27 September 2023

PubAffairsBruxelles: The EU Needs Fiscal Union

EU's need for closer fiscal union/cohesion in tackling looming challenges is now widely recognized. But until policymakers follow through with reforms to bring about these outcomes, EU fiscal and monetary policies will continue to do harm, potentially killing the patient before the cure arrives.

European economic policymakers have had a packed schedule lately. First, the European Central Bank’s Governing Council gathered to deliberate on what would become its tenth consecutive interest-rate hike. Then, the European Union’s Economic and Financial Affairs Council met for an as-yet-inconclusive negotiation about reforms to EU fiscal rules. Finally, European ministers, central-bank governors, and regulators held their traditional informal meeting to discuss economic governance and fiscal- and monetary-policy coordination. Unfortunately, however, none of these meetings is likely to bring the changes Europe needs.

When the COVID-19 crisis erupted, European authorities and central bankers moved quickly to implement a powerful, innovative response that few would have previously thought possible. But the resulting increase in public debt, together with the recent bout of inflation, has spooked policymakers. Now, some EU member states – particularly those that had reservations about the pandemic spending – are advocating a return to austerity, and the ECB has once again embraced a hawkish stance. Will this be a transient episode of reform fatigue, or is Europe poised to return to its old ways for good?

The European Commission, along with many central bankers and finance ministers, recognizes that an asymmetric federation with one central bank and many fiscal authorities, each operating according to national fiscal rules, has a deflationary bias. But even though this tendency clearly puts the EU at a disadvantage compared to the United States – which can respond to crises with a far more supportive mix of policies – the political will to counter it is nowhere to be found.

The European Commission’s proposal for reforming EU fiscal rules is a case in point. Despite being less stringent than the Stability and Growth Pact that is now in place, it includes many undesirable pro-cyclical elements. The implication is that today’s weakening growth will be accompanied by a sharp fiscal consolidation. If adopted in their current form, the proposed changes would require the EU to increase its overall structural primary surplus by an estimated 0.65% of GDP annually from 2025 to 2028. That is a significant figure – and it is even higher in the cases of France (1.1%) and Italy (0.9%).

To achieve that level of surplus, the EU would have to undertake a coordinated fiscal tightening. And, in fact, the European Commission is already forecasting that scenario in 2024, just as the ECB has announced that monetary policy will remain in restrictive territory....

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