Alexander Kriwoluzky: A Crisis Like No Other Before

European differences are shelved—for now. The question is, will they come again to the forefront, as the crisis comes to an end?—asks Alexander Kriwoluzky, Head of the Department of Macroeconomics at the German Institute for Economic Research in Berlin, in an interview with Jakub Dymek

JAKUB DYMEK: After the novel virus struck the world, when did you find yourself thinking “well, this spells big trouble for the European economy”, Professor?

ALEXANDER KRIWOLUZKY: In the beginning, there were hopes that this coronavirus would be somehow contained in the region, as was the case with previous SARS, SARS-2 and MERS epidemics, which did not develop into worldwide threats. But as soon as China took all these drastic measures—introducing full lockdown among them—and the virus spread to Europe, dragging the Lombardy economy to a halt, regardless… this is I think when it became obvious that this is an economic threat to the European Union as well. The Italian situation—how deadly, how infectious, how destabilizing this is—was the first proof that eventually European governments would have to introduce draconian measures of their own. Which, albeit in March, they did.

How does a macroeconomist look upon a shock like this?

In macroeconomics, we like to talk about two different shocks—one striking supply, the other demand. It’s important because depending on what kind of shock we’re talking about, there are different policy tools we have to look for. For instance, the 2008 financial crisis was clearly a demand shock—first the implosion of financial institutions, there was less money to be given in the form of credit, increasing unemployment. In such a case it was very prudent to use the financial stimulus to increase demand for goods, services and work. The USA did that relatively quickly, it took us in Europe some time, however, to be convinced how an unusual monetary policy can be applied here as well.

It was crucial to give people and companies instant access to credit, relief funds, subsidies which would enable a reduction in work hours during the health crisis.

Can both these shocks happen at once?

Exactly, that’s the problem! The corona-crisis is two of these at the same time. Supply chains all over the world had been disturbed, companies had to stop producing, football clubs had to stop playing, and restaurants had to stop serving food to guests… It obviously turns into a demand shock quickly, because people who are unable and discouraged from spending, will do just that. Then there’s fear that this shock will spread to financial institutions as well—because that’s where the crisis struck over ten years ago, and there’s a fear they didn’t fully recover.

So this demands extraordinary remedies?

It does and they indeed are. Let’s go back a while first. What we’ve experienced ten years ago is that financial markets are really fragile and the trust between them—leading to an unwillingness to borrow money from one to another—can be gone in a second. Central Banks eventually have to step in and lend money for the markets. And this is—coming back to the present day—what the ECB essentially did, providing liquidity and promising to purchase as- sets. Which in turn also increases the demand for these assets and then prices. Interest rates are lowered with the aim of boosting investment and in the end reaching an equilibrium of supply and demand. In the process, consumption resumes as well.

This is what happened?

This is what was done and done quickly. Much more so than in the financial crisis of 2008—the American Federal Reserve acted very rapidly then, but the Euro-pean Central Bank was decisively more cautious. The idea was that perhaps the crisis will hit American, and not European, banks and there was, as well, the legacy of the Deutsche Bundesbank—which had been dutifully advised to almost always re- main very prudent when using a monetary policy. This had then prevented the ECB from acting faster. The head of the ECB at the time, Mario Draghi, finally introduced some of the policies—like Quantitative Easing and the asset-purchase program—in 2014 and this, counted by some measures, the 6-year delay was largely caused by German reluctance and pressure. The Germans—to put it in the simplest terms possible—were telling everybody else “don’t do this, as this will lead to hyperinflation”. Now, fortunately, the process leading to the swift introduction of unorthodox anti-crisis measures was faster.

And do these instruments exhaust what can be done?

No. We have to remember that first and foremost it is the national governments, who have the tools to introduce monetary stimulus to economies. As well as, for example, reduce taxes on consumption to boost spending. Germany, again, acted very quickly on that front. It was crucial to give people and companies instant access to credit, relief funds, subsidies which would enable a reduction in work hours during the health crisis. It is important because we want people to return to full-time employment as soon as it’s possible, not to have them fired.

