During the 2008 financial crisis, many observers predicted the imminent collapse of the European currency project. They were wrong. The euro held together. Yet what the last crisis did not do, Covid-19 might yet bring about: the breakup of the eurozone.

The architecture of the currency union was ill prepared for the global banking crisis just over a decade ago. Yet in many ways, the situation is even worse today. Not only is the economic shock likely to be more severe, the coronavirus crisis is also, first and foremost, a fiscal rather than monetary challenge. As a result, it strikes at the central weakness of the eurozone.

Back in 2008, the banking sector was the centre of the crisis. The European Central Bank (ECB) could fight the fire by providing liquidity to financial markets and supporting the banks. Monetary tools provided the most important line of defence. But faced with coronavirus, the ECB cannot build hospitals, produce ventilators and masks, or organise income support for businesses and their employees. This remains the domain of national fiscal policy.

The economic fallout of Covid-19 hits all members of the currency bloc. But no mechanism exists that allows the governments of the eurozone to respond jointly to such a shock. The result is that the policy reactions to the pandemic are so far overwhelmingly national – accentuating differences rather than bringing Europe together in a time of crisis. Even in the face of a symmetric shock, the eurozone responds asymmetrically.

The existing differences in each nation’s fiscal condition are already causing a sharp divergence in the policy response. The longer the crisis lasts, the more visible these differences will become. Not all countries will be able to maintain life support for their economies on the same scale. Over time, this will trigger a political dynamic that could push the eurozone to the brink again.

The events of the last week already provide a case in point. With unusual speed and competence, Germany reacted forcefully to Covid-19. Berlin abandoned its cherished debt-brake – which sharply constrains its government borrowing – and legislated a €750bn rescue package for the German economy. Italy, the country with the highest number of infections and deaths from the virus, does not have the same fiscal leeway. Its response to Covid-19 amounts to a mere €28bn – about 4% of the size of the German package.

This substantial disparity in the policy response is exacerbated by differences in initial conditions. In 2019, Italian output was still 4% lower than in 2007 while German GDP was 16% higher. Owing to the ongoing GDP collapse, the Italian public debt ratio will soon approach 150% of GDP – even without a new support package. Yet despite their comparatively tepid response, Italian policymakers already have to nervously watch the interest rate differential between Italian and German government bonds. The spread widened substantially in recent weeks.

The writing is on the wall: without solidarity from its fellow eurozone members, Italy will not be able to respond to the crisis in the same way that other countries can. It is at risk of an economic depression on top of a humanitarian catastrophe.

The eurozone now risks repeating the same mistakes that were made just over a decade ago. The timid and delayed responses of the European national governments at the height of the last crisis have cost the economy dearly. Policy actions were typically taken only when the house was already on fire. And when the ECB intervened to buy time, the extra time was often wasted in European capitals.

A similar dynamic was visible last week. After some initial wobbles in its response to the crisis, the ECB announced a dramatic new programme of asset purchases to stabilise European markets. Yet the reaction in European capitals was predictable: once the markets were calmed, and bond spreads narrowed between countries, the perceived need for joint fiscal action evaporated. Each country turned its attention back to national rescue packages.

Europe needs a joint fiscal response to the Covid-19 crisis. All countries in the currency union must be able to do whatever is necessary to respond to the public health catastrophe. Two different options are on the table.

The best solution would the joint issue of one-off bonds with long maturities. The creation of such eurobonds would send a strong signal of solidarity in the face of a crisis for which no nation can be blamed. There is even historical precedent for such a move: the European Community issued bonds in the 1970s to jointly combat the economic shock of the oil crisis.

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Another option, but a distant second best, would be to use the European Stability Mechanism (ESM) – the institution that was created to deal with the last crisis. Individual countries could apply for ESM loans, subject to light conditionality. Yet only countries at the risk of losing market access will accept the conditions, and the domestic political costs of these deals could be prohibitively large. The design of the ESM embodies concerns from the last crisis about moral hazard and fiscal prudence. It is not the right institution for an emergency that is nobody’s fault.

What is needed is an unambiguous signal of mutual trust and burden-sharing within the European family. Nine heads of government, from Belgium, France, Greece, Ireland, Italy, Luxembourg, Portugal, Slovenia and Spain, have today called for the issue of “a common debt instrument” – a bond, in other words – to raise funds to fight the pandemic. This is the right path. This is a time for European solidarity. If the continent does not stand together now, the European project might never recover.

• Adam Tooze is a professor of history at Columbia University and the director of its European Institute. Moritz Schularick is professor of economics at the University of Bonn and managing editor of Economic Policy.



