Opinion

Why Europe needs a change of mind-set to fend off the risks of recession

Recession! This is the new worry in Europe and the US. A simple look at google trends shows that in Germany, France and the US, search interest for recession peaked in the last weeks. In Italy, the peak already occurred end of January. Whether a recession is actually occurring is difficult to gauge in real time. But there can be no doubt that significant risks such as the trade war and no-deal Brexit exist.

By: Date: September 2, 2019 Topic: European Macroeconomics & Governance

Versions of this Op-ed have been published in Le Monde, Handelsblatt, Caixin, Nikkei Veritas, Kathimerini, El Pais and Rzeczpospolita.

Le Monde logo

caixin logo english

nikkei veritas logo

El País logo

Rzecszpospolita logo

 

For European finance ministers, the situation represents a new challenge. When major recessions happened in the past, finance ministers knew that the central bank would be the first line of defence. But with interest rates at zero, room for cutting is very limited for the ECB. Still, the European Central Bank may still push the rate on excess reserves further into negative and restart some sort of asset purchase programme.

All of this ECB action can be somewhat useful, but the reality is that central banks’ ability to control inflation and manage the business cycle may be extremely limited at this stage. The former ECB vice president, Vitor Constancio, recently admitted that it is a “theoretical myth that – in any circumstance – monetary policy alone can control inflation at will”. In the same vain, former US secretary of the treasury and Professor of Economics at Harvard, Larry Summers, argues that structural and fiscal policies are now the key policy tools.

This puts the ball squarely in the camp of European finance ministers. But to succeed, a fundamental change of the finance ministers’ mind-set is needed:

It isn’t enough to rely on automatic stabilisers as Bundesbank President Jens Weidman has just suggested. The problem is that automatic stabilisers kick in late, when workers have already lost their jobs. Automatic stabiliser can only dampen the downturn. Alone, they are insufficient to fend off a recession.

It is time for Europe’s finance ministers to move from reaction to pro-active insurance against downturns. They should prepare concrete spending plans and tax cuts that could be quickly activated should the recession fears materialise. Contingent spending plans should be put in the budget of 2020 already now.

Given the risks to the outlook and the negative real interest rates, some measures should already be put in place to mitigate chronic underinvestment. In fact, recent estimates on the low equilibrium yields suggest that Europe has a weakness in investment and excess savings. Ideally, fiscal policy measures should therefore be targeted at long-standing investment gaps. Two concrete measures come to mind:

First, it would be appropriate for Germany to decide a full depreciation allowance for corporate investments in Germany for a period of say 5 years. This would not only provide an immediate incentive for new corporate investments. It would also tackle a long standing weakness of the German economy: its low rate of corporate investment. Contrary to a corporate tax cut, such as a step would not be a giveaway to companies but a time-limited incentive to invest. And a better capital stock would also help lift salaries.

Second, a significant public investment plan to green the European economy is needed if Europe wants to achieve its goal of climate neutrality. The financing of a sustainable European economy would require very significant investments, hence the name “green new deal”.  In fact, relying only on higher prices for carbon is unlikely to be acceptable. Citizens and companies need to see credible alternatives to their existing ways of life and doing business. Only large, publicly supported, investments could fill this gap. It would also provide a boost to Europe and could be funded literally at zero or even negative costs in the zero interest world.

The question is then how to fund such investments in Europe. Relying only on national budgets is likely going to be insufficient. Not only are some countries’ budgets severely constraint. But countries will also tend to rely on European partner countries to do much of the heavy lifting when it comes to developing the infrastructure. Clearly, climate change deserves a European response with European financing.  The European Investment Bank would be the right institution at the European-level to issue on a large scale sovereign bonds to fund the necessary investments across Europe in green infrastructure.

