If the pandemic lasts too long and triggers a major deterioration of bank asset quality, bad banks could be created to take over the non-performing loans, which could help the recovery.
Fortunately, banks are in a better position to absorb losses than at the outset of the 2007-2009 financial crisis. Bank capital levels have increased, and a great deal of effort has gone into reducing non-performing loans back to their 2007 level (European Commission, 2019).
Conclusion and policy implications
The government restrictions to contain the spread of the coronavirus pandemic are having a significant negative impact on the global economy. As the pandemic spread rapidly across the globe, many governments, especially in advanced economies, took drastic measures to contain the virus that severely constrained domestic economic activity and international trade. While most economies were bouncing back after the removal of the measures, concerns were rising of longer-term economic effects. Those concerns were intensified by the second wave of infections that washed over Europe in the fourth quarter of 2020.
The policy measures put in place have been expansive enough to contain the economic damage caused by severe government restrictions across the European Union. National governments, national central banks, the ECB and the European Union have rapidly mobilised resources to counteract the effect of restrictions on movement and social distancing. Fiscal and monetary policymakers, as well as financial supervisors, acted in coordination to mitigate the effects on firms, banks and employees. Most of these measures, however, were designed as an emergency response and were intended to be temporary. Removing them too soon might quickly prove devastating as a second wave of infections hit most EU members in the fourth quarter. At the same time, the policy measures’ bluntness and expansive use of resources suggest that they may not be sustained in full for much longer.
The symmetry and intensity of the shock is pushing EU members to substantially strengthen common economic policy. The EU policy response to the pandemic is impressive both in its size and speed of delivery. Several indicators show that the policy response was well received by markets and strengthened confidence in the future of the European Union. Progressing swiftly and delivering on expectations remains key. The rapid economic rebound in the third quarter shows how successful the policy response to the first lockdown was. If anything, the second virus wave is a strong argument for maintaining the policy measures over a longer-term horizon, until a vaccine is widely distributed. When this happens, support may be recalibrated to reduce possible long-term side-effects, but the overriding concern should be to preserve the ecosystem as it was before the pandemic.
In addition to supporting the income of those unable to work and minimising negative effects on demand, the policy package could also be instrumental in shaping the future of Europe. The crisis provided an opportunity to address the major challenges facing the European economy, such as climate change and digitalisation. The crisis response is also historic as it led to the first joint European issuance of debt on a large scale. The joint debt issuance could turn out to be a cornerstone of the capital markets union. The crisis has affected European economies differently, and recovery needs to focus on stronger financial integration if cohesion is to be maintained within the European Union.
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