A new take on ‘whatever it takes’?

In this piece, Professor Iain Begg reflects on Mario Draghi’s support for a closer fiscal union. The ECB president’s recent statements calling for cross-border fiscal transfers reinvigorated the debate between advocates for risk sharing and proponents of risk reduction. Draghi’s predecessor, Jean-ClaudeTrichet, has defended Draghi and his proposals against criticism from other former central bankers, but resistance from several key member states remains daunting.

Is the macroeconomic policy mix in Europe attuned to the evolving needs of the economy? In what could be interpreted as a valedictory interview for the Financial Times, reported on 29th September 2019, Mario Draghi called on governments to make greater use of fiscal policy to stimulate the eurozone economy and to work towards closer fiscal union. It is by no means the first time he has advocated moves towards fiscal union, but in the interview – controversially – he goes further by supporting cross-border fiscal transfers.

His plea came after what appears to have been broader opposition than previously within the European Central Bank’s (ECB) Governing Council to the latest round of monetary easing, agreed at its September 2019 meeting. Yet another resignation of a German member of the Executive Board, Sabine Lautenschläger who is leaving two years before the end of her mandate, is also seen as direct criticism of the Draghi strategy.

Then, in early October, six prominent former central bankers, who would probably not balk at being described as being inflation hawks, published a memorandum critical of what they regard as the overly accommodative stance of the ECB. Three of the signatories are German, and one each Austrian, Dutch and French, although the memorandum notes rather delphically that ‘our judgement is shared by’ two former French central bank governors.

However, Jean-Claude Trichet, Draghi’s immediate predecessor, wrote (in the Financial Times of 14th October) what has to be read as a rebuke to the group, most of whom worked directly with him. By the discreet standards of central bankers this is racy stuff. Trichet not only offers a staunch defence of Draghi’s record, but also weighs in on the need for a fiscal stimulus.  He calls for ‘fiscal action in countries with the requisite room for manoeuvre’ and ‘wage growth in the full-employment countries’. He also draws attention to the Eurozone’s excessive current account surplus’. There can be little doubt that Germany and, probably, the Netherlands are the countries in his sights.

After a prolonged period when monetary policy has been the main instrument used to manage the Eurozone economy, a fresh debate on macroeconomic policy is timely. With storm-clouds over the global economy as a result of trade wars, the fallout from Brexit and other geo-political tensions, the risk of a renewed downturn in Europe has grown, but the capacity to respond is in doubt.

The nub of the macroeconomic problem is that, with interest rates already at rock bottom and little sign of the cheap credit having any further effect on the demand-side of the economy, fiscal policy is the only immediate alternative. But it has largely been shunned, prompting former International Monetary Fund (IMF) chief economist Olivier Blanchard, though hesitant about pushing debt higher, to query the mainstream obsession with debt reduction.

Reforms on the supply-side of the economy, routinely advocated by central bankers, may eventually improve resilience, but cannot be expected to provide a short-term stimulus. Indeed, as Draghi asserted in a speech on 2nd October 2019, ‘when countries are under market pressure, they are typically either compelled to enter macroeconomic adjustment programmes, or they enact reforms that are poorly designed and easily reversed’. Evidence from Featherstone and Cottakis suggesting countries with weaker institutional capacity struggle to implement such reforms reinforces this concern.

In the same speech, reiterating his call for a cross-border fiscal backstop and emphasising that having it will lessen risk by enabling crises to be dealt with more swiftly, Draghi acknowledges that moving ‘in this direction is evidently politically difficult’. He nevertheless insists fiscal policy has to assume a greater role in stabilisation policy and argues for the priority to be on growth-promoting public investment.

The case is persuasive, but it leads to an obvious question: why is it resisted? There are several stock answers. First, the power in fiscal policy resides with member states and, despite efforts to establish new supranational mechanisms, they are being endowed with resources in hundreds of millions of euros when they would need to be in tens of billions or more to be credible.

