Coronavirus and Spanish economic policy: impact and responses

EsadeEcPol Insight

By EsadeEcPol

Authors: Toni Roldán (Director, EsadeEcPol), Antonio García Pascual (Visiting Scholar, SAIS, Johns Hopkins University) & Pedro Rey (Associate professor, Esade)

Download the report on EsadeEcPol's website (PDF, in Spanish)

Executive summary

  • The shock of the coronavirus for the global economy and financial markets is beginning to be comparable to that of the 2008-09 crisis, although there is still considerable uncertainty about its development and duration. The economic disruption is enormous on the supply side (due to the collapse of production and distribution chains) and on the demand side (due to the impact of uncertainty and virus containment measures). The impact on the markets, and in particular on the Spanish stock market, with a 14% fall in a single day, is unprecedented in recent history.
  • An immediate, forceful and coordinated response is needed from the EU to ensure that member states have all resources necessary to overcome the temporary impact of the pandemic. The panic in the financial markets shows that isolated actions – a monetary policy based around the idea of "every man for himself" – is completely inadequate for facing Covid-19.
  • The economic impact in Spain will be more severe than in other nations due to its economic structure. The demography, the relative abundance of small and medium sized businesses and the high level of dependence on the service sector (tourism, retail, hotels and transport) make Spain more vulnerable than most nations. Europe will probably enter recession in the first half of 2020, and Spain is likely to do so in the second half. However, the duration and depth of the recession are not yet known.
  • Spain must act early and decisively to flatten the contagion curve. The evolution of infections is following the same curve as Italy – but nine or ten days behind. Evidence from other countries shows that early containment measures, such as those implemented in South Korea, are very effective in limiting contagion. The economic cost of early action is considerable but affordable. Healthcare and socio-economic costs multiply when the number of Covid-19 cases exceeds the capacity of the health system.
  • Communication strategy is crucial, and the seriousness of the situation should be honestly and clearly reported. Behavioural economics teaches us that the public response to official advice on preventive measures is just as important – or even more important – than the actions of the authorities. Sending simple and clear messages is essential for generating the necessary responses from the public and so reducing the health and economic costs of the epidemic. 
  • Economic policy must be aimed at protecting jobs and preventing profitable companies from closing due to a lack of liquidity. The commitments made last Thursday by the Spanish government, in particular the injection of €14 billion to small and medium sized businesses is a step in the right direction, but is probably insufficient. Fiscal resources must be mobilised to help affected employees and companies, and so avoid mass layoffs for the duration of the epidemic. The role of the EU here will be crucial. In addition to economic production, it is essential to prevent the crisis from spreading to the financial system. If the system remains well capitalised and with sufficient liquidity then it can help support an early recovery; if not, the economy will further deteriorate.


What we know (and what we don't know) about the spread of the epidemic (Q&A)

This section summarises the available data and the best scientific evidence regarding what we know and don't know about the coronavirus. In an exceptional situation such as this, we believe that it is everyone's responsibility to contribute their knowledge to the pool of available information.

This is even more relevant for a think tank such as the Esade Center for Economic Policy & Political Economy, whose mission is to improve public well-being by supporting debate on public policies based on scientific evidence.

What we do know:

Is it very contagious?

Estimates by epidemiologists indicate that the reproductive number (R0) of the virus is between 1.6 and 2.5, which makes the coronavirus much more contagious than flu (with an estimated R0 between 1.2 and 1.4). When the R0 is greater than one, each person infects more than one other person, causing the virus to expand exponentially, as happens in the early stages of an epidemic. 

The coronavirus is much more contagious than flu

As the epidemic widens, and the proportion of potential contacts decreases, so the R0 decreases, then stabilises (R0=1) and finally falls below one. This reduction is either because there are fewer people left to infect, or because of the effectiveness of the measures taken to control it. Some estimates, such as those of the epidemiologist Mark Lipstich, from Harvard University, consider a massive contagion that reaches a large part of the world population as possible or even probable.

Who is most at risk?

The death rate increases with age. Epidemiologists who have analysed the Chinese data conclude that, for people over 70, the death rate is between three and four times higher than the average, and for those over 80, around seven times higher than average.

