Opinion

Europe must fix its fiscal rules

The pandemic has shown that the EU’s spending framework reflects an outdated economic orthodoxy.

By: Date: May 27, 2021 Topic: European Macroeconomics & Governance

This opinion piece was originally published in the Financial Times, the Money Review section of Kathemerini and is forthcoming in El Economista.

Last spring, as the economic impact of the coronavirus pandemic began to bite, the European Commission suspended the stability and growth pact (SGP), a set of rules designed to ensure that countries in the EU pursue sound public finances and co-ordinate their fiscal policies.

And in March this year, the commission signalled that the rules would remain suspended for a further year in 2022. Paolo Gentiloni, the EU’s economics commissioner, said that where fiscal policy is concerned, “the risks of doing too little outweigh the risks of doing too much”.

The suspension of the fiscal rules due to the pandemic provides a welcome opportunity to rethink them. Most observers agree both that the rules have not been properly applied since the SGP came into force in 1998, and that in any case they are flawed.

Reform is needed, therefore, but the direction this should take requires that we first understand the role that fiscal policy has in the economy.

When it was first built, the EU framework was intended to prevent fiscal indiscipline by member states and to stop it spreading across the eurozone. Its design reflected the prevailing economic orthodoxy in the 1990s on the role of fiscal policy.

This emphasised automatic adjustments in tax revenues and spending to stabilise income, consumption and business activity over the business cycle. Any fiscal policy that attempted to go beyond these “automatic stabilisers” was likely to cause inflation. Consequently politicians, who have an incentive to overspend, ought to be institutionally constrained.

Today, however, after a global financial crisis and now a global pandemic, two “once-in-a-lifetime” shocks in the space of just over a decade, the economic context is very different.

Both these episodes show that fiscal policy is about more than just automatic stabilisation, although at first policymakers in Europe were slow to recognise this — partly because of the grip exerted by the old orthodoxies, but mostly because of the fear of fiscal spillovers across borders.

In each case the policy response, at the macro level, had to be sufficient to cushion the severity of an economic shock.

During the pandemic, fiscal policy has had to maintain demand when markets failed by protecting companies, as well as employment and households. The response to the crisis was both timely and on a sufficiently large scale, aided by the European Central Bank’s asset purchase programme which kept the cost of borrowing low.

More active fiscal policy also has implications for co-ordination between countries, which can no longer solely be about constraining public spending. We need to find a different way to deal with the alleged threat of spillovers.

Indeed, things have already shifted in this respect. The EU’s no-bail out clause — which stipulates that no member state is liable for the financial commitments of another — has effectively been replaced by the European Stability Mechanism as the lender-of-last resort for countries that are cut out of markets.

The issuing of common debt under the auspices of the EU’s post-pandemic recovery fund to provide transfers to countries hit hardest during the pandemic is a reflection of the idea that risk-sharing is a necessary ingredient of “insurance”.

Although intended as a one-off tool, this pooling of risks to issue common debt might have to be used again in the future to protect the single currency. More explicit co-ordination of policy along these lines is something EU member states will have to discuss.

Finally, it is now clear that fiscal policy will have a pivotal role to play in promoting the EU’s long-term climate and digitisation goals. Public funds will be essential to the public-private investments needed to transform our economies and place them on a more sustainable footing. Rules that do not differentiate between investment and expenditure are no longer fit for purpose.

But we do not start with a clean slate. The past 12 years have left countries with large debts. Debt sustainability will therefore need to be a core concern of policymakers. On the other hand, persistently low interest rates will help to keep financing costs for countries down.

Commitments to public investment for the green and digital transformation and insurance against common shocks should be enshrined at the EU level. By increasing our common fiscal responsibilities, we limit the scope for indiscipline at the national level and so reduce the risk of negative spillovers across the bloc.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic More by this author
 

Opinion

For remote work to work, new ground rules are needed

The pandemic has shown workers and employers that another way to work is possible. The European Union should develop a framework to facilitate hybrid work.

By: Mario Mariniello Topic: Innovation & Competition Policy Date: September 23, 2021
Read article More on this topic
 

External Publication

EU-India trade relations: assessment and perspectives

In-depth analysis prepared for the European Parliament's Committee on International Trade (INTA).

