The ECB Response to COVID-19

Since the outbreak of the COVID-19 crisis, the European Central Bank (ECB) committed to inject an additional 870 billion euro – about 7% of the euro area’s GDP – into financial markets to address the significant challenge the pandemic poses to the economy. Through its refinancing lines it is also making up to 3 trillion euro in liquidity available, including at the lowest interest rate at which it has ever offered bank funding: -0.75%.

Its actions are critical. It is crucial to accommodate the surge in emergency credit demands that will be coming from individuals, firms and governments during and after the shutdown. To target this objective, the devil is in the details: the ECB must ensure that its financial help reaches those most in need, i.e. the most vulnerable households and businesses. It must also sow the seeds for a resilient and sustainable European economy in the recovery and thereafter.

The credit challenge is massive

Containing the COVID-19 pandemic requires shutting down significant parts of the economy. Less economic activity means less income for most people and firms. To overcome this crisis, depending on the extent of government support through fiscal measures, many households and firms will have to resort to emergency credits to sustain businesses as well as minimal living standards.

Moreover, public services – most importantly those provided by the public health sector – and fiscal transfers are crucial to provide the help that the most vulnerable need during and after the shutdowns. Euro area countries have announced ambitious emergency fiscal plans summing up to trillions of euros. Countries will need to turn to sovereign debt markets to fund these measures. The terms and conditions for this debt on financial markets are critical, as they shape both the capacity of governments to respond to the crisis now, as well as the sustainability of their sovereign debt moving forward.

In short, the ECB is facing a surge in demand for emergency debt by both the private and public sector. It must act decisively to ensure that the need for emergency credit is met, at conditions that do not jeopardize our economic future.

The ECB measures come a long way

The ECB has opened monetary policy taps widely to respond to this challenge and to guarantee liquidity in sovereign and private credit markets in the euro area. Its support measures rest on three key pillars.

First, the ECB announced an extra 120 billion euro to be added to its Asset Purchase Programme (APP) and launched an additional new Pandemic Emergency Purchase Programme (PEPP) with an envelope of 750 billion euro until the end of the year. It also waived eligibility requirements for Greek sovereign debt within the PEPP and expanded its purchases within the APP and the PEPP to also include non-financial commercial paper to better support firms through the crisis.

Second, the central bank considerably eased the conditions for banks to grant loans, in particular to small and medium-sized businesses. It added additional longer-term refinancing operations (LTROs) and reduced the interest rate at which it provides funding through its targeted longer-term refinancing operations (TLTROs) to a record low of ‑0.75%. It also increased maximum borrowing for banks from 30% to 50% of their stock of eligible loans and removed the bid limit per operation.

Finally, the ECB Banking Supervision lowered capital requirements for its directly supervised banks – more precisely, below Pillar 2 Guidance, below the Capital Conservation Buffer, and below the Liquidity Coverage Ratio. Banks are also allowed to mobilize new capital instruments to meet their capital requirements.

The measures the ECB has taken come a long way in supporting the necessary surge in credit to both the private and public sector. It remains critical, however, to ensure that credit is given at sustainable conditions and that it reaches those most in need.

Guaranteeing sustainable credit conditions

Crucially, the additional burden of emergency credits on debtors must be minimized – both from an equity as well as an economic standpoint. Strict shutdowns are necessary to contain the epidemic; their consequences should not come at an undue cost for those most affected – and with financial gains for others. A “solidarity” zero-interest rate would reflect the value of the public good that is provided by both individuals and businesses in the fight against the propagation of the virus. Moreover, the speed and robustness of the recovery after the crisis would be severely hampered if debt burdens are not contained.

From the outbreak of the crisis, the ECB has kept its interest rates at zero, or even below it. It should maintain this level and guarantee sustainable conditions for emergency credits. With PEPP, the ECB has taken decisive measures to ensure that sovereign debt in the euro area remains at interest rates close to zero. Its actions have also addressed concerns about debt sustainability for some European countries to contain risk spreads in sovereign debt markets.

Ensuring that banks pass on low refinancing costs to their clients is a critical further pillar to reduce debt burdens. The favourable funding conditions offered by the ECB must be passed through to individuals and businesses. Like emergency loans to sovereigns, emergency loans to households and firms should be provided at interest rates at or very close to zero. With this in mind, the ECB must monitor bank loans markets and ensure that the loans offered reflect the favourable conditions at which it provides refinancing to banks.

Credit where it is needed

In the past, the ECB’s sovereign debt purchases were allocated between countries according to its capital key reflecting EU national economies and populations. Public credit needs to respond to COVID-19 will not follow this key. Some European countries will need more resources than others; some have more fiscal space than others. The purchases under PEPP must reflect this situation. The ECB announcement that it retains flexibility to deviate from its capital key in PEPP purchase flows over time is a critical alignment with this requirement.

Similar considerations should be explored with regard to the ECB’s corporate debt purchases. These are hitherto allocated to firms with an investment grade rating and based on the share of their nominal value in the overall eligible universe of non-financial corporate bonds. However, similar to the rationale for deviating from the capital key in the public sector purchases, the distribution of credit needs among firms is unlikely to match their current share in the European corporate bond market. The ECB should reflect that by accounting for the distribution of European firms’ emergency needs in its corporate sector purchases and thus retaining flexibility to deviate from its current market benchmark.

Finally, it is important to note that the ECB’s measures offer support for all firms, without distinguishing between those which need an emergency credit to go through the crisis from those that had structural financial problems before it. The question to what extent the latter should receive public help is subject to debate – in particular also in view of the potential trade-offs between the targeting of measures and the speed to make them available. As the need for speed abates, a review of further targeting options should move up the ECB agenda.

Time for the helicopter money to take-off?

If the measures taken prove to be insufficient to provide households and firms with the necessary amount of emergency liquidity, the ECB has an additional, if unconventional, instrument in its toolkit: helicopter money! This alternative would directly put funds from the central bank into the “hands”, i.e. the bank accounts, of people. It may be the fastest way to reach the most vulnerable. It may also be an approach to minimize the burden on households and firms and thus to contribute to a fast and robust recovery as the current storm passes.