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22 May 2023

CEPR: The far side of the EU’s expenditure benchmark


This column argues that there is a blind spot in the dominant narrative, which can be easily fixed but can also weaken a reformed system if ignored.

The ongoing debate on the future of the EU’s fiscal framework puts a lot of trust in the expenditure benchmark as single operational rule. The benchmark is meant to eliminate the overspecification of the current system, mitigate the noise implied by unobserved variables, and act as a dependable compass on the way towards more prudent levels of government debt. 

From planet Earth we see only one side of the moon because our celestial companion rotates on its axis at the same rate as it orbits earth; the far side remains hidden to us. In the ongoing debate about the EU’s future fiscal framework, the expenditure benchmark – the prospective linchpin of a reformed system – is a bit like that. It has been lit up intensely over the past several years, but have we explored all sides of this wunderkind among fiscal rules? 

The dominant narrative underlines a number of important advantages of expenditure benchmarks. 1 First and foremost, they are predicated on the sound and intuitive notion that public finances will normally stay on a sustainable path as long as government expenditures do not outpace the aggregate level of economic activity in the medium to long run – the governments’ ultimate tax base. In practice, this notion is made operational by relying on estimates of potential output growth as speed limits. Although unobservable, estimates of potential output growth are surrounded by a lower degree of uncertainty than the output gap, the unobserved and fickle ‘fellow’ that has frustrated fiscal policy makers since it appeared on the stage of EU fiscal surveillance in 2005 (Valla and Cohen-Setton 2010, Darvas 2015).

Second, unlike the budget balance or government debt, expenditure benchmarks cover the budgetary aggregate, which, for its most part, is directly controlled by national authorities. With very few exceptions, such as unemployment benefits, the bulk of public expenditure is discretionary and a priori unresponsive to changes in the macroeconomic environment; it is fixed by law. Policymakers may very well decide to curb or increase expenditures for economic or political reasons, but those are deliberate choices requiring the agreement of national legislators. In short, while revenues follow the economic cycle, there is very little automaticity in the evolution of expenditure; governments are bound to implement plans adopted by their parliaments. Hence, what better yardstick to assess the track record of fiscal policymakers? Once an expenditure path has been set, deviations from that path must be the responsibility of national authorities, period.

CEPR



© CEPR - Centre for Economic Policy Research


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