France and Germany agreed a €500bn rescue fund on Monday, to be financed through European Commission debt issuance, and to be channelled to the worst affected sectors and regions of the European economy. However, it must be agreed upon by other member states.
Last month, Vallée called for a “coalition of the willing” to press ahead and work on coronabonds — the latest tag given to joint-EU sovereign issued bonds — in the absence of unanimous support across member states. The Franco-German plan presents a similar way to share liabilities across the bloc, but it remains to be seen whether all of the other countries will agree
Vallée has also previously been an adviser to George Soros and senior economist for Soros Fund Management. In addition, he was an advisor to Herman Van Rompuy when the latter was president of the European Council.
GlobalCapital: What is your perspective on where the eurozone is in the wake of the crisis?
Shahin Vallée, DGAP: The big question I think was the extent to which member states would agree to mutualise part of the response to the corona crisis. And then if they mutualised, if they would agree to monetise part of this response. And this debate has been somewhat muddled by the quick actions of the [European Central Bank (ECB)], which became de facto the mutualising and monetising force of the response without much discussion at the fiscal level taking place.
I think with that backdrop, the ruling of the German constitutional court that came out two weeks ago was very important, because it potentially signalled limits to what the ECB could do, or political discomfort with what the ECB was doing. And to some extent there were two ways to respond to that.
There was the good old European way, which was to basically ignore the ruling or brush it under the carpet and carry on with business as usual, which was entirely possible. The EU could have launched an infringement procedure against Germany.
Even if Bundesbank were to end its participation in the European Public Sector Purchase Programme (PSPP), that would actually not necessarily undermine the ECB’s ability to carry on with its programme because what the Bundesbank would not buy could be purchased either by the ECB in Frankfurt or by the other national central banks together. So there was a path basically to muddle through and ignore the ruling of the court.
There is an alternative path, which is to consider that what the court has said as important. Even if we can argue over the legal validity or the economic sense of some of the argument, there is a fundamental political argument that is made by the court indirectly, which is that the architecture of euro area is imperfect and that this forces upon the ECB a set of actions that were not initially intended.
My sense is that the Franco-German response we’ve seen yesterday is somewhat the result, at the margin, of the courts pressuring the German government to undertake more mutualisation through the front door, rather than let the ECB do all the dirty work by stealth.
What do you think of the risk of the agreement being watered down or blocked by one of the other member states?
I think the risks are important. You may have seen since the announcement of the Franco-German agreement that chancellor [Sebastian] Kurz from Austria has openly come out against it. There are probably others waiting on the sidelines that will express similar views, maybe not so publicly — Sweden, the Netherlands and Denmark — and the reactions of these players are going to be important. What is not clear is whether the position is a negotiating tactic in order to extract concessions or whether it is a more fundamental objection.
That’s still to be seen in the coming weeks, and what is going to be important as a result is to see whether the French and the Germans are prepared to go ahead with a coalition of the willing in the absence of a unanimous agreement, and that’s very unclear at this point.
Do you think Germany would be prepared to do that and break away with the Dutch and the Danes and so on?
I would have thought no up until recently, but I think that decision by the court and the Franco-German agreement yesterday might change that.
We’ve discussed how maybe to some extent this agreement was a reaction to that court ruling. Do you think more generally we need some sort of new framework or new discussion about what the purpose of the ECB is, in light of all of the asset purchases, financial stability and all of other roles it’s taken on in the last decade or so?
I think there is a case for reviewing more deeply the legal basis for ECB actions, its mandate and the accountability that comes along with that. I think there’s a strong case for that. The question is whether this should take place through revision of primary laws, the reopening of the EU treaties, or whether we can actually create the accountability that is justified without such treaty change. You have pros and cons to both.
The beauty of doing this through a change in the European treaties is that it would put to rest potential challenges by the German constitutional court. The dangers of doing this by treaty is that you’re held up by the need for unanimous agreement.