Many in Europe and Germany such as the for example German savings banks complain about the low interest rates. But those rates are naturally low because so little is invested and so much is saved. The ECB cannot solve this problem. Europe’s finance ministers can. Time to change mind-set from reactive to proactive fiscal policy. Time to provide fiscal insurance against downturns and fund green investments at zero costs.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article More on this topic More by this author

Podcast

Podcast

Cars, steel and national security: The EU-US trade spat

Guntram Wolff is joined by Alan Beattie, the author of the FT's new Trade Secrets newsletter, and by Andre Sapir, Bruegel's very own trade expert to discuss President Trump's tariffs and whether or not they're working

By: The Sound of Economics Topic: Global Economics & Governance Date: November 14, 2019
Read article More on this topic More by this author

Opinion

Scholz's improved plan to complete the banking union

The head of German Finance has written in the Financial Times defending the need to deepen the banking union, now London is about to leave

By: Rebecca Christie Topic: European Macroeconomics & Governance Date: November 8, 2019
Read about event More on this topic

Upcoming Event

Dec
11
08:30

The Great Reversal-Causes and implications of the rising corporate concentration in the US

During this event, Thomas Philippon will present his thesis on market concentration and explain the reasons behind the rising corporate market power in the US.

Speakers: Thomas Philippon, Georgios Petropoulos and Reinhilde Veugelers Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Schaut in die Region!

Die deutsche Industriepolitik folgt bisher keiner klaren Strategie, sondern ist von Unternehmensinteressen getrieben. Das ist der falsche Weg.

By: Georg Zachmann Topic: Energy & Climate Date: October 29, 2019
Read article More on this topic

Blog Post

Talking about Europe: La Stampa 1940s-2010s

An on-going research project at Bruegel seeks to quantify and analyse printed media discourses about Europe over the decades since the end of the Second World War. In this third blogpost, we carry out the exercise on 9.9 million articles from an Italian daily newspaper, La Stampa. The trend increase in the frequency of European related articles, previously found looking at the French and German press, is confirmed in the case of Italy.

By: Enrico Bergamini, Emmanuel Mourlon-Druol, Francesco Papadia and Giuseppe Porcaro Topic: European Macroeconomics & Governance Date: October 22, 2019
Read article More on this topic

Blog Post

Implications of the Japan – United States Mini Trade Agreement

Details of the US-Japan mini-trade deal are lacking but the agreements’ direct impact on the US and Japanese economies is likely to be minuscule. The deal seems to have been made to compensate American farmers – a crucial electoral base of the President – for their losses from the trade war with China.

By: Sybrand Brekelmans and Uri Dadush Topic: Global Economics & Governance Date: October 11, 2019
Read article More on this topic More by this author

Opinion

Europe: en finir avec la politique en silos

Projetée dans un monde de rapport de force dont les principaux protagonistes ne séparent pas géopolitique et économie, l’UE va devoir conduire un changement de logiciel culturel, une mutation organisationnelle et un rééquipement opérationnel, explique l’économiste Jean Pisani-Ferry.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: October 8, 2019
Read article More on this topic More by this author

Opinion

The Case for Intelligent Industrial Policy

Although national industrial policies have a bad reputation, there is a strong case for government support to sectors that will increasingly rely on artificial intelligence. In this regard, the German government’s plan to promote production of electric-car batteries may accelerate an industrial renaissance in Europe.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: October 7, 2019
Read article More on this topic More by this author

Opinion

How to ward off the next recession

Despite confident official pronouncements, the deteriorating state of the global economy is now high on the international policy agenda. The OECD recently revised down its forecasts to 1.5% growth in the advanced G20 economies in 2020, compared to almost 2.5% in 2017. And its chief economist Laurence Boone warned of the risk of further deterioration – a coded way of indicating a growing threat of recession.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: October 2, 2019
Read article More by this author

Blog Post

Questions to the High Representative and Vice-President-designate Josep Borrell

Josep Borrell, the incoming High Representative and Vice-President-designate must explain how von der Leyen’s ‘geopolitical Commission’ intends to adapt to a global landscape dominated by an intensifying rivalry between Washington and Bejing.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 30, 2019
Read article

Blog Post

The EU is in the US trade war crosshairs. It should further raise its game

The incoming European Commission faces a dilemma on the transatlantic trade relationship, because of the unpredictable policies of the Trump administration. The EU must rally its citizens; the greater the divides between member states and EU institutions, the lesser the chances are of forging effective policies toward the United States and China.

By: Anabel González and Nicolas Véron Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 19, 2019
Read article More on this topic

Opinion

Trump's Backfiring Trade Policy

President Trump’s radical trade policy continues, as do trade disputes with China. The president promised to sign far better trade deals, ensure fair treatment of American firms and reduce the United States’ trade deficit. None of these objectives have been met.

By: Uri Dadush and Laurence Kotlikoff Topic: Global Economics & Governance Date: September 17, 2019
Load more posts