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The severity of the Covid-19 pandemic and its adverse effects on the economy have induced Europe to suspend the rules of the Stability and Growth Pact by activating the general escape clause. In January 2023, the escape clause will expire and, if nothing changes, the old rules will be back in place, possibly forcing painful fiscal adjustments in countries that are already struggling. Over the last few years, there has been a growing consensus that the current rules are outdated, too complicated, and not countercyclical enough. At the same time, there have been positive developments in the ability of Europe to pursue investment to address long-term challenges, such as the green transition and digitalisation process, through the EU recovery plan NextGenerationEU (NGEU).
In light of these developments, in Giavazzi et al. (2021) we offer a proposal to strengthen the European fiscal framework based on two elements: a revision of the fiscal rules, and a plan to create a European Debt Agency to absorb the debt accumulated during the pandemic. It is important to think about these two elements in conjunction, but for exposition we divide our discussion here in two parts. In this first column, we discuss the fiscal rules side; in a second column, we discuss the debt management side. The overarching theme is that for the EU to live up to its ambitions, it is necessary to rely on the capacity of the Union to act as an effective central authority that can exercise effective supervision on member states finances and, at the same time, can take advantage of its enforcement powers to create additional fiscal space for all members and use it wisely.
The main objective of a fiscal rule is to define a predictable path for public finances to ensure that investors are willing to purchase public debt, provide a reliable source of funds when the need arises, and avoid financial instability....
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