For people under 40, the average death rate is 2 out of every 1,000 people.

What is the current situation in Spain?

Like other European countries, Spain is in the exponential growth phase of the epidemic. The trajectory is very similar to that of Italy, although nine or ten days behind.

The date when infections peak will depend on the effectiveness of measures taken to reduce the rate of infection. The number of confirmed cases is doubling every three or four days, and it must be remembered that the data may be biased by the recent discovery of new cases (since new infections – as well as recent discoveries of old infections are measured).

Covid en Madrid
With effective control measures, the number of infections can be prevented from exceeding the capacity of the health system.

Why is it necessary to quickly control the infection?

The graph below shows the importance of taking early measures to control the epidemic: with effective control measures, the number of infections can be prevented from exceeding the capacity of the health system, which means patients can be better treated.

This saves lives, both directly – the lower the number of infections, the fewer deaths; and indirectly – since a collapse of the health system is avoided and patients at risk receive better treatment.

Graph coronavirus
Source: US Center for Disease Control and Prevention. Rosamund Pearce (The Economist).

The experience of northern Italy, particularly the region of Lombardy (which has a very good health service), suggests that hospitals in some areas of Spain may soon approach their limits of capacity.

What can be done to control the contagion?

Measures that reduce the infection rate include reducing contact between people (such as preventing crowds, closing schools and encouraging remote working) and isolating infected people or areas. The number of new infections in China has dramatically fallen in recent days and this demonstrates the effectiveness of quarantines, "social distancing" and the isolation of infected populations.

Quarantine in China during the Coronavirus
A neighbourhood in Wuhan under coronavirus lockdown.

A preliminary study published by the University of Southampton estimates that containment measures implemented by China might have reduced the number of infected people by 66% if they had been implemented one week earlier.

In the following section we will discuss lessons from behavioural economics; the need to broadcast accurate, verified and reliable information on risks; and why responsible behaviour by the public and a rigorous monitoring of recommendations made by health authorities are essential elements for the control of the epidemic.

What we don't know:

Exactly how many infected people are there?

Today's data on infections underestimates the total number of infections, but we do not know to what extent. Although we cannot know the total number of infected people, we do know the total number of people who have been tested in each nation.

In nations where many people have been tested, such as South Korea, the death rate – calculated by dividing the total number of identified infected people by the total number of deaths – drops significantly.

Today's data on infections underestimates the total number of infections

What is the death rate?

The uncertainty is very high because of the unreliability of the data for the total number of infected people. Fewer tests have been made in Italy (death rate 5%) than in many other nations, while the rate in South Korea is 0.7%.

The World Health Organisation estimates that of the people tested who have contracted the disease, between 3% and 4% have died; however, this figure is likely to be a considerable overestimate.

Coronavirus lab
There are currently no vaccines for any of the seven registered coronavirus types.

Epidemiologists assume that most people (up to 80%) who have contracted the disease have no symptoms, or very mild symptoms, and are not being captured by these numbers. For example, a recent study shows that a substantial proportion of the Covid-19 cases on a Princess Cruises ship were asymptomatic, something that has already been noted in clinical trials.

Epidemiologists assume that most people who have contracted the disease have no symptoms

Will rising daytime temperatures affect the coronavirus?

There is no evidence that the spread of the virus will lessen (as occurs with other viruses) as we enter warmer seasons in Europe.

Can we expect a vaccine soon?

We do not know, but probably not. Vaccines normally take several years to develop. In the process of scientific research, it is necessary to carry out numerous clinical trials with animals and people to test the effects in a long process with no shortcuts.

There is no evidence that the spread of the virus will lessen as we enter warmer seasons in Europe

There are currently no vaccines for any of the seven registered coronavirus types, including SARS-CoV-1 and MERS-CoV.

Can it be transmitted when we have no symptoms?

The incubation period is estimated to be between five and six days. There is no conclusive evidence that the virus is contagious or otherwise before symptoms appear.

Some virological studies indicate that the infection period is lengthy for Covid-19 and may last for ten days or more after the incubation period.

