Europe Needs a Temporary Fiscal Union

(Bloomberg Opinion) -- At a recent meeting of European Union leaders, French President Emmanuel Macron said the coronavirus emergency had brought the EU to a moment of truth. He wasn't exaggerating. Europe as a single entity, as opposed to a partnership of separate nations, was in no way prepared for the crisis. For good or ill, its response could set the union's path for years to come.

The EU's main structural weakness has been apparent for years: It is a monetary union without a fiscal union. When individual countries come under economic pressure, they cannot tailor monetary policy to suit their particular needs; at the same time, unlike states within the U.S., they can't rely on automatic fiscal support from parts of the union that aren't struggling. The pandemic is putting this point of fundamental weakness under enormous new stress.

The answer is to create a fiscal tool that is big and bold enough to work in these extraordinary circumstances, yet limited enough to quell fears of a permanent new “transfer union” — one that would put economies like Germany on the hook for the fiscal excesses of countries like Italy. This combination of big and temporary shouldn't be impossible. Yet progress toward such a plan has been slow.

The emphasis so far has been on talking up smaller steps. European Commission President Ursula von der Leyen has proposed a recovery fund of a trillion euros ($1.1 trillion) or more, but that large-seeming number appears to envision private investment triggered by guarantees and official support in the form of loans. The EU needs to muster a lot more public money than a trillion euros, and it needs to issue outright grants, not loans. The countries under greatest pressure can't safely plan to keep on borrowing and borrowing.

The European Central Bank has provided some breathing space by promising to support the euro system with a big new bond-buying program. But how far the ECB can pursue this policy without coming under fire for exceeding its powers (tightly circumscribed by the EU's treaties) is unclear. Germany's constitutional court has again expressed strong reservations and has told the central bank to justify its programs. The ECB shouldn't be counted on to do whatever it takes for as long as it takes. A big new fiscal component is going to be needed.

Perhaps, therefore, this is the moment to launch the next great phase of European political integration? If not now, when? The trouble is, it's unlikely to be possible. Even trying would be counterproductive. Popular skepticism of political integration was running high in the EU before the new coronavirus emerged and sure isn't subsiding because of it. Pushing an accelerated ever-closer-union agenda under these conditions would inflame anti-EU sentiment, the last thing Europe needs.

That's why a strictly temporary response makes the most sense. A new or existing EU vehicle should be given the power to issue, say, 2 trillion euros of pandemic-emergency bonds, to be serviced jointly by EU member states in proportion to their population and gross domestic product. This vehicle would then disburse grants to member states using a formula based on the severity of the pandemic shock — measured by the drop in output and/or the rise in unemployment.

Make no mistake, for as long as it lasts, that's a transfer union. A system of this kind would therefore face legal challenge, even though the EU treaties allow for supporting members facing exceptional difficulties. (Difficulties on the scale of this pandemic weren't foreseen.) The crucial thing is to design it, and explain it to voters, as a bold but temporary response to an exceptional event. A transfer union, yes. But not one for the ages.

There'd be political resistance as well as constitutional debate, and these objections shouldn't be blithely overridden. For instance, those opposing a reform of this kind often cite the “moral hazard” argument against transfers — the idea that a fiscal union would discourage budget discipline. Advocates say this argument doesn't apply, because the pandemic was an act of nature that had nothing to do with budget policy.

Unfortunately, that's only partly true, and the skeptics have a point. Governments that were fiscally disciplined before the emergency can afford to borrow more now that they really need to; governments that have overborrowed for years have fewer options. It's true that this particular crisis was unforeseen, but governments chose whether to build fiscal capacity to deal with an emergency if one arose. Even a pandemic-only fiscal union shifts the incentives for future policy.

Nonetheless, if European solidarity means anything, it surely ought to extend to generous mutual assistance under circumstances as egregious as these. And for such assistance to work, it must be of a scale (big) and form (grants) that are adequate to the test.

The ECB, after a moment's hesitation, has seen the need and is doing all it can. For as long as this emergency lasts, Europe's governments should promise to do no less.

Editorials are written by the Bloomberg Opinion editorial board.