Beiträge von mmsteidl

There is an excellent and timely book that just was e-published, in which some of the leading economic thinkers of our times have contributed their thoughts on the economic fallout and necessary measures to the Covid-19 crisis:
https://voxeu.org/content/mitiga…atever-it-takes
I have tried to summarize some of the main points of the book, with a special emphasis on the EU, SMEs and the financial sector.

The book calls for: ACT FAST AND DO WHATEVER IT TAKES

In the same way we are taking public health measures to flatten the epidemic curve, we must take economic measured to flatten the (inevitable) recession curve. Measures include central bank liquidity, fiscal stabilizers and discretionary fiscal measures. There is also a role for the financial sector.
The priority should be:
1. To ensure that workers can remain employed – and collect their wages – even if quarantined or forced to stay home to look after dependents. Temporary layoff assistance is a key component; without it, it is even unclear whether public health advisories can be followed. Households need to be able to make basic payments (rent, utilities, mortgages, insurance).
2. To ensure that firms can weather the storm without going into bankruptcy, with easier borrowing terms, possibly temporarily waving tax or payroll payments, suspending loan payments, or providing direct financial assistance where needed.
3. To support the financial system as non-performing loans will mount, so as to ensure the crisis does not morph into a financial crisis. (p.36)

A fundamental principle promoted throughout the book is: Better to do too much rather than too little.
The current situation is one of radical uncertainty. And given this radical uncertainty, policy has to be based on a risk analysis of the cost of doing too little and the cost of doing too much. In this case the risk analysis is increasingly clear: the cost of doing too much is the time value of money, which right now is negative given the negative real interest rates. The cost of doing too little could potentially be enormous both in terms of immediate human suffering and a prolonged economic crisis that exceeds the one in the wake of the global financial crisis. (p. 193)

As for Europe, one of the main problem is that the crisis hits when some of the structural problems of the Euro area are not yet resolved.
The vengeance of the unfinished reform agenda is that the euro has no meaningful fiscal stabilisation tool and no common safe asset, it is missing a common deposit insurance, and it still suffers from the ‘doom loop’ (e.g. Alogoskoufis and Langfield 2018). Fighting the crisis will mean sharply higher debt levels everywhere, but in countries with already high debt levels this can trigger spiking sovereign spreads and a vicious circle. Fears of financial fragmentation and redenomination risk could lead straight back into a euro crisis and a sudden stop of capital flows. This is not something the world needs in the midst of a pandemic. The instruments and institutions that the euro area has created over the course of the last ten years are not designed for this type of crisis. They are designed for an asymmetric shock to a single country (or a series of small countries), originating in the financial or public sector. (p. 18)
A more comprehensive European approach is needed on two levels. 1. An ambitious ‘Catastrophe Relief Plan’ to share the burden and support the efforts of member states in combatting the pandemic; 2. A stronger ‘roof’ for the euro, since financial fragmentation at this point could trigger a dangerous cascade of political, economic and social effects. (p. 20)


“Whatever it takes” would mean a really strong fiscal and monetary bazooka for Europe, that includes support for SMEs.
A financial backstop for companies, particularly SMEs. Such a programme would bring guarantees, credit lines, and working capital loans to ensure SMEs remain liquid and can return back to normal when the economy is ‘unfrozen’. This would mean a programme with the level of ambition of the German bazooka. Relative to GDP, the German level of ambition would entail a €2.2 trillion programme at the EU level. Assuming the level of leverage the EIB can achieve, this would require around €275 billion in guarantees. (p. 133)

One of the proposed measures is a pandemic bond, potentially issued by the EIB.
A second financing option would be to create a new instrument: a common pandemic bond issued by the ESM or EIB (or a combination of both). The bonds would have to have a high rating, which might necessitate a capital increase of these institutions. The bonds would need to be structured to be a targeted to the specific purpose of pandemic fight and limited to a case of extreme emergency. The proceeds of this bond could be allocated pro rata to member states or they could flow to specific activities of the EIB or ESM. The service of the bond could be through the EU budget or take the form of an EU ‘special solidarity tax’ (to be levied only after the recovery). An important advantage of this solution is that is constitutes supranational debt, and therefore does not add to the national debt levels, although governments would have a contingent liability through their capital shares in the ESM/EIB. The bonds would be eligible for ECB asset purchase programmes. Overall, a pandemic bond would serve the dual purpose of helping to financing the costs of the crisis (see above) and sending a strong signal to markets, firms and citizens that Europe was united and working for the benefit of all. That, in turn, would boost trust. (p. 22)

