Bruegel's Darvas: Fiscal rule legislative proposal: what has changed, what has not, what is unclear?

05 May 2023

The proposed new fiscal rules constitute a major improvement from the current fiscal framework but missed an opportunity to foster green investment.

The main gist of the European Commission’s economic governance reform proposal is to create a conceptually new system focusing on debt sustainability (Blanchard et al, 2021) and a single operational indicator, which is a measure of public expenditure growth. This would replace the current unfavourable system of fiscal rules (Caleys et al, 2016). Many similar reforms were proposed years ago (Darvas et al, 2018). Further attractive features of the European Commission’s proposal are the integration of fiscal and macroeconomic imbalance surveillance, the requirement for comprehensive national fiscal-structural plans and the requirement for making all relevant documents publicly available. The main conceptual basis and the boldness of the proposal are welcome.

Ashes and relics of past rules

The one-twentieth debt reduction rule (reducing the debt ratio by the one-twentieth of the excess over the 60 percent criterion annually) and the medium-term objective (MTO) requirements for the structural budget balance (actual budget balance cleaned from the impacts of cyclical and one-off effects) have been proposed to be removed from the fiscal framework. This is good news. The one-twentieth rule could require excessive fiscal adjustment in some cases and this rule was anyway disregarded when Belgium and Italy repeatedly violated it. The structural balance is a very unreliable indicator (Darvas, 2021).

The EU Treaty-based 3 percent of GDP deficit criterion and the requirement to reduce the debt ratio when it is over 60 percent of GDP remain.

New fiscal requirements

The main new requirement is that the net expenditure path set by the national fiscal-structural plan should ensure that the public debt ratio is on a “plausibly downward path” when it is about 60 percent. When it is below 60 percent, it should remain at “prudent levels”. The plausibility assessment checks if the debt ratio is declining in a deterministic projection and if there is a “sufficiently low” probability (numerical value not stated) that it will not decline according to a stochastic analysis.

There are three additional requirements for all countries:

• The 3 percent deficit criterion must be met under unchanged policies over a period of ten years after the adjustment period (which could last from four to seven years).
• No backloading: the average annual adjustment over the “period of the national medium-term fiscal structural plan” should not be lower than the average over the “entire adjustment period”.
• Reduced debt ratio: the debt ratio at the end of the “planning horizon” must be smaller than before the period began...

 

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