EU member states should not have to choose between financing the COVID-19 response, undertaking crucial long-term investments to tackle the climate crisis, and debt sustainability, write Irene Monasterolo and Ulrich Volz.
Irene Monasterolo is an Assistant Professor of Climate Economics and Finance at the Institute for Ecological Economics, Vienna University of Economics, and visiting researcher at Boston University’s Frederick S. Pardee Center for the Study of the Longer Range Future.
Ulrich Volz is Director of the Centre for Sustainable Finance and Reader in Economics at SOAS, University of London.
Financing the COVID-19: the issues at stake
The COVID crisis requires a rapid and large-scale fiscal response from all European Union member states to keep the economy on life support. Moreover, it will necessitate substantial investments to reignite the economy while building resilience to future pandemics and compound risks associated with climate change.
However, some of the EU members most affected by the virus are those with least fiscal space. If they are left on their own, they will need eventually to finance COVID measures by issuing new debt. This, in turn, could lead them to a debt crisis. It could also thwart their ability to undertake investments needed to achieve the EU’s climate targets.
The European Central Bank (ECB)’s new Pandemic Emergency Purchase Programme is a vital contribution to stabilise markets, but today’s crisis responses will have long-term fiscal ramifications nonetheless.
Several proposals for tackling the COVID crisis have been put forward, ranging from monetary financing through the ECB, and the issuance of COVID bonds by the European Stability Mechanism (ESM), to long term maturity COVID perpetual bonds issued by individual countries and possibly purchased by the ECB to keep interest rates low.
While direct monetary financing of governments is prohibited by the EU Treaty, any arrangement that would increase countries’ public debt to GDP ratio to finance the COVID response would worsen debt sustainability problems and compromise countries’ future development.
Importantly, it would inhibit crucial investment in climate adaptation and mitigation, with implications on future socio-economic and financial stability. Thus, the issuance of Eurobonds by the EU institutions was suggested by several EU governments.
A coordinated and synergic response
To finance the COVID emergency in a sustainable and inclusive way, EU member states and the European Commission should not seek to reinvent the wheel but rather expand the scale and scope of the Green Deal, and exploit complementarities across existing instruments and institutions.
To this end, we propose a coordinated issuance of COVID-bonds by the European Commission to fund a comprehensive stabilisation response, and Green Deal bonds by the European Investment Bank (EIB) to finance structural investments to support recoveries and strengthen climate infrastructures:
- The European Commission would issue long-lived Eurobonds whose use would be restricted to address the effects of the COVID crisis. The proceeds would provide an immediate relief to all EU member states and enable adequate COVID-emergency spending. The bonds would go on the market and everybody could purchase them.
- At the same time, the EIB would issue new Green Deal bonds that support projects in the COVID-reconstruction phase. These structural investments should be aligned with the Green Deal’s carbon neutrality targets. To enable a large-scale bond issuance, EU member states should agree on an increase of the EIB’s capital, extending its ability to raise private capital by exploiting its AAA rating and thus low-rate financing on international markets. Although an EIB capital increase would increase member states’ debt/GDP ratio, it would be much less than if they were to issue COVID bonds individually.
Three advantages of our proposal
First, our proposal would operationalise the call for a common debt instrument without a need for direct monetary financing. At the same time, it would not leave countries most in need in a position to accept conditionality that their citizens could not accept, thus triggering potential political crises. This would allow to showcase EU unity and solidarity in front of financial markets and its peoples.
Second, our proposal would address both the urgent need for financing short-term crisis stabilisation measures, and crucial climate change investment. It would prevent a trade-off for using scarce national resources for either COVID response measures or Green Deal investments, and ease the public debt burden of EU member states, thus preserving financial stability at the level of individual EU countries and the EU. This solution would operationalise a concept of EU solidarity that embraces a systemic, long-term approach to the management of complex crises, such as those stemming from pandemics and climate change.
Third, our proposal could promote a deeper integration of EU institutions and EU member states’ responsibility, opening the way to a responsible shared management – among EU member states and generations. It would contribute to avoid moral hazard by individual member states, the risk of a new debt-led financial crisis in the EU that would likely blow up the Eurozone, and of postponing the urgent transition to a carbon free economy in the EU.