Download publication

External Publication

Simple Rules for Better Fiscal Policies in Europe

Proposals to reform the euro area are on the agenda again. An overhaul of the complex set of European fiscal rules should be top priority on this agenda because the fiscal framework in place suffers from clearly identified problems: rules are complex (therefore difficult to internalise for policymakers), pro-cyclical (therefore potentially destabilising), and noncompliance is the norm (therefore not credible).

By: , , , , and Date: September 24, 2019 Topic: European Macroeconomics & Governance

Either because countries did not abide by the rules or because the rules were not sufficiently stringent during good years, there was insufficient debt reduction in many countries in the 2000s, and this reduced fiscal capacity during bad years. Consequently, several countries experienced excessive fiscal austerity during the crisis, contributing to the aggravation and prolonging of its consequences. A major drawback of these rules lies in measurement problems. The structural budget balance (the budget balance cleaned from the impact of the economic cycle and one-time budget measures like bank rescue costs), which is the cornerstone of current rules, is a useful theoretical concept but it is not observable and its estimation is subject to massive errors. The typical annual revision in the change of the structural balance is larger than half a percent of GDP, while half a percent of GDP is the baseline fiscal adjustment requirement for countries in breach of EU fiscal rules. Alone, such huge revisions highlight that this indicator is not suitable for policymaking.

The policy mistakes generated by the fiscal rules also led to overburdening the ECB as the main remaining stabilisation instrument. The fiscal framework has also put the European Commission in the difficult position of enforcing a highly complex, nontransparent, and error-prone system, exposing it to criticism from countries with both stronger and weaker fiscal fundamentals. The rules are used as a scapegoat by anti-European populists because they are seen as a centralised micro-management that infringes on national sovereignty.

However, in a monetary union like the euro area, arguments exist to justify the existence of fiscal rules and the adoption of a common framework. A specific issue in a monetary union is that governments may not fully internalise the risk of accumulating public debt. The reason is that they (and markets) may expect a bailout in case of difficulties to finance themselves. Indeed, a debt restructuring event accompanied by exit risk may generate financial disruption, contagion to other countries, and collateral damage so large that other members of the eurozone prefer a bailout. This implies that the no bailout rule is not fully credible in the eurozone (see Gourinchas, Martin, and Messer 2019) and this itself is a reason why a fiscal rule that binds all members of the monetary union is necessary.

In addition, expected bailouts may also have reduced market discipline in the sense that the cost of borrowing for some countries may have been too low in the period before the crisis. This may also have reduced the incentive for fiscal prudence, as was the case in Greece in the 2000s. Note, therefore, that debt sustainability, not public deficit per se, should be the core objective in the EMU. Note also that macroprudential rules that limit the vulnerability of financial institutions are a necessary complement to fiscal rules, as we have seen (for example in Ireland and Spain) that bank debts can rapidly be transformed into public debts.

Finally, because countries in a monetary union loose the monetary instrument to stabilise the economy against asymmetric shocks, the fiscal instrument is a key countercyclical policy tool. Hence, fiscal rules in the EMU, more than in countries with independent monetary policy, must play a countercyclical role. However, fiscal rules are not a silver bullet and cannot substitute the national democratic debate on fiscal choices and debt sustainability. Instead, they should help frame this debate. In particular, it is important that fiscal rules do not impose a low or high permanent level of public spending, or a low or high permanent level of taxation. This should be left to the democratic debate. However, the fiscal rules should be such that the levels of public spending and taxation are consistent and generate a sustainable level of public debt. If we agree on the necessity to change the rules, how should this be done?

Read about event More on this topic
 

Upcoming Event

Apr
13
13:00

An alpine divide? Comparing economic cultures in Germany and Italy

A discussion of Italian and German macro-economic cultures and performances.

