02 November 2022

Bruegel's Zettelmeyer: European Union fiscal rules: is a better system feasible?

Advances in policy frameworks are generally the result of a ping-pong between policy ideas and political needs. In the area of EU fiscal rules, there has been a lot of ‘ping’ in recent years. Academics and think tankers have criticised the rules for being ineffective—partly by design, partly due to poor implementation—while making recessions worse and constraining needed public investment. Scores of reform ideas have been proposed. ¹  But there has not been much of a ‘pong’, reflecting deep disagreements over the direction of reform among EU governments and the suspension of the rules until the end of next year.

Two official documents issued in the last 6 months, by the Dutch and Spanish governments (jointly) and the German government, suggest that this may be changing. The papers agree on four reform objectives.

First, the core objective of the fiscal rules is to ensure debt sustainability “in a more effective and efficient manner” (Dutch and Spanish paper). This requires a set of rules that leads members to build fiscal buffers, through both the numerator in the debt ratio (fiscal adjustment) and its denominator (raising growth through improved composition of public finances and economic reforms).

Second, there can be a trade-off between building these buffers and other fiscal policy objectives, such as stabilisation and public investment (including green investment). Fiscal rules should aim at getting that trade-off right.

Third, bilateral deals between the European Commission and EU countries are not an acceptable way of figuring out the optimal compromise between fiscal adjustment, output stabilisation, and investment. In the words of the German paper, “it is essential for the fiscal framework to ensure the equal treatment (both real and perceived) of member states and to use common benchmarks”. The Dutch and Spanish paper calls for “a level playing field … to safeguard transparency and equal treatment for all Member States.”

Fourth, better implementation of the fiscal rules is critical. According to the German paper, “the further development of the fiscal framework should place a particular emphasis on the application of the rules”. The Dutch and Spanish paper emphasises “the potential to create a virtuous circle between national ownership and compliance”—and in its absence, enforcement of the rules by the Commission and the Council.

Compared to the past, in which the ‘South’ regularly called for more flexibility in applying the rules, while the ‘North’ regularly called for tougher enforcement, this is big progress. We now seem to have convergence on the main objectives of reform by at least one prominent ‘Southern’ and two prominent ‘Northern’ members.

But even if all members agreed with the objectives formulated in the two papers, this may not be enough to put a successful reform of the fiscal framework within reach, for two reasons.

First, there is potential conflict across objectives. Ensuring debt sustainability (objective 1) while also allowing compromises between fiscal adjustment, output stabilisation and public investment (objective 2) requires decisions that carefully reflect country-specific circumstances. This may conflict with even-handedness (objective 3).

Second, it is unclear whether there is any way to meet objective 4 (much better implementation than in the past)—at least not without much tougher enforcement, which is unlikely to be feasible either legally or politically. The Dutch/Spanish paper offers a potential solution: “National governments could be better held accountable if they are also empowered to propose country specific medium-term fiscal plans to reinforce fiscal sustainability in a growth-friendly manner.” But a fully empowered national government may ignore the adverse fiscal externalities of high debt, undermining the very purpose of the fiscal rules....

 more at Bruegel

© Bruegel