Coronavirus
Source: Based on original graph by Silvia Merler; data compiled by Johns Hopkins University.

 

What can behavioural economics teach us for dealing with the coronavirus?

How the public responds to official advice on preventive measures is even more important than actions taken by the state. For this reason, communication strategies that keep the population well informed while maintaining public confidence (and the subsequent responsible behaviour by the general public) are vital for overcoming the epidemic.

Behavioural economics uses aspects of psychology to better understand how individuals behave. The three main concepts that behavioural economics has incorporated into the study of economic decision making (in a broad sense) can be found in the current epidemiological crisis:

1. Uncertainty

Many aspects of the origin and evolution of this epidemic remain unknown. We do not know if a vaccine will exist in the near future, or how our individual (and collective) behaviour affects the probability of contagion.

Given the uncertainty, heterogeneity in individual attitudes to risk makes it difficult to agree the best preventive measures and then actually comply with them.

Dos personas desinfectando una estación
Workers spray disinfectant chemicals on the Henri Coanda International Airport to prevent the spread of coronavirus.

An additional problem is our limited cognitive ability to understand the probabilities of uncertain events, even more so for very low probability events, which greatly hinders the process of simply explaining the risks we face.

2. We care more about the present than the future

Like other healthy behaviours that are difficult to achieve (such as dieting or exercising) one of the greatest difficulties in encouraging preventive behaviour in a population facing an epidemic is that the cost of prevention (such as increased handwashing, avoidance of crowds, quarantine on the suspicion of infection, no food and health product hoarding) must be paid now, while the possible (and uncertain) benefits will only be "enjoyed" in the future.

In addition, the results of our behaviour are not observed immediately (or may not be observed if the infected person is asymptomatic), and so we further discount the consequences of our actions.

3. We do not consider the benefits of our behaviour on others

Preventive behaviour in the face of an epidemic is a major contribution to the public good. However, the individual cost of taking preventive measures (such as declaring having been in a risk zone, cancelling an event, or not hoarding) is individually higher than the benefit we gain.

When each individual is not incentivised to behave in a way that favours the collective good, the spread of the epidemic hurts us all. Assuming individual responsibility for stopping the spread of a collective disease is one of the biggest challenges we face.

Preventive behaviour in the face of an epidemic is a major contribution to the public good

For this reason, and given our tendency to imitate the behaviour of others, highlighting supportive behaviours (such as students without classes offering to care for the elderly or children, people cooperating in hygiene awareness campaigns, or cancelling trips to slow the spread) is much more productive than pointing to abusive and unsupportive behaviour (individuals over-burdening hospitals when only suffering mild symptoms, looting, and so on).

The objective is to normalise our psychological reactions in these days of uncertainty, so that we do not contribute to exacerbating the problem.

The broadcast of accurate information, trust in organisations that put public health before other interests, an awareness of our own biases, and individual responsibility, will enable us to emerge in the best possible condition from this crisis.

Recommendations from behavioural economics

1. Carefully balanced information

Reporting in such a way that stimulates preventive behaviour without causing the counterproductive social alarm is especially difficult, even more so if the information on the epidemic is changing and, therefore, the measures taken a few days ago seem insufficient (or exaggerated) given the current situation.

Our tendency to extrapolate using linear predictions when the tendency is exponential means that: "Everything we do before a pandemic will seem alarmist. Everything we do after will seem inadequate."

We are not good at adapting psychologically to rapidly changing information, and therefore we must frequently review our beliefs about the disease, its extent, and what we need to do individually.

2. The messenger is important

While scientists, and especially healthcare professionals, are among the professions that generate the most confidence among the public, politicians rank last in the same confidence indices.

That is why it is important to centralise in health authorities the epidemiological information, and to a certain extent, decisions. Healthcare professionals know the most about epidemics and people believe that they are motivated exclusively by public health concerns.

The establishment of independent organisations, or emergency committees made up of scientists, to decide and report, can be useful.

3. Maintain trust by avoiding political confrontation

Although debate in the coming months will inevitably focus on the epidemic and its consequences, we should avoid political confrontation and seek the greatest possible coordination between organisations (and nations).