Speakers: Thomas Mayer, Patricia Mosser, Marianne Nessén, Hiroshi Nakaso, Francesco Papadia, André Sapir and Jean-Claude Trichet Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Past Event

Past Event

Presentation of the Euro Yearbook 2021

Join us for the launch of the eighth edition of the 'Euro Yearbook'

Speakers: Maria Demertzis, Fernando Fernández, Fiona Maharg-Bravo, Antonio Roldán and Jorge Yzaguirre Topic: European Macroeconomics & Governance Date: March 12, 2021
Read article Download PDF More on this topic More by this author
 

External Publication

When and how to unwind COVID support measures to the banking system?

Study of regulatory measures and supervisory practices that have supported public guarantee schemes and moratoria in euro-area countries prepared for the ECON committee of the European Parliament.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: March 9, 2021
Read article Download PDF More by this author
 

Parliamentary Testimony

European Parliament

Euro area accession countries in the context of the pandemic

Testimony before the European Parliament on the subject of euro area accession.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 19, 2020
Read article More on this topic
 

Opinion

Politics, not economics, demands a strengthened international role for the euro

Not just the EU but also other countries, particularly China, need a defence against weaponisation of the dollar.

By: Alicia García-Herrero and Federico Steinberg Topic: European Macroeconomics & Governance Date: October 28, 2020
Read article Download PDF More by this author
 

Parliamentary Testimony

European Parliament

Strengthening the international role of the euro

Testimony before the European Parliament on the International Role of the Euro.

By: Guntram B. Wolff Topic: European Parliament, Testimonies Date: October 1, 2020
Read about event More on this topic
 

Past Event

Past Event

The Euro area after COVID-19 - a conversation with Mario Centeno

At this event we will welcome Mario Centeno to talk about his time as President of the Eurogroup and reflect on the future of the Euro area.

Speakers: Mário Centeno and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 1, 2020
Read article
 

Podcast

Podcast

Will COVID-19 boost the euro as a global currency?

The euro is, by definition an international currency. However, since being established in the late 90s the single currency has always been somewhat less than the sum of it's parts and has yet to challenge the US dollar for global dominance. Its international status declined with the euro crisis of 2008. 

By: The Sound of Economics and Bruegel Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 8, 2020
Read about event More on this topic
 

Past Event

Past Event

The Covid Crisis and European State Aid Rules: The Case for a Rational Approach

Considering a new approach to find the way out of the Great Financial Crisis.

Topic: European Macroeconomics & Governance Date: May 27, 2020
Read article More on this topic More by this author
 

Blog Post

Banking regulation in the Euro Area: Germany is different

Despite progress in recent years towards a single banking policy framework in the euro area – a banking union – much of the German banking system has remained partly sheltered from uniform rules and disciplines that now apply to nearly all the area’s other banks. The resulting differences in regulatory regimes could generate vulnerabilities in the still-incomplete banking union, which is being tested in the context of the COVID-19 pandemic.

By: Nicolas Véron Topic: European Macroeconomics & Governance Date: May 7, 2020
Read article More on this topic
 

Opinion

A European approach to fund the coronavirus cost is in the interest of all

We had not seen a common challenge as clear as this pandemic. The sum of national actions and programs is likely to be insufficient.

By: Agnès Bénassy-Quéré, Arnoud Boot, Elena Carletti, Jan Pieter Krahnen, Miguel Otero-Iglesias, Lucrezia Reichlin, Dirk Schoenmaker, Guntram B. Wolff and Bruegel Topic: European Macroeconomics & Governance Date: April 6, 2020
Read article Download PDF More on this topic
 

External Publication

Facing the lower bound: what will the ECB do in the next recession?

In responding to the global financial crisis, the ECB has pushed its monetary policy into unchartered territories . Today, it appears increasingly constrained by persistently low interest rates. This paper seeks to understand this challenge and assess whether its toolkit would allow the ECB to weather a European recession.

By: Aliénor Cameron, Grégory Claeys and Maria Demertzis Topic: European Macroeconomics & Governance Date: March 27, 2020
Load more posts