Three important questions to answer about global financial stabilization policies amid the coronavirus recession

On March 24, my colleagues Emmanuel Saez and Gabriel Zucman at the University of California, Berkeley asked me to present to a teleconference of about 100 economists and other experts on the coronavirus recession from an international perspective—particularly the situation in the European economies and emerging economies. Below is a summary of my remarks, updated to account for more recent events since that convening late last month.

I will start by summarizing the way I’ve been thinking about the coronavirus pandemic from the public health side and the resulting economic implications. As is now well-known, flattening the curve of the infection rate of COVID-19, the disease resulting from the new coronavirus pandemic, requires public health steps, including suppression and mitigation measures that allow societies to cope with the influx of infected patients. The immediate consequence is that a great number of people are forced to stay away from work, which has a tremendous cost on all economies.

Nevertheless, there are things policymakers can do to try to mitigate this sharp adverse economic impact and also prepare for when the pandemic recedes and economies begin to recover. The point I want to make here is that the pandemic is global, and the recession is also global. There are slight differences across countries in terms of timing, but those are differences of only a few weeks or a few months and don’t matter much from a macroeconomic perspective. In other words, this coronavirus recession is highly synchronized around the world even though different countries are instituting different public health and economic measures.

Looking specifically at the European economies and emerging economies, they are all experiencing a tremendous amount of strain. Let me start with the eurozone governments, which, by and large, have implemented or announced fairly large fiscal programs to provide support to businesses in the form of credit guarantees or direct employment assistance for workers, including short-time work hours and the extension of unemployment benefits. For households, there are some suspensions of mortgage payments, utilities payments, and tax payments. These measures are pretty comprehensive and are very big in terms of size.

Of course, some countries in the eurozone are in a relatively weak fiscal position, with Italy probably drawing the most attention right now. The spread on Italian 10-year government bonds relative to German government bonds with the same tenor started widening fairly rapidly at the onset of the health crisis in Italy and also due to the initial blunder by the President of the European Central Bank Christine Lagarde, who, early on, said of the ECB, “we are not here to close spreads.”

Fortunately, the European Central Bank’s actions quickly dispelled the notion that it would sit on the sidelines. The first line of response came in late March, when the ECB implemented its very aggressive new Pandemic Emergency Purchase Programme, which is targeted toward financing additional fiscal expenditures that countries may have to incur as a result of the pandemic. The program is quite sizable, about 750 billion euros, which represents about 6.5 percent of the eurozone Gross Domestic Product at this point. That announcement certainly had a dramatic effect on the spreads, reducing stress in eurobond markets, for now.

But this first step doesn’t solve all the issues or concerns going forward, given the structure of Italian debt. Some solvency concerns could emerge if somehow the European Central Bank and other European countries are not able to join in the efforts to ensure fiscal sustainability across the entire eurozone. First, the existing constraints on how much the ECB can invest in a single country, or how much of a particular issuance it can purchase, have been lifted temporarily. This gives the central bank the room it needs to purchase Italian debt in massive amounts if it needs to.

But solvency concerns are not completely alleviated. The European Central Bank cannot purchase the debt of a country when it is unsustainable. These more medium- to long-term issues still lurk in the background. To address this, various proposals have been put on the table. They all aim to provide some sort of joint funding for European countries in need. Right now, this is Italy, given the severity of the health crisis there and the precariousness of its public finances. These proposals aim to get as much fiscal support as possible to Italy.

There are three main proposals on the table, listed below in increasing order of complexity and political resistance:

  • A COVID-19 credit line, which would use the European Stability Mechanism to provide funding with long duration and light conditionality
  • A long-term coordinated joint bond issuance, which would bypass the European Stability Mechanism and thus avoid conditionality, and come with a European Central Bank backstop, possibly with joint guarantees
  • A coronabond, which would use the European Stability Mechanism to issue large amounts of long-term bonds deployed according to needs for COVID-19-related expenditures

This last idea of a coronabond faces the steepest institutional and political obstacles but remains an important idea. It is also quickly gaining ground. There is, I think, growing support for something like this—and even on the German side, where, of course, there is still tremendous opposition, there are growing signs of support. There is a sense that this is a key moment for the European project, and that if European countries are not able to pull resources together at a time like this, where it’s clearly something that has nothing to do with fiscal moral hazard or fiscal incentives, then the European project will be dealt a very severe and potentially fatal blow.

My worry is that European policymakers will come up with something that might be mostly symbolic and not have the firepower that is needed to really address the underlying fiscal issues. That would leave the European Central Bank as the sole institution in charge of handling the crisis across the eurozone, trying to backstop individual governments.

Let me turn next to emerging economies because I think that’s something that we need to keep in mind as well. These economies are experiencing enormous capital outflows from their financial markets back to advanced economies. In fact, these outflows are unprecedented in terms of their size. A lot of things are unprecedented these days, and this is one of them. The cumulative portfolio outflows dwarf anything that has happened before, even during the global financial crisis in 2008.

Moreover, it is synchronized across all of these countries and is associated with a very rapid appreciation of the U.S. dollar. In many countries, these sovereign borrowers have reduced their dollar borrowing, but at the same time, their corporate sectors increased their dollar-denominated debt, so it is unclear overall whether national balance sheets are becoming less or more dollar-dependent.

This leaves these emerging economies with large foreign-exchange vulnerabilities, which also threatens to shut down global supply chains because of cascading calls for dollars. Add to this the fact that most of these countries do not have as much expansionary fiscal capability as many of the advanced economies, which means there is definitely a need for sizable external financial assistance.

As I said at the start of my remarks, we’re in the common global battle here, in terms of fighting the coronavirus pandemic and also fighting the global coronavirus recession. It’s important that we don’t forget the developing-nation side of the world. Otherwise, we’ll be looking at a situation where the pandemic crisis rages out of control and the economic crisis becomes a total calamity right outside the advanced world, and comes back to contaminate us.

The U.S. Federal Reserve already has taken an important first step by extending swap lines between the Fed and a number of central banks around the world. But there is a subset of emerging economies without such access to these swap lines. The right institution here is probably the International Monetary Fund. It needs to step into the void. But the IMF clearly doesn’t have the firepower to do this alone at present. It needs its financial resources increased, so that it can issue “coronavirus pandemic loans” to developing nations in need with little or no conditionality but with complete transparency about the use of these new emergency funds.

There is a danger that the governments of the advanced economies will not devote enough bandwidth to the rapidly deteriorating public health and economic crises abroad because of the serious health and economic crises they are already facing at home. The problem is, just like the pandemic and recession are global, so the recovery must be.

—Pierre-Olivier Gourinchas is the S.K. and Angela Chan Professor of Management at the University of California, Berkeley, where he also directs the Clausen Center for International Business and Policy and is affiliated with the Haas School of Business.

April 20, 2020


Pierre-Olivier Gourinchas


Monetary Policy


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