A coordinated fiscal plan at the pan-European level, complementing national measures, is crucial for financial stability in Europe. The plan has to be substantial in size, implemented immediately and backed by a common fiscal backstop. According to a position paper by several international financial experts around the Leibniz Institute for Financial Research SAFE in Frankfurt, the uncoordinated manner of fiscal policy responses in Europe and the strong reliance on debt instruments could otherwise threaten financial stability.
Governments and central banks all over the world initiated extensive measures to provide much needed liquidity to firms and counteract the negative economic effects of the containment strategy against the Coronavirus. In a new SAFE Policy Letter, the authors point out that the current asymmetric national solutions may destabilize the financial system in the longer run because of inescapable side effects, arising from diverging fiscal capacity to support domestic firms across Euro member states which could further increase the economic imbalances in the euro area. Monetary policy by the European Central Bank alone cannot deal with the economic divergence in the Eurozone. The authors include Arnoud Boot (University of Amsterdam), Elena Carletti (Bocconi University), Hans-Helmut Kotz (Harvard Center for European Studies and SAFE), Jan Pieter Krahnen (SAFE), Loriana Pelizzon (Goethe University Frankfurt and SAFE), and Marti Subrahmanyam (New York University, Stern Business School).
Besides a pan-European backing and coordination of assistance programs, there should be a shift away from debt- towards equity-like instruments in supporting businesses. Through these risk-sharing instruments, smaller and larger firms can become less indebted and add to their risk-absorbing capacity. In addition, such a “skin-in-the-game” financing scheme, akin to the Troubled Asset Relief Program (TARP) used in the US after the global financial crisis, may also leave an upside to European member states and its taxpayers in the case of an economic recovery.