Will EU spending plans survive a tug of war with the ECB?
“If we are serious about preparing for the world of tomorrow, we must be able to act on the things that matter the most for people,” EU Commission president Ursula von der Leyen said in her State of the Union address.
She made clear what is needed to achieve this: changing the European Treaty — a process that might take years and is politically fraught —to give individual member states more financial leeway to invest in green tech.
Battle-tested by years of crises — pandemic, war, an energy crunch and a looming recession — she is doubling down on lessons learned in the early days of 2020: that it is public authorities, not markets, that are the last line of defence when crisis hits.
European governments are now moving to increase their grip on volatile energy markets.
“We are in war mode,” an EU diplomat said, speaking anonymously, referring to a growing sense of achievement and collaboration among commission employees, who have become trained in stamping out complex crisis plans.
By imposing price caps on the revenues of some energy companies and a “solidarity contribution” on fossil fuel companies, €140bn is supposed to be shifted from market winners to vulnerable businesses and households.
But just as Europe is planning another massive bail-out of the economy, the European Central Bank is unloading its balance sheet and retreating into monetary austerity.
“The tug of war between the ECB and fiscal authorities has changed,” Frank van Lerven, a senior economist leading the macroeconomics programme at the New Economics Foundation, told EUobserver.
Before the pandemic, the ECB operated as “the only game in town” — the lender of last resort tasked to prop up the economy using market-based tools — while governments cut public spending and welfare programmes.
This system boosted economic growth by increasing the value of asset markets and real estate but increased inequality.
Covid-19 ended the dynamic. When governments launched massive support programmes, they were supported by generous ECB-lending, which led to rapid economic recovery.
Von der Leyen has now called to stick to the programme. Much of the €700bn pandemic support funds are yet to be invested.But a repetition of such a scheme may not be in the cards for the current crisis, as the European Central Bank has increased the cost of borrowing by a record 75 basis points.
“In 2010, governments threw the bank under the bus [by retreating into austerity.] Now it is the other way around,” van Lerven said.
€400bn has already been earmarked by EU governments for support measures this year, and more is likely needed as energy prices are expected to remain high for the foreseeable future.
Increasing the cost of borrowing now will make these support schemes more expensive.
“It dramatically affects people and small businesses who have borrowed money,” van Lerven said. And as banks move their excess reserves to the ECB’s deposit facility, the ECB has to pay out more interest to the private banking sector, using interest payments from governments which would otherwise be returned to them.
“Higher interest rates will have a huge impact on government debt servicing costs,΅ he said. “And it will not have any effect whatsoever on gasoline prices.”
Crisis now, cuts later?
In the short run, it is unlikely to derail emergency crisis spending, van Lerven expects. But it may necessitate public cuts later, threatening von der Leyen’s green agenda.
“Ursula von der Leyen called for a [treaty change] to allow for more spending. But it is well known that this won’t be possible,” he said. “That raises questions: if governments post-crisis have to cut spending, how are they going to invest in renewables?”
The problem, he said, is the complete separation of roles between monetary and fiscal authorities.
“If you’re worried about inflation, governments can also raise taxes. This has the same effect on demand as higher interest rates. If they keep working in separate silos, they will continue to work in different directions,” he said. “I genuinely think there needs to be more coordination.”