11 December 2020

SUERF: Is NGEU a game changer for the ECB’s role in fighting the fall-out from COVID-19 in the euro area?

Given the asymmetric nature of the COVID-19 shock, fiscal policy is better equipped to implement measures targeted to sectors that are most affected. At the same time, national fiscal responses could be constrained by the national fiscal space in those countries that are most affected.

Therefore, NGEU and SURE clearly complement monetary policy to reduce market fragmentation. However, they have a different time horizon than PEPP (especially NGEU) as most of its stimulus will only come into effect after the end of the pandemic. Thus, for the simple reason of timing, APP and PEPP will not become redundant as a result of the creation of NGEU/SURE, but the urgency of using the PEPP’s flexibility to counter market fragmentation has been reduced.

1. Introduction

It has often been argued that when an economic crisis happens in the euro area, it ultimately comes down to the Eurosystem (European Central Bank and national central banks of the euro area) to act as “policy maker of last resort”, as EU policy makers are (a) too slow to act, (b) in some cases lack policy space to take decisive action, and (c) given asymmetric shocks, react without a euro area/EU-wide perspective. The main obstacle, it has been argued, is that the euro area (resp. the EU) lacks a central fiscal capacity to take decisive action. This lack of a fiscal and political union gave rise to redenomination risks and a sovereign debt crisis, which motivated the Eurosystem’s SMP (Securities Markets Programme) and OMT (Outright Monetary Transactions) announcements.2

As the shock induced by the COVID-19 crisis is asymmetric in terms of sectors and countries, fiscal policy is better equipped to implement targeted measures to sectors that are more affected. However, the fiscal response may be constrained by national fiscal space in those countries that are most affected.

With the announcement of the Pandemic Emergency Purchase Programme (PEPP), the Eurosystem has again provided a strong policy response. In particular, the embedded flexibility in the PEPP introduced the innovation of combining two policy aims: first, to ease further the monetary policy stance in a period of already very low nominal interest rates, and second, in light of the tail risks associated with the crisis, to reduce market fragmentation and guarantee a smooth transmission of the monetary impulse to all jurisdictions by keeping risk premia in these markets consistent with fundamentally justified levels, and by stopping intra-euro area capital outflows from periphery to core (safe-haven) bond markets.

The question arises to what extent the announcement and, ultimately, establishment of SURE (Support to mitigate Unemployment Risks in an Emergency) and NGEU3 (Next Generation EU) are game changers for the above narrative. Are these instruments the long-awaited “central fiscal capacity”, which will help vulnerable euro area countries absorb asymmetric shocks, thus taking off pressure from national sovereign debt sustainability concerns and taking off pressure from the Eurosystem to step in?

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