Could the COVID-19 debt be wiped out?
In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2018-2022) discusses the current debate surrounding the cancellation of the covid debt.
In March 2020, the French President Emmanuel Macron announced during a televised speech that the French government would “mobilize all necessary means […] to save lives, whatever the cost”. In one year, the “whatever the cost” has resulted in a sharp increase of the French national debt from 100% of GDP in March 2020 to 120% in March 2021. In 2020, debt increases and money creation have taken on unprecedented proportions. The Federal Reserve in the US and the Eurosystem in Europe have injected nearly $3 trillion and $2 trillion respectively in the economy.
For many months now, economists in Europe have been calling for a cancellation of the “Covid-debt”. What are their arguments? Why do some refuse to consider this option? What could be the consequences of such a cancellation?
How does public debt work in Europe?
The Article 123 of the Treaty on the Functioning of the European Union forbids the European Central Bank (ECB) to finance and refinance directly the members of the Eurozone. The ECB can only acquire national debt securities such as treasury bills through the secondary market: it has to repurchase the securitizes from other investors which purchased them on the primary market in the first place (where the national debt securities were first emitted).
The European national debts are mainly held (75%) by other States and institutional investors such as banks and insurance companies. The remaining 25% are held by the ECB. The debate around the covid-debt cancellation is solely focused on the 25% held by the ECB. In effect, the very idea of cancelling some of the remaining 75% of debt hold by other States and investors is inconceivable (it would immediately undermine the European union credibility, which would increase the risk linked to national European state securities, thus increasing the cost of debt financing for European countries).
Why should the Covid debt be wiped out — and why it shouldn’t
In February, 150 economists from 13 European countries (such as Thomas Piketty or Gaël Giraud) explained in an opinion page published in Le Monde, that accumulated public debt had reached a level too high to be entirely paid out without a drastic austerity that would damage European economies. They highlighted the fact that raising taxes and/or reduce public spending would have devastating social consequences.
Furthermore, according to Thomas Piketty, as 25% of the European debt is hold by the Eurosystem, which group the ECB and national central banks (such as “Banque de France”), this is equivalent to consider that European countries hold 25% of their own debt. Hence the fact that these 25% of debt are a zero-sum game. He also argues that as “it is unlikely that the ECB […] will ever decide to put these securities back on the markets or to demand their repayment, the decision to no longer count them in the total public debt could be taken now”.
From this perspective, several right and left wing public figures (such as former minister Arnaud Montebourg or economist Alain Minc) advocate for a cancellation of these 25% of debt or a conversion into a perpetual debt with a zero-percent interest rate.
On the other side of the arena, according to those who are against the cancellation, it is forbidden to cancel the debt. Christine Lagarde herself (President of the ECB) has declared such a cancellation is “unthinkable” as it would be a “violation of [the article 123 of] the European treaty” which forbids the ECB to finance and refinance directly Eurozone states.
Furthermore, in the strictest sense, the debt of Eurozone countries is held by the Eurosystem. This implies that European national debt securities generate interests, which are paid back members of the EU. This cash-flow would be cut-off if the debt were to be cancelled or converted into a zero-interest long-term debt.
Finally, some economists like Jean Pisany-Ferry (who backed of the French President Emmanuel Macron during the last 2017 presidential campaign) and Henri Sterdyniak compare this cancellation solution to a “mystification” and a “fake theory”. Cancelling the debt would make the Eurozone States “neither richer nor poorer”. According to them, the 25% of debt held by the Eurosystem is a real debt. Thus, the Covid-debt issue should be addressed with “real economic arguments” like reducing public spending to avoid future macroeconomic imbalances, rather than using a “magic trick to hide public debts”.
What could be the consequences of such a cancellation?
The opponents to this option explain that a debt cancellation goes against the long-term goal of the Eurosystem of a having a controlled inflation rate. Indeed, when a country increases its debt, it receives the amount of money lent through money creation. Money creation is supposed to increase the inflation rate in the long run. Nonetheless, the reimbursement of a debt translates into money destruction. In a perfect world without inflation, the reimbursement of a debt destroys the exact amount of money created to issue the debt, resulting in no inflation effect. Cancelling the debt would thus remove the destruction phase of money creation, which could result in the long run in an increased inflation way above the targeted inflation.
Furthermore, cancelling the debt would undermine the ECB reputation. In another opinion page published in Le Monde newspaper, 80 economists explain that “the supposed alleviation from a cancellation would be quickly cancelled out by the risk premium that the markets would inevitably charge on the signatures of the euro zone member states”. In other words, the loss in credibility of the ECB implied by the cancellation of the debt would increase the interest rate of national Eurozone national securities, thus making the financing of public debt more expensive for Eurozone states and riskier for investors.
The advocates of debt cancellation reply that the risk of creating an uncontrollable inflation is minimal, as the amount of money released by the debt cancellation would be invested in the real economy and support investments, job creation etc. To the argument of loss of credibility, Thomas Piketty replies that an unprecedented situation (the Covid crisis) requires unprecedented means of action.
Amidst this debate, what appears to be certain is that the sharp increase in public debt doesn’t threat public finances in the short run. Nevertheless, this debate introduces relevant questions for the long term, especially in the Eurozone where it could question its model. Finally, if efforts have already been made in favor of developing countries notably by the International Monetary Fund (IMF), associations such as OXFAM call for the pure and simple cancellation of the debts of these countries in order to allow them to survive the Covid crisis.
The Eurozone is a monetary union of 19 member states of the European Union that have adopted the euro as their primary currency. The monetary authority of the eurozone is the Eurosystem. The eurozone is comprised of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
The Eurosystem is comprised of the ECB and the national central banks of the 19 member states that are part of the Eurozone. The national central banks apply the monetary policy of the ECB. The primary objective of the Eurosystem is price stability, followed by systemic stability and financial integration.
Sources: Le Monde, Les Echos, Oxfam, European Union Law
About the author
Article written in April 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2019-2022).