So an alternative could be to do this indirectly by changes in the doctrine and changes in the practices of central bank accountability — for instance, the European Parliament could vastly expand its hearings of the ECB, intensify the scrutiny and the accountability that it exercises over the ECB, and that could take place without a treaty change.
I think there’s a debate — and a very valid debate — as to whether it can take place through a change in the treaty or whether it can actually take place through changes in the doctrine and practices.
Is there were such a debate, what changes would you like to see? People talk about the fact that the US Federal Reserve has the dual role of focusing on employment as well as inflation.
There is a big debate as to whether the fact that the ECB didn’t have a dual mandate has caused deviations from the attitudes of the Federal Reserve and I’m not sure that’s the case. I think it’s not necessarily the absence of a dual mandate that has held back the ECB.
I think there’s a valid question raised by those who say the ECB can deliver very much the same thing the Fed delivers. It’s not the mandate that’s the issue, it’s the political backing.
A lot of the response to this crisis has been at a national level. How effective do you think different national governments have been from an economic perspective in terms of supporting the economy?
Different governments have been undertaking different policies and stimulus packages of different sizes. What’s interesting is that the sizes of these stimuli have in part been driven by the existing, or the appearance of, fiscal space that each country has. I think this has been a very important source of potential divergence between European countries.
Those countries with the greater fiscal space have been able to undertake all the measures and those with more limited fiscal space or more concerned about medium-term debt sustainability have been less able to do so. This I think has created important divergences in the economic responses which are likely to fuel economic divergence between member states over the medium term.
I think the fact that each member state has been able to undertake different policies is going to change this symmetric crisis into a potentially asymmetric one in the medium term.
And that goes back to the need for some sort of joint support mechanism. One of concerns with the idea of a joint coalition of the willing has been whether there would be enough fiscal space for the southern European countries plus France to do something on their own. But presumably with Germany involved as well that would be a game changer in terms of how much bond markets would be willing to lend?
I think there are two issues. There’s the issue of who is part of this coalition. Of course, if Germany is part of it, it would be more credible and would potentially make it easier to place this debt.
I think there’s another issue, which is how much the ECB would be prepared to back this common issuance. I think what’s very interesting is that the ECB can buy supranational debt, the debt issued by the [European Stability Mechanism], the debt issued by the [European Investment Bank], for instance [with a 50% issuer limit under the public sector purchase programme, compared with 33% for sovereigns].
That means that the ECB could potentially actually buy a higher proportion of this debt issued by the EU budget or by the coalition of the willing than it would buy of German or French bonds. So I think that’s an important element as well of the creditworthiness of this new issuance. It’s not only who is part of the coalition but how much the ECB is prepared to buy of it.
There is an argument that this would make ordinary national bonds subordinate in a way. What do you make of this?
To me, this is fungible, so in the end the debt that will be issued by the euro area, or by the EU, or this coalition is debt that will not be issued at the national level. So I think net-net, it will actually improve the financing conditions of the euro area as a whole, so I wouldn’t be too worried.
That the entry into the issuance market of a new actor would crowd out national government bonds, I think is a misplaced concern, especially because the money raised would actually be transferred in a large part to the countries that need it the most. If it does lead to a marginal increase in BTP rates, I think that will be vastly offset by the transfers that will come from this vehicle, so I wouldn’t be concerned at all.
What would be a good response to the German court ruling?
There are two possible responses. One is a muddle through response, which is basically trying to avoid a real confrontation and try to carry on with business as usual.
The alternative is to use the ruling as a stepping stone to launch a bigger debate about the institutional and constitutional reforms that need to take place for the Euro area to operate properly.
My hope is that instead of doing the usual European muddling through we will opt for a bolder response. That involves launching a fiscal, institutional, and constitutional debate.
And the Franco-German agreement is quite hopeful because it suggests that it’s the second path that is being chosen.
Exactly.