Europe has to be at its best; supporting Italy is vital.
Most advanced economies should be able to face such a one-off increase in public debt. There are important exceptions: euro area countries like Italy, with elevated public debt levels and subject to stringent fiscal rules. Here, the answer is clear: strong signals should be sent that the euro area will support these efforts. (p. 37)
The lockdown in Italy did not stop the virus, but it did slow down the contagion to others and bought the rest of Europe a few weeks of (largely wasted) preparation time. (p. 19)
Without excusing the mistakes Italy has made in the past (and hoping that they are not repeated), this is not the time for the EU to impose constraints. Despite the initial indifference and lack of foresight of France, Germany and other countries, which is finally is changing (too late), the virus will come to them too. And then it can only be contained it with a determined, credible and ideally joint European effort – “whatever it takes”. There are two options. Either each country is left to find the additional resources alone, or they are part of a EU-wide programme. (p. 54)

SMEs are seriously affected, not only in their liquity, but also in their solvency.
The crisis not only affects corporate liquidity, it also has serious effects on the earnings situation of many companies and self-employed. As these are mainly caused by restrictions imposed to protect the health of the population, they can be regarded as negative external effects for which companies must in principle be compensated. Apart from the short-time working allowance, which plays an important role here, the German government has not yet taken any major steps in this direction. (p. 175)
What is now missing above all are measures to stabilise the liquidity and earnings situation of the self-employed and owners of smaller companies. For these people there is no automatic stabilisation mechanism available, such as unemployment benefit or short-time work. What is needed here is short-term and administratively simple aid, which should be provided either in the form of direct transfers or loans with very long maturities and, if possible, free of interest. (p. 176)
Companies will go bankrupt throughout the economy, although the extent and magnitude will depend on the policy response. In some cases, these could be disorderly bankruptcies that separate firm-specific management capital, worker capital, and a nested set of arrangements and sever all of them simultaneously. Putting that back together will not be easy. (p. 192)

Banks have to be induced to keep lending to businesses.
While banks can help their clients to overcome their liquidity constraints, they have a limited ability to do so. Initiatives such as those by the UK government and the Bank of England, as well as the German and French governments, to offer funding liquidity for banks and credit guarantees can be helpful in this context. (p. 180)
One of the defining characteristics of bank lending over the business cycle is its procyclicality: in a recession banks reduce lending rapidly, especially to smaller enterprises and riskier borrowers. While some of this lending retrenchment is demanddriven, agency conflicts at the core of banking point to substantial supply effects. Regulation can further exacerbate this procyclicality, requiring forward-looking loan classification (as under IFRS 9) and provisioning, as well as forcing an increase in risk weights and thus capital. Anticipating negative effects from the disruption for real economy and financial sector and mitigating these negative effects is therefore critical and urgent.
Steps taken by supervisors across Europe to:

• lower countercyclical buffers where currently above zero;
• reduce capital requirements, allowing banks to operate temporarily below the level of capital defined by the Pillar 2 Guidance and the capital conservation buffer (CCB); and
• allow banks to operate below 100% of their liquidity coverage ratio (LCR)

are adequate and can help reduce the risk of lending retrenchment. (p. 180)
Assistance to businesses will require the most creativity. Large-scale lending programmes will be an important part of the response, including partial or full government guarantees of loans made by banks to businesses in order to keep them able to employ people and out of bankruptcy so as to be in a position to resume activity after the pandemic ends – something Germany, among others, has launched. New procedures are needed to enable large-scale workouts and avoid costly bankruptcies and liquidations without relying heavily on government administration. Whether the government should directly cover a large fraction of payroll, as in Denmark, is worth seriously considering. Finally, ensuring banks can extend and pretend on loans while extending new loans will require not just temporary regulatory changes but also backstops for the financial system. (p. 195)
The bank supervisors should agree to mutual allowance of rollovers, done in a transparent manner, to smaller companies in the affected sectors. Otherwise, there is the risk that supervisors will tell lenders to pull credit home to their local markets. (p. 207)