Second, there is an enduring antipathy to even the prospect of cross-border fiscal transfers, typically rooted in narratives about moral hazard and the alleged ‘fecklessness’ of the persistent debtor countries. Although Draghi does his best to debunk these claims, they reflect mentalities unlikely to be easily shifted.

A third, linked consideration is the imbalances in national fiscal ‘space’: those with room to engage in fiscal stimulus see no justification for it and tend to have deep-rooted doubts about its efficacy; those most in need of stimulus are constrained by fiscal rules and market pressures. This incongruity translates into conflicting attitudes to a supranational fiscal capacity.

All these objections feed into the continuing division of member states into two camps: those insistent that risk sharing has to be implemented urgently, while their antagonists believe risk reduction must precede any pooling of risk. The latter camp is also, on the whole, the net creditors in the Eurozone and their resistance means risk-sharing faces an uphill battle.

Germany has long been regarded as the standard-bearer of the risk reduction camp. But the ‘new Hanseatics’ a group of eight smaller member states (supported latterly by the Czech and Slovak Republics), has recently led the opposition to new fiscal instruments, effectively neutering ambitious proposals championed by France. According to Reuters, Wopke Hoekstra (Dutch Finance Minister) went so far as to claim after a June 2019 meeting that ‘as long as this government in the Netherlands is in place, the stabilization function will not be there’.

Recently, however, the threat of an economic downturn, possibly becoming a recession, has seen questioning of the ‘schwarze null’ – black zero: Germany’s policy of avoiding any fiscal deficit – for example by Christian Reiermann in Spiegel Online. The IMF’s October 2019 World Economic Outlook stresses the increased risks to global growth and, in her foreword, IMF economic counsellor Gita Gopinath singles out Germany as a country which ought to boost public spending ‘in social and infrastructure investment, even from a pure cost-benefit perspective’. She also speculates on whether ‘an internationally coordinated fiscal response, tied to country circumstances, may be required’.

While political factors have been crucial in inhibiting resort to more pro-active fiscal policy, economic constraints also have to be considered, especially as regards Germany. As many commentators have stressed, the country needs higher investment in infrastructure, without which its underlying growth rate is likely to be lower. Higher public investment would, therefore, be warranted and, with borrowing costs unprecedentedly low, it would be hard to find a more propitious time to boost such spending.

A catch is that the German economy is effectively at full employment, implying it would be hard to recruit the labour needed to construct or repair the infrastructure, even if the political objections to incurring debt could be overcome. A slowdown or even a mild recession would pull Germany and other fiscally conservative countries towards a fiscal deficit in the absence of any tightening of fiscal policy through the functioning of automatic stabilisers, but sticking rigidly to ‘schwarze null’ would limit the likely stimulus.

The received wisdom is that demand spillovers from a fiscal stimulus in creditor countries will only have limited benefits for the most fiscally constrained countries, such as Italy. However, new research by Paul De Grauwe and Yuemei Ji suggests otherwise, implying that a concerted stimulus from the creditor countries, which account for close to half the Eurozone economy, would have a more marked stabilisation impact.  The problem remains their reluctance to do so and, in the case of those with near full employment, whether labour constraints would detract from the ability to expand demand.  The inexorable logic points to the need for an authentic cross-border fiscal stabilisation capacity, as Draghi advocates.

As Christine Lagarde takes over the ECB hot seat in Frankfurt, the tectonic plates of macroeconomic policy thinking are shifting, although they will probably not settle rapidly enough to cope with the looming downturn. Even so, national fiscal policy should play an enhanced role. It may be time to apply to fiscal policy the statement for which Draghi will always be remembered, with a revision to the second phrase: ‘whatever it takes, but it needs to be enough’.

Professor Iain Begg is the Academic Co-Director of the Dahrendorf Forum and Co-Chair of the Dahrendorf Working Group “The Future Of European Governance”. He is also a Professorial Research Fellow in the European Institute at the London School of Economics and Political Science.


The opinions expressed in this blog contribution are entirely those of the author and do not represent the positions of the Dahrendorf Forum or its hosts Hertie School and London School of Economics or its funder Stiftung Mercator.