to fall less than without the scheme.
Relative to the 2008-2009 recession, the benefits firms derived from STW schemes in the current crisis increased because the schemes were more generous. As a result, take-up has been much higher during the COVID-19 crisis than the 1% to 3% of employees observed in most EU countries in 2009 (Hijzen and Venn, 2011 and European Network of Public Employment Services, 2020). Indeed, a few countries, such as the United Kingdom, introduced STW schemes only in 2020. The schemes were made more generous for several reasons. First, economic activity collapsed as lockdowns were imposed, leaving firms with no time to prepare. In contrast, the 2007-2008 global financial crisis reached its peak with the insolvency of Lehman Brothers in September 2008 and only gradually started to affect real economic activity over the following six months. Second, uncertainty about the depth of the economic crisis was considerably higher in 2020 (Figure D.3). This greater uncertainty has increased the option value of temporarily supporting firms that might become profitable again after the crisis subsides. Third, in many EU countries the decline in output has been more broadly spread out during the COVID-19 crisis than in 2009, when the service sector fared better than construction and manufacturing (Figure D.4). The risk that STW schemes discourage workers from finding jobs that are more productive in other sectors therefore appeared smaller than in 2009.
Figure D.3
Standard deviations of consensus forecasts of euro area GDP growth in 2009 and 2020
Source: Consensus Economic Forecasts.
Note: Forecasts were made in the month shown and were for the annual GDP growth in 2009 and 2020, respectively.
Over time, the unintended effects of STW schemes may become more apparent. As countries emerged from lockdowns over the summer, participation in STW schemes declined. With the health crisis continuing, however, a number of countries extended their schemes (including Germany, France and the Netherlands). This raises the risk that in some sectors, firms that continue to participate in STW schemes might become unviable because demand for their products has declined permanently. For example, demand for office space and public transport may not fully recover. In addition, the cost of discouraging workers from finding jobs that are more productive may soon increase.
Figure D.4
Euro area GDP declined more sharply during the pandemic than in 2009
Source: ECB data warehouse.
Schemes may therefore need to be recalibrated to contain their unintended effects, and they must continue to reflect the institutional and market environment of the various countries, as well as the unfurling of the health crisis. In general, directing the STW schemes towards the sectors worst hit by government measures and promoting the mobility of workers from subsidised to unsubsidised jobs could help mitigate the schemes’ unintended effects.[4]
Financial developments and policies
Compared to the global financial crisis, the COVID-19 crisis took hold against the backdrop of already ultra-accommodative monetary policies and apparently smaller and very limited fiscal space. However, major steps had been taken to increase the resilience of Europe and its institutions: the creation of the European Systemic Risk Board and the three European Supervisory Authorities,[5] the setup of the Single Supervisory Mechanism and other building-blocks of the banking union, and the establishment of the European Stability Mechanism. Contrary to what might have been expected prior to the crisis, policy support unfolded massively and swiftly. As the eradication of the virus and the return to normal take longer than previously thought, this support may be recalibrated to ensure it can continue while minimising its side-effects.
An unprecedented crisis
The COVID-19 crisis is not a normal recession but a halting of activity triggered to prevent a public health disaster. The policy response has therefore had to be different. The purpose is to limit social distress and avert unnecessary bankruptcies that could hold back the recovery. Monetary and fiscal policies have cushioned the blow, mainly by providing financial assistance to companies and workers.
Figure 14
Corporate and bank stock prices (European Union, 100=Dec. 2019)
Source: Refinitiv and EIB calculations.
Note: Last record, 4 November 2020.
The initial contraction could have easily turned into a financial collapse. At the onset of the crisis, the stock market plunged, with corporate stock prices indices plummeting by 35% and bank stocks by 40% as investors fled to safer assets (Figure 14). However, a massive and unprecedented response by central banks and governments prevented a financial collapse from compounding the freefall in output. Share prices recovered strongly for corporate stocks, whose performance was uncoupled from bank stocks. Nine months after the start of the crisis, in late November 2020, bank stocks are still 30% below pre-crisis levels. In the longer term, banks´ profitability is likely to remain subdued, given the persistent low interest rate environment that is squeezing net interest income and the returns from maturity transformation.
The ECB swiftly dispelled initial fears about the integrity of the euro area. In Figure 15, we plot quanto CDS spreads, or the difference between credit default swap quotes in US dollars and euros. The resulting measure is an indication of the risk associated with the break-up of the euro area as perceived by investors.[6] In contrast to what happened during the sovereign debt crisis, the quanto CDS spreads did not escalate for the three major sovereigns – France, Italy and Spain – compared to Germany, and stayed almost unchanged compared to the period prior to the COVID-19 crisis. This suggests that the ECB’s response was perceived as bold enough to support the integrity of the euro area.
Lower inflation for longer. At its onset, some analysts argued that the crisis could have a negative or positive impact on inflation (Shapiro, 2020). Since the lockdown has resulted in both an adverse supply shock and an adverse demand shock, inflation could theoretically have responded either way. In the first few months, however, inflation slowed down sharply across Europe, and the decline was due to other factors than the most volatile components, such as energy (Figure 16). In the long term however, the risk of inflation rising beyond its target is substantial given the amount of liquidity injected in the system. Moreover, as public debt accumulates, monetary policy may well give way to fiscal constraints (come under fiscal dominance), if rate hikes are seen as doing too much damage to public finances.[7]
Figure 15
Quanto CDS spreads (basis points)
Source:
