising costs related to population ageing. Based on very optimistic assumptions, simulations carried out by the EU’s Economic Policy Committee suggest that these costs are manageable. Persons that enter the workforce now are unlikely to retire under the same conditions as those who retire at the moment. The transition to leaner public pension schemes calls for accompanying measures such as incentives to remain longer in the labour force and inducements to better prepare retirement. In particular, the authorities could inform employees regularly about their pension rights and encourage them to increase their retirement savings.
Clear progress has been made at the European Council meeting this week. The proposals of the recent Eurogroup meeting on the creation of three safety nets have been endorsed. There is agreement to work on a recovery fund intended for the most affected sectors and geographical areas in Europe. Its financing would be linked with the multiannual financial framework. Importantly, Chancellor Merkel has declared that, in the spirit of solidarity, one should be prepared to temporarily pay a higher contribution to the European budget.
