Debt Obscures European Recovery

The EU is going to overcome the most severe crisis in its history, caused by the pandemic, at the cost of reaching record debt. The current financial turmoil caused the rise in the government debt to GDP ratio from 79.7% to 87.8% in the EU. 

This burden will be intolerable for half a dozen countries. Thus, raising questions about the sustainability of their public accounts in the medium and long term, as the European Commission advised in early November. These are the usual suspects: Greece, Italy, France, Portugal, Belgium, and Spain.

Economists tend to agree that public debt is sustainable if it can grow above the costs of financing it. Furthermore, this increased growth reduces the burden of debt, when measured concerning GDP.

The ECB will play an essential role in this effort. Its debt purchase program of 1.35 trillion euros, activated against the pandemic, and its rates close to zero, have kept interest rates around 1% for ten-year bonds in the case of Italy and Spain.

Analysts think that as long as the ECB buys 75% of the debt these countries issue, there will be no problems. However, when it stops, it will be very dangerous. These countries can be forced to make very abrupt adjustments.

The Eurogroup and the European Commission have ruled out new European stimuli. However, the president of the ECB has promised that she will act again with determination in December.

How long will the ECB debt purchase program last?

To boost this growth, last July, the EU agreed to the new recovery fund of 750,000 million euros. The recovery fund aims to finance investments and reforms in the Member States. The fund, which the Member States are still trying to approve, will be financed with a record indebtedness that the EU will allow. It will relieve part of the cost of the recovery, especially to Italy and Spain. These two countries are not only between the most indebted but also those most affected by the pandemic.

According to economists Lorenzo Codogno and Giancarlo Corsetti, precisely the impact of the massive European stimulus can give wings to the little inflation. It would force the ECB to consider starting to turn off the tap. However, economists are taking into account the evolution of inflation in recent years and the current paradigm. Because of which central banks like the Fed are willing to exceed their inflation target to support fiscal policy. They believe that the ECB will act with caution, and it will not repeat the mistakes of the past crisis.

Even with strong support from the ECB in the medium term, some believe that the growth recipe will not be enough, especially in an environment of so much uncertainty.