13 December 2023

Bruegel: Bringing the reform of European Union fiscal rules to a successful close

The long-awaited reform of the European Union fiscal framework – the set of rules designed to ensure that debt in one country doesn’t drag down the rest – seems to be heading towards agreement. EU finance ministers will squeeze in an extra meeting on 19 December to close the deal. 

But will it be a good deal? Negotiations on the reform, proposed by the European Commission in April 2023, focused initially on the so-called preventive arm of the framework. According to the Commission’s proposal, governments would be required to put public debt “on a plausibly downward path” by the end of a four to seven-year adjustment period or keep it below 60% of GDP and bring or maintain government deficits below 3% of GDP over the same period. The main dispute between countries has been whether these requirements should be complemented by ‘safeguards’ – simple quantitative rules requiring minimum debt and/or deficit reductions – and how such safeguards should be designed. 

Disagreements on these matters have narrowed. The main outstanding issue is now the framework’s excessive deficit procedure (EDP). This requires countries with deficits above 3% of GDP to reduce their deficits by at least 0.5% of GDP per year. The question is exactly how the 0.5% deficit reduction is measured. The answer is important, because almost half of EU countries might end up in the EDP next year, and because some of their deficits are expected to be large (with those of France, Italy, Belgium, Hungary, Slovakia, Malta, Poland and Romania exceeding 4% of GDP). 

One group of countries, led by France, has wanted to exclude both interest payments and green investment expenditures from the calculation of the 0.5% adjustment minimum. This would make a big difference. France’s interest payments are projected to rise by 0.2%-0.3% of GDP per year as higher interest rates push up the average cost of borrowing. Like many other EU countries, it will need to raise green public investment by 0.5% to 1% of GDP in the next few years to meet green targets. Excluding these expenditure items would cut France’s annual fiscal adjustment substantially. As a result, it would also have lengthened the time needed to reduce the deficit to less than 3%.

This rang alarm bells for another group of countries, led by Germany. They worry that diluting the EDP would endanger the ability of the new system to ensure debt declines within a reasonable period. 

The deal that might be finalised on 19 December could be based on a reported Franco-German compromise. This would lower the minimum adjustment under the EDP up to 2027, after which it would rise to the current level of 0.5%, including interest payments. It is a bad compromise because it does not tackle the core problem. ...

 more at Bruegel

© Bruegel