Avoiding a financial crisis is highly important, especially in Italy. There is criticism about the ECB’s response so far.
We might easily come into such a situation later this year when authorities in the euro area are faced with several mid-sized, if not large, banks showing significant undercapitalisation. At a time when the real economy will be trying to get back on its feet and will have to rely on bank lending for this, widespread recapitalisation efforts with taxpayer support might be the only option. On the other hand, applying an approach built for idiosyncratic bank failures – including bail-ins and liquidation – might deepen the crisis further. (p. 183)
Financial institutions could come under tremendous strain and, absent an ambitious policy response, the economic crisis could turn into a financial crisis. Banks had substantial amounts of capital going into the crisis, including both the required levels and additional countercyclical capital buffers in many countries, but not the United States. Business credit lines have already been drawn, loans will be extended or not repaid, and funding could be increasingly difficult – all threatening to freeze up the financial system. (p. 192)
Emergency liquidity support by governments may lead to strains in the euro area’s financial system. Government bond spreads have risen, especially after ECB President Christine Lagarde’s unfortunate statement on 12 March, when she said that the central bank was “not here to close spreads”. The opposite message to markets is required from euro area policymakers, who must make clear that the ECB will provide unlimited liquidity to governments who are under temporary financial stress. They should announce that the European Stability Mechanism (ESM), the euro area’s bail-out fund, will be open to all member states, without imposing tough conditions as is usual for a bailout programme. Lagarde should stress that the ECB is ready to use its Outright Monetary Transactions (OMT) programme of unlimited government bond purchases if a government needs it. And the European Commission should allow member-states to break the euro area’s fiscal rules this year for COVID-19-related measures. (p. 148)
Another point of vulnerability is the Italian banking system. Italian banks have lower capital ratios than other European banks and larger shares of non-performing loans. The high risk premium and lower expected earnings of Italian banks are reflected in priceto-book ratios which, even before the virus outbreak, were well below the average of other European banks (Figure 8). A recent analysis of an Italian rating agency (Cerved Rating 2020) suggests that the crisis could push the probability of default of Italian non-financial corporate to 10%. Such a wave of bankruptcies would further weaken bank balance sheets. (p. 159)
A final unfinished item on the agenda has been to cut the link between banks and governments in the euro area, which would require concentration limits for sovereign bonds and the creation of safe assets. Obviously, these are not reforms that can be introduced in time for a possible crisis later this year, but one can hope that a crisis might be the trigger for finally completing the banking union. It is widely accepted that the bank resolution regimes established under the BRRD across the EU and at the euro area level are not adequate for a systemic banking crisis. If we see widespread bank undercapitalisation, if not failures, a flexible and systematic approach is needed, and at the euro area rather than national level. (p. 182)
China took strong economic measures, not least through the banking sector.
Financial institutions cut the loan rate and provided additional credit to virusrelated manufacturers and the daily necessity retail and delivery sectors, as well as producers of critical medical products. For SMEs, the commercial banks were required to roll over debt contingencies. The central bank also required commercial banks to improve the quality of services, including establishing a ‘green channel’ for COVID19-related businesses, and increasing e-payments and online services. Financial institutions offered additional credit to the trading industry for the importation of medical products from abroad. The China Banking Regulatory Commission (CBRC) required commercial banks to adjust personal loan repayment arrangements for housing mortgages and credit cards and delayed repayment periods. (p.91)

South Korea’s SME policy had not been very successful.
The government has also established an ‘emergency management’ fund for small business owners worth 1.4 trillion won. This is aimed at providing liquidity for SMEs and their owners. However, the procedure for preparing an application, the evaluation the application and the confirmation of a guarantee can take more than two months, and it then takes another week to actually receive the funds. This has not worked well. Supporting institutions have stuck to conventional methods, which sometimes means letting people receive support after they face bankruptcy. Moreover, the evaluation criteria for the funds are very strict. Only 4% of the government budget has been dispersed.