To build trust, those managing the crisis must not take advantage of the situation to win points or justify measures that they previously wanted to take, nor must those in the opposition try to gain credibility by highlighting poor management.

The media must responsibly broadcast realistic information without using sensationalism

4. Focus information on what helps alleviate the problem

The media must responsibly broadcast realistic information without using sensationalism to win audience share. Constantly covering a topic activates our bias for the immediate ("availability bias") and for giving greater importance to a hot or trending topic ("over-representation bias").

Therefore, we are highly sensitive to the amount and orientation of the information we receive. We must not focus on the numbers of infected or dead, but on what can and should be done.

5. Individual responsibility in the transmission of information

Each of us is also responsible for not creating further panic or spreading misinformation, especially with the degree of connectivity that social media currently enables.

Each of us is also responsible for not creating further panic or spreading misinformation

While forwarding amusing messages, we must be careful to only share information that has been verified so that we do not create more uncertainty. Carefully filtering hoaxes and not spreading panic is crucial.

6. Avoid statistical discrimination

People tend to focus on a single characteristic, such as origin, and then extrapolate that single characteristic to all those who share it. This leads to racist behaviour towards specific groups (such as Asians and Italians), which is never justified and is especially absurd as such beliefs about the probability of contagion are not based on objective data.

Avoiding establishments simply because they are run by people from one country or another, or keeping our children away from other children from certain countries, is going to reveal to what extent our prejudices are based on information that we lack or do not wish to examine.

7. Inability to process information in stressful situations

An additional difficulty in transmitting adequate information and making good decisions is our limited ability to act correctly when we panic. For this reason, it is especially important that broadcast messages are simple (for example, using graphs rather than figures) and suggest clear patterns of behaviour.

A supermarket during the coronavirus crisis
Massive supermarket purchases can create shortages of health products.

Faced by stress, people need to "do something" to regain the feeling that we are in control. This partly explains the massive supermarket purchases and hoarding. Although such behaviour momentarily calms us, it can collectively create shortages of health products and basic necessities.

8. Self-fulfilling expectations and economic crisis

As we explain in this article, there seems to be no doubt about the major economic repercussions of the measures to contain the epidemic. However, we can contribute to reducing these repercussions.

Many of our changes in consumption during these days come from making a conscious decision about whether or not we should purchase something. By focusing on a decision, rather than buying semi-automatically, we give greater emphasis to losses rather than gains ("loss aversion bias") and this can aggravate the coming crisis.

The coronavirus crisis will have a major economic impact in the second quarter of 2020

When carefully considering our buying decisions and actions, we must not panic and should follow official recommendations.

Vulnerabilities and economic impact

The coronavirus crisis will have a major economic impact in the second quarter of 2020, even if the contagion is successfully controlled. 

The impact would be very great if the contagion accelerates in a way that we are now unable to predict, or if the response from governments and international organisations is insufficient. At the moment, as can be seen in the VIX Volatility Index (see graph 3), financial market uncertainty has reached levels unknown since the Great Recession.

coronavirus esadeecpol
Source: Bloomberg

Markets events on the 12 March indicate that we may be running out of time to avoid a shock similar to the crisis of 2008-09 (at least temporarily).

We are facing a simultaneous supply and demand shock caused by the pandemic and the response to it.

Consumers and companies tend to assume a "wait and see" attitude during a crisis and this will have economic effects. Its severity will depend on risk factors that are not yet well quantified: the duration of the crisis; contagion rate; death rate; or how the epidemic behaves as the weather gets warmer.

International organisations estimate that in a containment scenario, the impact of the coronavirus crisis on global economic growth will be a half point contraction in global GDP growth (currently 2.9%, having previously been estimated at 2.4-2.5%). The eurozone, in this scenario, would enter a recession during 2020 (it grew 1.2% in 2019) from which it is difficult to predict when it would emerge.

It is highly likely that the Spanish economy will experience a GDP contraction in real terms in the second quarter

It is highly likely that, after growth of 2% in 2019, the Spanish economy has slowed to approximately 1% in the first quarter and will experience a GDP contraction in real terms in the second quarter.

