Europe gets it together…temporarily

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Via the excellent Damien Boey at Credit Suisse:

Temporary fiscal union forming. The European Commission (EC) is launching an unprecedented fiscal package of €750 billion (5.6% of GDP) to deal with the fallout of COVID-19. Under the plan, €500 billion will be distributed to member states in the form of grants, while the remaining €250 billion will be available as loans, with the grants not counting towards any countries’ debt tally. The package will be part of the European Union (EU) budget and funded by mutual debt issuance in the EU’s name. Some member states are reluctant to participate in mutual debt issuance, but importantly, Germany and France are on board. The stimulus package is not overwhelmingly large, and still needs to be ratified through the appropriate legislative processes. But the good news is that it represents a step toward a temporary fiscal union, with a central body able to provide help to troubled and funding constrained member states when they are in need of help. If only someone would provide the funding …

European Central Bank expands quantitative easing. Enter the European Central Bank (ECB) and its quantitative easing program (QE). The latest iteration of the ECB’s version of QE, the Pandemic Emergency Purchase Program (PEPP), will be increased by a much larger-than-expected €600 billion, and extended through to June 2021, with reinvestment of the proceeds of maturing bonds through to June 2022. From the start of 2020 through to mid-2021, the ECB should buy over €1.8tn of assets (15% of GDP), sufficient to fund major stimulus packages, including that of the EC. Recall that in the EU, member states do not have access to overdraft-like funding facilities at the ECB, and therefore cannot automatically create deposits through fiscal deficit spending. They cannot spend funds before raising them – rather they have to raise them first before spending, creating funding risks. This is where ECB QE in secondary bond markets is so critical, because it renders member state borrowing a risk free exercise. Marginal buyers of debt are guaranteed of being able to sell new issuance to the ECB by virtue of its QE program. Therefore, indirectly, the ECB funds fiscal deficit spending. The European monetary system might be more like a manual car than an automatic one – but the ECB makes sure that the transition between gears is quick and seamless, making the system look more like its other developed world counterparts.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.