Sharing and strengthening the euro’s privilege

Blog post by Fabio Panetta, Member of the Executive Board of the ECB

For eurozone leaders, the Covid-19 crisis has provided fresh impetus to the argument that the single currency deserves a greater international role.

Policymakers look at the US as a benchmark. The dollar’s global status has made it easier for America to counter the economic shock caused by the virus. The US has benefited from what has been called the dollar’s “exorbitant privilege”. That benefit accrues through seigniorage — the profits made from issuing currency, after production costs — and the ability to tap capital markets to fund a large increase in spending at low cost, despite a substantial build-up of sovereign debt.

The dollar’s predominant role in global trade has helped shield the US economy from the exchange-rate appreciation that safe-haven status usually brings. And American companies have enjoyed the stability that comes from being able to conduct international transactions in their own currency.

As the world’s second currency, the euro should provide advantages that are comparable with the dollar’s. European Central Bank data indicates that the euro’s share in international currency use stands at about 19 per cent. While this is lower than the dollar’s share, at around one-half, it remains well ahead of any other currency.

But the euro’s global potential has not been fully reached, nor are its benefits evenly shared among its members.

International use of the currency has stalled over the past decade, and not all eurozone countries have profited from the “privilege” of lower borrowing costs in global capital markets, especially in times of heightened risk aversion.

Why? The key ingredients for achieving international currency status are broad and deep financial markets, well-anchored expectations of price stability and economic resilience, a strong fiscal position, and the willingness to ensure liquidity in times of stress. The euro area, however, is characterised by market segmentation and a limited supply of what are perceived to be safe assets.

As a result, when shocks occur, their impact is felt asymmetrically. The distribution of any benefits from the euro’s international role is unevenly skewed towards the few countries issuing what investors perceive to be safe assets. This only exacerbates the vulnerabilities caused by the absence of fiscal integration in the eurozone and diminishes the single currency’s global standing.

In this way, such crises serve as an acid test of global currency status: currencies that fail to provide safety and liquidity fall behind.

The euro’s international role will only grow if we can share its privilege better. Two policy responses are necessary.

The first is for Europe to provide common instruments that generate safe assets for all member states in times of crisis, thereby ensuring that necessary fiscal reactions do not generate further instability and fragmentation. The recently proposed €750bn recovery fund is an excellent example of how to do this. It will provide a forceful European fiscal response to the Covid-19 crisis, building confidence among investors that the euro can be relied on during major shocks.

At the same time, the bond issuance needed for this recovery fund will allow global investors to get exposure to the euro area without exacerbating divergence among national issuers. It could also provide a useful benchmark: issuing bonds with different maturity dates between 2028 and 2058 — consistent with the European Commission’s proposal — would go some way towards establishing a genuine euro area yield curve.

This will provide the building blocks for a deep, common capital market backed by safe euro assets. But the temporary nature of the recovery fund and its relatively small size compared with the European sovereign bond market are drawbacks.

If we are to truly shift perceptions of the euro, investors will have to be confident that this type of action can always be expected in times of great need.

The second response involves monetary policy. It is clear that investors’ trust in the US Federal Reserve anchors the dollar’s global role. A central bank backing a global currency must be relied on to safeguard liquidity conditions in the financial system and avoid procyclical tightening during crises — where rising borrowing costs make financial conditions worse — including through sovereign bond markets.

These were key motivations for the ECB’s pandemic emergency purchase programme, which we scaled up to €1.35tn last week and extended until at least June 2021. These actions were dictated by the ECB’s mandate, which obliges it to intervene as necessary to achieve its price stability objective. They confirm that we remain guided by the principle of central bank independence and the primacy of EU law.

Managing a global currency also requires providing liquidity to foreign central banks through swap and repo lines in times of stress. The ECB has already reactivated a number of these since the pandemic began, and we will go further if warranted.

The goals of boosting the euro’s global standing and sharing its advantages more evenly are one and the same. Through the right mix of fiscal and monetary policy, we can build a better functioning, more stable monetary union, which in turn could increase the euro’s influence and the benefits that accrue to eurozone members.

This blog post first appeared as an opinion piece in the Financial Times on 12 June 2020.