The proposed new fiscal rules could represent modest steps from the status quo. But they are going in the right direction.
The European Commission has adopted a communication to the European Parliament for the upgrading of the budgetary rules associated with the economic and monetary union, suspended since 2020 due to major economic shocks. The commission’s intention is to design a “simpler, more transparent and effective framework, with greater national ownership and enforcement, while enabling strategic investments and reducing high public debt ratios in a realistic way.” , progressive and sustainable”.
The proposal is the result of lengthy negotiations and public consultations, beginning well before the pandemic and the energy crisis and involving economists, governments and other institutions. Jan Priewe reviewed the main proposals that were on the table this week in Social Europe. The next step is the discussion of the commission’s proposal by the governments of the Member States and the European Parliament.
The main objective of the new regulation is to oblige Member States to reduce public debt along a more achievable (and credible) trajectory than that set out in the Stability and Growth Pact. This prescribed a reduction in the debt-to-gross domestic product ratio by 1/20th of the amount exceeding 60% of GDP each year, keeping the “structural” budget deficit close to an esoteric threshold called the medium-term objective. (WTO). .
Involved and ineffective
The committee admits that the current pact had a strong focus on fiscal discipline rather than growth, as expressed even in the position papers of three orthodox European governments (Spain and the Netherlands jointly and Germany). She also admits that the sanctioning procedure was so complicated and inefficient that while almost every member state broke the rules at least once in the past decade, none were actually sanctioned. A simple look at the multi-tiered “pyramid” of steps needed to implement the excessive deficit procedure (in the 2019 edition of the Pact Committee’s ready review) shows why this happened. Additionally, the MTO is notorious for its volatile and incorrect guidance to national governments, helping to amplify rather than smooth the business cycle.
Thus, the committee decided to focus on a more transparent measure to assess deviations from prudent fiscal policy, the “expenditure benchmark”. This is total government expenditure net of discretionary revenue, excluding interest payments and cyclical unemployment-related expenditure. The reference makes not however exclude capital expenditures, as proposed by many stakeholders and academics.
Formally, the 1/20th debt reduction rule, the “structural” budget deficit based on the controversial “output gap” measure and the MTO thus disappear from the new European budgetary framework. The 3% ceiling for the budget deficit is maintained (as it is prescribed by the Treaty on the Functioning of the European Union) but this would be assessed over a four-year period, instead of being an annual target exposed to short-term fluctuations. disturbances.
Stable and durable
The national debt reduction plans prescribed by the new rules would then (deliberately) have the same average duration as a government, four years, and would only be revised in exceptional cases. Thus, each government would pass on a healthy fiscal position to the next. The commission proposes a unified approach (probably very similar to the current methodology) to these multi-annual programmes, although they are subject to modification by Member States in the framework of bilateral negotiations. There would be annual targets for net government spending, instead of budget deficit, consistent with projected revenue, debt reduction and GDP.
In the committee’s view, plans still need to ensure that the debt-to-GDP ratio is placed on a stable and sustainable downward path under unchanged policies, and that the budget deficit is below 3% of GDP for the next ten years. years, although with some relaxation for moderately indebted countries. Member States are classified as highly indebted (and at high risk) according to a methodology inspired by the International Monetary Fund, whose main benchmark is a debt-to-GDP ratio above 90%.
The plan can be extended over a period of seven years if the Member State undertakes to implement a program of reforms and investments recommended by the commission. Each Member State must submit an annual report on the implementation of the plan. In assessing progress, the committee would (seriously) take into account other issues included in the procedure concerning macroeconomic imbalances, such as unemployment and territorial disparities. Independent national and European fiscal councils would play a greater role in assessing deviations from the plan.
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The penalty system would also change. The excessive deficit procedure would be maintained for breaches of the 3% rule (and opened and closed mechanically for high-risk countries). Nevertheless, fines would be reduced, while a suspension of European funds (including the Recovery and Resilience Facility) and certain reputational sanctions would be introduced, such as the summoning of a Minister of State before the European Parliament .
An embittered observer might say of the new rules what a character in a novel Il Gattopardo (The Leopard) said of Italian unification: “If we want things to stay as they are, things will have to change. The “expenditure benchmark” appears to be a reformulation of the “structural” deficit benchmark, and the “potential output” replaces the controversial “output gap” to adjust fiscal policy to the economic cycle in the ten-year debt projection. The commission will likely consider some variants of the OMT when proposing and evaluating stabilization plans. Heavily indebted countries can hardly deviate from the plans designed by the commission, to avoid negative reactions on the financial markets, which is not so different from the effects of the “enhanced surveillance” envisaged by the current pact.
Discriminating between Member States according to their level of risk would be a reasonable approach if debt accounting were perfectly comparable between Member States. Yet debt measured by the Maastricht Treaty standard can offer a misleading assessment of the risk each country presents.
Consider the liabilities of public enterprises classified outside general government expenditure (notably public investment banks). According to Eurostat, in 2020 these liabilities varied as a proportion of GDP, with the conventional Maastricht debt-to-GDP ratio in brackets, thus: Greece 171% (206%), Germany 101 (68), Netherlands 89 (55) and Italy 65 (155). When the first ratio was higher than the European average, the published debt ratio would represent a comparative underestimation and vice versa.
The European Union’s average official debt was around 90% of GDP in 2020, at the threshold of high-risk designation under the new regime. But that would rise to 156% with the inclusion of these other liabilities, making Germany a high-risk country, unlike Spain, even though its public debt is 120% of GDP.
Moreover, at least two points are missing in the commission’s proposal. The first is the coordination of national policies, required by the significant repercussions of budgetary policies on European economies. Thus, the new rules could still be pro-cyclical and risk propagating recessions in the EU, as low-debt countries are still not encouraged to pursue expansionary fiscal policies.
Second, the “expenditure benchmark” implicitly continues to assume that the fiscal multiplier – the impact on national income of public expenditure – is zero: otherwise, it would be pointless to monitor expenditure without taking into account the effect on income and GDP. Yet austerity is recognized as counterproductive when the debt-to-GDP ratio multiplied by the fiscal multiplier exceeds one.
A fair view, however, is that attempting to reform the pact after 25 years is a significant achievement in itself. Another piece of good news is the recognition that fiscal consolidation is not achievable without economic growth and that imbalances other than the fiscal deficit need to be seriously considered.
The pursuit of multi-annual targets could encourage forward-looking structural policies rather than short-term legislative measures (sometimes distorted by the showmanship of public accounts). Rising reputational costs and streamlining penalties for deviations from plans provide strong incentives for governments to be accountable to citizens.
The motivation to increase public investment and implement structural reforms is still weak – retaining only a postponement of fiscal consolidation – but it is a way to focus on the quality of public spending and encourage more productive use of tax revenues. Linking European installations to the results obtained, as in the NextGenerationEU programme, is a good practice. Finally, the new proposal (almost) erases from European jargon the 1/20th rule, the output gap and the OMT.
Of course, on many points, improvements are necessary. But we are on the right track.
Enrico D’Elia is an economist who has worked, among others, for Eurostat as well as for the Ministry of Finance, the Statistical Office and the Institute of Economic Analysis of Italy. He has written over a hundred articles on macroeconomics, corporate and household behavior, inflation and economic forecasting. The opinions expressed here are entirely his own.