Germany, of course, had the tools and possibility of doing all that, because there was fiscal space—savings. Relief during the times of the coronacrisis was permitted by, for example, years of savings on climate change-related technologies—which is one of the downsides of Germany keeping a low debt to national product ratio. The up-side, of course, is that you can spend that much more money in the times of crisis.

So this is where the question of European solidarity comes in?

Yes, that’s why a common European plan, the so-called Merkel-Macron plan, had to be introduced. National governments do not always have the fiscal space to stimulate their economies.

You cannot say that certain European countries are making mistakes and are being punished for them—like the Germans used to like to say. Here, the situation is different.

Not everybody was as prudent as Germany, yet in a situation like this, everybody still needs to have some leverage and freedom while trying to revive the economy?

Yes. The Merkel-Macron plan was a very important first step in introducing some universal measures, at least in the eurozone. The plan lays the foundations for ideas like Eurobonds, raising taxes from new spheres and services (take digital tax as an example) and this capacity will be there to help Europe in a future crisis. This is also necessary because we all agree that every country struck by the coronavirus has been put in this situation, not by their own fault. Simply said, you cannot say that certain European countries are making mistakes and are being punished for them—like the Germans used to like to say. Here, the situation is different. It’s not Italy’s, Spain’s, France’s fault, it’s a shared European interest to have a fund that would enable the revival of all the economies that have been hurt—as all of them are interconnected parts of the common market—not only those who somehow ‘deserved’ it.

There are already some politicians here in Germany for example, saying exactly that: we have to intervene during the crisis and all that, but after the crisis ends we have to go back to where things were.

Is the coronacrisis going to—or has it already—revised some ideological convictions previously held?

I think it’s too early to say it has changed the views in general. It changed the views during the times of crisis, though. Here, remarkably, everybody even in Germany agrees it is necessary to have a huge stimulus package. Also, everybody agrees it’s good we have a common European solution. But will attitudes like these re- main after the crisis—that is yet to be seen. There are already some politicians here in Germany for example, saying exactly that: we have to intervene during the crisis and all that, but after the crisis ends we have to go back to where things were, to save money in order to repay the debts. I can imagine the same will apply to Europe as a wholesome will say that during the crisis we had to integrate more and introduce a more multilateral and open approach, but as soon as this ends, we also have to reverse these changes.

Not to “carry each other’s burden” any longer?

Yes. I’m afraid it could happen. On the other hand, I can see already how the response of governments, international agencies, politicians and researchers was different than usual.

What will the relief packages achieve—revive the economy, ease the stress on markets, hasten green transformation or just shelter citizens and companies from some of the worst consequences of the crisis?

The foremost goal, in my opinion, is to stimulate the economy. To respond to the crisis—provide liquidity to financial markets and decrease interest rates even further. These are strictly economic goals as I see them. Sounds very boring, but it is what it is… [LAUGHS]

Right, got it [LAUGHS]. Another thing: Will the stimulus package from the ECB help some economies more than others?

This is indeed a very good question, but I’m afraid we have to wait for research to answer it. We know that stimulus packages affect different types of households differ- ently, but to measure it country-by-country as well we—and this is a type of research we at the German Institute for Economic Research (DIW) are doing—will have to wait for comprehensive data. So as interesting as this is—we cannot speculate on this yet.

The foremost goal, in my opinion, is to stimulate the economy. To respond to the crisis—provide liquidity to financial markets and decrease interest rates even further.

Do you think conventional political and ideological differences between countries in the EU—north-south, east-west divisions for example— played any role when discussing the coronacrisis measures?

I think there was some reluctance from the ‘frugal four’—Austria, Denmark, Sweden and the Netherlands—initially. There were some objections from the northern sphere of the Eurozone. This is where the old north-south divide actually played some role, but when Germany abandoned its previous orthodoxy, things moved forward in a positive, quick and goal-oriented manner.

What signs of recovery and economic trends should we—as journalists and members of civil society—look for and observe most closely?

Not to disappoint you, but this all depends on whether there will be a second wave of the pandemic later in the year. Will it hit the economy as hard? If so, when? How will this all play out during the regular flu season in November? This is—let us not forget—a crisis of a twofold nature, where risks to public health and the economy are interlocked and reinforce one another.