Obviously, in a scenario in which the persistence of the contagion is greater, or public policies fail to respond, then the economic contraction could be more severe. The Organisation for Economic Co-operation and Development in a more extreme, but also plausible scenario, triples the estimated fall in global GDP to -1.5% (compared to -0.5%). Conversely, a strong European reaction could mitigate this situation.

Economic shock transmission channels

On the supply side, factory closures (mostly in China) and interruptions in global distribution and production chains mean that production inputs are delayed or simply do not arrive.

In countries with production exposed to China or southeast Asia, such as Germany, the effects will be considerable

Logically, in countries with production exposed to China or southeast Asia, such as Germany, the effects will be considerable. This slowdown in activity, which will probably increase in the coming weeks as the epidemic expands across France and Germany, will dampen economic activity in the rest of the European Union.

Added to this is the impact of the disease itself on employees – who stay at home – and the containment measures selected by the government and companies to reduce the infection rate (isolation, stoppage of business activities, quarantine, and so on).

Part of this negative impact can be partially mitigated by technologies that enable remote working, but in sectors such as services (with a high relative weight in Spain) the possibilities are limited.

On the demand side, uncertainty and increased risk aversion by consumers and companies will negatively affect private consumption and investment.

The drastic reduction in travel, both for work and tourism, will also contribute to a drop in international demand.

Countries like Spain – the world's most popular tourist destination after France – will suffer the consequences more than others.

Along with transport and tourism, the service sector, leisure and hospitality (in particular) will be among the worst hit.

Supply shocks and weak demand may force profitable companies into bankruptcy

The supply and demand shocks will feed on each other to create a vicious circle that may affect the financial sector. If no mitigating measures are taken, supply shocks and weak demand may force profitable companies into bankruptcy as revenue falls and cash runs out.

What starts as a temporary shock can become a serious liquidity problem for smaller firms that are relatively undiversified and lack financial reserves. This generates even more unemployment (smaller firms are intensive employers), a further drop in disposable income and a further fall in aggregate demand.

Loss of value in financial assets means loss of financial wealth for families

The impact of the crisis is unprecedented – particularly on the Spanish stock market with a recent 14% fall in one day. The risk premium for Spanish government bonds has risen 25 basis points, and Italian bonds are up 58 points.

The negative reaction of markets continued after the announcement of monetary policy measures for combatting the coronavirus by the European Central Bank and after Federal Reserve intervention on American debt markets.

Loss of value in financial assets means loss of financial wealth for families and creates additional stress in the financial sector. This, added to the downward review for growth and negative interest rates, means additional losses for the banks. 

The objective of public policies, as we will see in the next section, should be to enable the banks to lend to companies in the most vulnerable sectors with, for example, the extension of existing credit lines. However, when banks extend loans to companies, they also assume risks, and so credit support for banks is essential – through public investment banks or other mechanisms.

Spain: three vulnerabilities

Spain faces three challenges that make its exposure to the pandemic especially difficult in economic terms.

  • Demographics. Spain has relatively few children (who are less affected by Covid-19) compared to the rest of the EU; but it has a high percentage of more vulnerable elderly people.
  • Relative weight of tourism, retail, hospitality and transport. The services sector contributes 78% of Spanish GDP and retail, tourism, hospitality and transport represent 24%. These sectors (where small and medium sized firms and the self-employed are numerous) are among the worst affected by the crisis.
  • Temporary job contracts. The excessive number of temporary job contracts in the Spanish labour market dramatically increases unemployment during recessions. In periods of recession, companies tend to dismiss temporary staff instead of reducing working hours for all employees (temporary and permanent) with the consequent rise in unemployment.


Public policies to mitigate the impact

Priority objective: support for health system and containing the pandemic

In the first weeks of the crisis in Wuhan, the government was able to mobilise vast resources and build emergency hospitals in a matter of days, and so reduce the enormous cost of saturating the health system.

In Lombardy, Italy, with one of the best healthcare systems in the country, Covid-19 patients are being flown by helicopter to regions less affected by the virus. Lombardy has a total of 900 beds in intensive care units.

