In the Eurozone, a Familiar Worry Over a New Disease

SMITH BRAIN TRUST – Among the many worries brought by Covid-19 is this one: What will the pandemic mean for the future of the eurozone?

It’s a new fear with familiar echoes, says Maryland Smith’s Albert “Pete” Kyle, as the novel coronavirus underscores divisions about the appropriate path of monetary policy across the currency union, and renews criticisms about the feasibility of having one monetary policy authority for the 19-country eurozone.

The novel coronavirus, newly classified as a pandemic by the World Health Organization, has spread to more than 120,000 confirmed cases across 118 countries and regions. Across Europe, the disease has been spreading at a speed that has left governments scrambling to cope.

Other countries can relate. As the outbreak has begun disrupting supply chains, output, spending and consumer confidence, policymakers have begun adopting measures aimed at underpinning their economies.

Central banks in the United States, Britain, Canada and Australia, for example, each lowered their key interest rates by 50 basis points. The European Central Bank announced a package of stimulative measures aimed at bolstering the economies across the eurozone’s 19 countries.

In Europe, Kyle says, the problem is that unlike its central banking peers, which set monetary policy based on the economics of a single country, the ECB must take into account the economic indicators, risks and tolerances of the entire union, whose economies and crises frequently differ more than they align.

“It’s a fatally flawed currency structure that doesn’t make any sense,” says Kyle, an economist and the Charles E. Smith Chair Professor of Finance at the University of Maryland’s Robert H. Smith School of Business.

Today, Italy is among the countries hardest hit by Covid-19, with almost all businesses across the country ordered to close, as infections and deaths continued to climb. Its economy is likely to endure a tougher hit than some of its euro-zone rivals, Kyle explains.

The level of monetary stimulus that Italy might need to emerge from the Covid-19 crisis, therefore, might be far more than what’s in the best interests of a less-impacted country, where such stimulus could bring adverse consequences. When monetary policy is too accommodative it effectively weighs on the value of the country’s currency, and risks over-the-top inflation.

“None of the countries in the European Union countries in the eurozone have the flexibility to just ‘print money’ as needed,” says Kyle, using the term often associated with highly stimulative monetary policy. “That really hamstrings the EU. It forces them into a kind of deflationary set of policies that they are not easily going to get out of.”

And there are the limitations imposed from a fiscal standpoint. The European Union requires that member countries not exceed fairly modest deficit levels. More importantly, if they seek to stimulate the economy with fiscal policy that violates debt limits, the debt they issue is likely to carry high interest rates because buyers of the debt know that the country cannot print money, if needed, to pay it back. They must instead beg for loans from the European Central Bank, which may or may not accommodate their needs. Greece, for example, defaulted on its debts, setting an example which other countries in Europe may follow as a result of coronavirus-induced economic dislocations.

Kyle has been sounding alarm bells about the single currency for a long time. He says the coronavirus outbreak merely underscores the system’s flaws. There are the limitations faced from a monetary policy standpoint – limitations that come from striking a balance between economies that are sagging and those at risk of overheating.

“It’s much better for these countries to have their own currencies. If you have your own currency, you can let interest rates go to zero, and even go negative.”

It’s what’s needed to grapple with a deep economic crisis, like the one being brought by the current pandemic.