Energy, inflation, supply chains, the consequences of a pandemic – the EU is struggling with many crises at the same time. Here are some of their attempted solutions.
Increase in interest rates
After many years of the zero interest rate policy, the European Central Bank (ECB) finally initiated the turnaround in interest rates on Thursday (July 21). It increased the key interest rate from zero to 0.5 percent, further increases will follow.
It is more than questionable whether that will be enough to get the high inflation of 8.6 percent in the euro zone under control. Especially since the main reasons for the price increases are beyond the control of the EU: Energy prices have risen because of the strong demand after the pandemic, as well as because of the Russian war against Ukraine. Torn supply chains in global trade also drive prices up.
In addition, the ECB is walking a tightrope with its rate hikes. In economics, prices usually rise in boom times when all capacities are fully utilized. Higher interest rates then have a dampening effect because they make credit more expensive and thus also slow down economic activity.
But inflation is now hitting EU countries, all of which have emerged weakened from the pandemic, some with greatly increased debt. It is therefore not without risk to further weaken already ailing economies with higher interest rates.
TPI anti-crisis instrument
With the end of the zero interest rate policy, a specter is coming back that brought the euro zone to the brink of collapse a good ten years ago: the very different credit conditions of the member states.
Countries borrow money in the financial markets by issuing government bonds. The more confidence investors have in a country's creditworthiness, the lower the interest that country has to pay on its debt. Conversely, countries with high debts and weaker economies are “punished” by lenders demanding higher interest rates. This difference, also called the spread in jargon, is now increasing again. Italy, for example, had to pay 1.21 percent higher interest than Germany a year ago if it wanted to borrow money for ten years. The spread has now almost doubled to 2.26.
Highly indebted countries like Italy could get into trouble as a result, because higher interest costs leave politicians with little financial leeway. During the euro debt crisis from 2010, market participants therefore began to speculate against individual states – a kind of bet on the collapse of the currency union.
In order to prevent this crisis from recurring, the ECB has created a new tool. With the bond purchase program TPI (Transmission Protection Instrument) it wants to lend money specifically to those countries that the markets trust particularly little. It is intended to send a signal to speculators: don't bet on the end of monetary union, you can only lose.
The downside of the new instrument: the ECB is forbidden from providing direct state financing. Protracted disputes before the courts about the limits of the ECB's mandate are therefore foreseeable. Here, too, it will again become clear how different the demands for a common monetary policy are – which in turn should increase bets against monetary union.
Emergency plan for energy
Rising gas prices prompted the EU Commission to draw up an energy emergency plan on Wednesday (20 July). This provides for a 15 percent reduction in gas consumption in the EU next winter. If this amount is not saved on a voluntary basis, the EU Commission wants to call out the “EU alarm” and force the member states to save. Certain sectors of the economy could then receive less gas. Financial incentives are also planned for companies switching to other energy sources.
However, the emergency plan must be approved by the EU states in order to come into force. Spain and Portugal have already announced opposition, rejecting the plan as “unsustainable”. Here, too, the signs point to a dispute.
Government support for the citizens
Many EU countries have put together relief packages to relieve their citizens in the face of rising inflation and high energy costs – and to calm voters' anger somewhat. They range from tax breaks to flat-rate deductions on electricity bills and direct cash payments to state participation in ailing companies, such as in the case of the German energy supplier Uniper.
The size of the aid packages varies greatly from country to country. What they all have in common is that they are a burden on national budgets and continue to increase debt. And all of this comes on top of the burdens countries have accumulated during the coronavirus pandemic. This is being watched closely on the financial markets – and could then lead to rising spreads (see above).
EU recovery fund
In order to shoulder the enormous burden of the corona pandemic, had the EU 2020 launched the Corona Recovery Fund. With a volume of 750 billion euros, it is the largest aid package in the history of the community. The money is intended to help countries weather the economic downturn caused by the pandemic and at the same time enable investments to make economies more climate-friendly and digital.
Like many other measures to combat the crisis in the EU, the recovery fund is also sending mixed signals. On the one hand, it should demonstrate unity and the strength of the community. It is the first time that the EU countries have taken on joint debt for this purpose. On the other hand, the dispute during the negotiations showed how big the differences between the countries of the EU are. Disputes and compromises will probably also accompany the Union in the future.