The healthcare capacity and trajectory of the contagion in Spain is similar to that of Italy – with a lag of nine or ten days

The authorities in Italy predict that by the end of March, there will be around 3,000 patients who will need these beds.

The healthcare capacity and trajectory of the contagion in Spain is similar to that of Italy – with a lag of nine or ten days – and Madrid is similar to Lombardy. For these reasons, all initial government efforts must focus on mitigating the impact on health systems.

Prevent profitable companies from going bankrupt and protect jobs

However, even if the containment phase is successful, the macroeconomic impact of the pandemic will be severe. The careful coordination of public policies – monetary, fiscal, and financial – to mitigate the impact of the virus will be essential.

The macroeconomic impact of the pandemic will be severe

In economic terms, the key objective is to mitigate the severity of the crisis by ensuring access to liquidity for profitable companies to avoid closures and so protect workers from unnecessary layoffs. There are various mechanisms to achieve this objective:

Fiscal measures

Fiscal measures are the main tool by which authorities can mitigate the economic impact of Covid-19. It is important to remember that, in part thanks to the ECB, the ability to finance the treasury at negative rates makes the necessary public spending possible – providing it is done effectively, quickly and temporarily.

Fiscal measures are the main tool by which authorities can mitigate the economic impact of Covid-19

Employees and companies in the most affected sectors, such as hospitality, tourism, retail, or transport services, should be the priority for these fiscal aids.

Temporary assistance for employment and income

Fiscal policy should help maintain stability for employee incomes and jobs while controlling the pandemic. This is essential, particularly for Spain, with a high percentage of workers with temporary contracts who could lose their jobs in the coming weeks.

This fiscal aid can be offered to companies, with formulas such as the "Kurzarbeit" implemented in Germany and other countries, whereby firms agree with their employees a temporary reduction in working hours while the pandemic lasts, with temporary state aid for payroll costs.

This would achieve two objectives:

  • The first and fundamental objective is to keep as many employees as possible in work. Unemployment in Spain is still well above our neighbours, and we cannot allow it to shoot upwards as in previous crises – and with the appropriate fiscal measures this can be avoided.
  • Secondly, if these policies are implemented in time it would mitigate a significant drop in household income. If disposable income does not suffer too greatly, this will help consumption and so minimise the negative impact on aggregate demand and the financial sector.

Spain cannot allow unemployment to shoot upwards as in previous crises

Temporary support for small and medium sized companies

Spain’s official credit organisation, the ICO, in coordination with the European Investment Bank, must maintain lines of credit for small and medium businesses that are directly or indirectly vulnerable to the temporary shock of Covid-19.

This measure, together with the help of commercial banks offering low interest rates, and in some cases, the temporary restructuring of bank loans, can substantially mitigate the impact on smaller firms. In this way, bankruptcies can be avoided despite temporary falls in revenue and liquidity.

Monetary policy

The ECB's ability to respond is limited because of low inflation in the eurozone (QE, TLTRO, forward guidance, negative rates) and the fact that much of the war chest has been used to tackle the debt crisis. But there is still scope for action.

European Central Bank
The European Central Bank's ability to respond is limited.

The ECB announced on Thursday a well-calibrated package of measures to help provide cheap and broad liquidity support for companies – and especially small and medium sized firms (TLTRO III). The purchase of financial assets (QE) was also expanded, especially debt issued by the private sector to help finance Spanish and European firms.

This enables companies to cheaply finance themselves on the markets, and takes the pressure off bank balance sheets so that banks can offer more financing to smaller firms. In addition, the ECB enables banks with large capital buffers to partially use these buffers to offer credit for struggling families and businesses.

Monetary policy is not enough in itself to restore confidence

However, the markets have not reacted well to the ECB announcement. Prices of risky assets have continued falling, including on the Spanish equity market and credit spreads. The reason is obvious. Monetary policy is not enough in itself. Restoring confidence requires a coordinated announcement by the European authorities on fiscal aid to combat the pandemic. The next section describes these requirements in more detail.

Emergency social policies

One of the problems we face with the temporary closing of schools is childcare. Many parents can go home without losing their jobs, either because they have flexible timetables or because they have permanent contracts.

But more than one in three Spanish workers have temporary jobs or are self-employed. Many of these workers, most of them women, stop earning the moment they stop working. It is necessary to offer extraordinary support for these families.

For this type of situation, temporary assistance similar to parental leave can be offered, with the state effectively paying the salaries of these parents for a certain period. The measures announced by the Spanish prime minister are in the right direction.

The Covid-19 crisis has already triggered a reaction in the markets that could destabilise the financial sector

Financial stability

The 2010-13 debt crisis originated in the financial sector with the real estate credit bubble, but in contrast, the Covid-19 crisis has its origin in the real economy and the authorities must try to avoid it spreading to the financial sector.

The Covid-19 crisis has already triggered a reaction in the markets that could destabilise the financial sector.

The flattening of interest rate curves, negative rates, and the fall in growth and job prospects for 2020 has made investors worry about the health of Spanish banks.

The banks can help resolve the Covid-19 crisis with measures such as the temporary restructuring of company loans

The shares of the major Spanish banks have lost one-third of their value since February and the credit spreads on bonds issued by the banks have widened.

At the moment, risks to financial stability are not high thanks to sufficient liquidity and large capital buffers, which can now be used to support the families and companies that need help.

The banks, under Bank of Spain supervision, can help resolve the temporary Covid-19 crisis with measures such as the temporary restructuring of company loans. However, the Bank of Spain must ensure that this support is proportional, transparent and temporary.
 

Europe must lead the way against Covid-19

Although there is still considerable uncertainty about the duration and impact of Covid-19, we must develop a coordinated economic policy for mitigating the effects of a potentially very serious crisis for the European Union.

As we learned in the previous financial crisis, failure to promptly coordinate a response can significantly increase the economic costs. This crisis is an opportunity for Europe to emerge stronger, but if there is a failure to respond with ambition and the crisis worsens, then the costs for the European project and the euro could be enormous.

This crisis is an opportunity for Europe to emerge stronger

The virus is still in the expansion phase in several nations. The British government team of medical advisers estimates that the peak in infections will arrive in the UK between May and June. From a conservative perspective, this means that economic disruption will probably last until the summer and its effects are likely to continue until the autumn.

A coordinated European response is justified for many reasons. The most important is to ensure that the fiscal vulnerabilities of some member states do not result in a risk premium penalty (as happened in 2010-2013) that unfairly increases the cost of the crisis and generates risks for the whole of Europe.

The risk premium has recently increased for Italy and Spain. Coordinated European action is needed to prevent markets from exacerbating the crisis.

The measures announced so far (the "Corona Investment Initiative," more state aid, and promises of greater flexibility in the interpretation of the Stability and Growth Pact) have been completely insufficient.

Coordinated European action is needed to prevent markets from exacerbating the crisis

Even if the European Commission decides to provide flexibility on fiscal objectives in accordance with the Stability and Growth Pact, this will not prevent spending from adding to the public debt of each member state.

For example, the Spanish deficit will probably exceed GDP by 1.5-2.5 points in 2019, as a result of:

  1. Automatic fiscal stabilisers (growth slowdown).
  2. Fiscal measures of the type previously discussed (mainly aid for employment and companies).

If all this extra public spending is borne exclusively by the Spanish state, the markets will probably increase the risk premium for Spain.

There are several ways to organise EU fiscal support. Luis Garicano has proposed creating a European fund for employment protection that reduces unemployment caused by the virus with temporary employment support programmes, such as the previously mentioned Kurzarbeit.

Other options include more aggressively using the capability of the European Investment Bank, or deploying the spending ability of the European Financial Stabilisation Mechanism which was established before the crisis (and still has €14 billion to spend).

Finally, there are clear political reasons to react. With political tensions rising in many member states, an insufficient or late response could reinforce eurosceptic arguments and boost populism.

On 11 March, one of the most viral news stories in Italy highlighted China’s donation of 100,000 masks to Italy, while Germany banned the export of masks. As the Wall Street Journal correspondent in Italy highlighted: "the lack of a European focus in such a serious crisis is something that Italian voters will remember for a long time."

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