By: Suman Bery, Sonali Chowdhry, Alicia García-Herrero and Niclas Poitiers Topic: Global Economics & Governance Date: September 10, 2021
Read article Download PDF More on this topic
 

Policy Contribution

A green fiscal pact: climate investment in times of budget consolidation

Increasing green public investment while consolidating deficits will be a central challenge of this decade. A green fiscal pact would address this tension, but difficult trade-offs remain.

By: Zsolt Darvas and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: September 9, 2021
Read about event More on this topic
 

Past Event

Past Event

Conference on the Future of Europe: envisioning EU citizens engagement

Bruegel Annual Meetings, Day 3 - Panellists will discuss different options and what they may entail while revisiting the debates on the future of Europe at national and EU-level that have been conducted thus far.

Speakers: Caroline de Gruyter, Kalypso Nicolaïdis, Niclas Poitiers and György Szapáry Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1 Date: September 3, 2021
Read article
 

Blog Post

Will European Union recovery spending be enough to fill digital investment gaps?

The recovery facility will boost digital transformation, but questions remain whether it will be sufficient to achieve Europe’s digital ambitions.

By: Zsolt Darvas, J. Scott Marcus and Alkiviadis Tzaras Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 20, 2021
Read article More on this topic
 

Opinion

Increasing the global supply of essential medical supplies: Time for Europe to step up its global leadership

Europe has already made a significant financial contribution to beating the pandemic, now it has the opportunity and moral responsibility to do more.

By: Anne Bucher and Guntram B. Wolff Topic: Global Economics & Governance Date: July 19, 2021
Read article Download PDF
 

External Publication

Building the Road to Greener Pastures

How the G20 can support the recovery with sustainable local infrastructure investment.

By: Mia Hoffmann, Ben McWilliams and Niclas Poitiers Topic: Global Economics & Governance, Testimonies Date: July 15, 2021
Read article Download PDF
 

Policy Contribution

A new direction for the European Union’s half-hearted semiconductor strategy

The EU needs a more targeted strategy to increase its presence in this strategic and thriving sector, building on its existing strengths, while accommodating its relatively low domestic needs.

By: Niclas Poitiers and Pauline Weil Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 15, 2021
Read about event
 

Past Event

Past Event

Financing for Pandemic Preparedness and Response

How can we better prepare for future pandemics? In this event, co-hosted by the Center for Global Development and Bruegel think tanks, speakers will present "A Global Deal for Our Pandemic Age", a report of the G20 High Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response.

Speakers: Masood Ahmed, Victor J. Dzau, Amanda Glassman and Lawrence H. Summers Topic: Finance & Financial Regulation, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 14, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

What should public spending look like?

What should we do about the increase in public spending due to COVID-19? Bruegel Director Guntram Wolff and Former Deputy Secretary-General of OECD Ludger Schuknecht discuss.

By: The Sound of Economics Topic: Global Economics & Governance Date: July 14, 2021
Read article More on this topic
 

Blog Post

Fair vaccine access is a goal Europe cannot afford to miss – July update

European countries must do more to tackle the vaccine uptake gap. Vaccination data should be published at the maximum granularity level so researchers and local decision-makers can monitor progress.

By: Lionel Guetta-Jeanrenaud and Mario Mariniello Topic: European Macroeconomics & Governance Date: July 14, 2021
Read article More on this topic
 

External Publication

A Global Deal for Our Pandemic Age

Report of the G20 High Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response.

By: Tharman Shanmugaratnam, Lawrence H. Summers, Ngozi Okonjo-Iweala, Ana Botin, Mohamed El-Erian, Jacob Frenkel, Rebeca Grynspan, Naoko Ishii, Michael Kremer, Kiran Mazumdar-Shaw, Luis Alberto Moreno, Lucrezia Reichlin, John-Arne Røttingen, Vera Songwe, Mark Suzman, Tidjane Thiam, Jean-Claude Trichet, Ngaire Woods, ZHU Min, Masood Ahmed, Guntram B. Wolff, Victor J. Dzau and Jeremy Farrar Topic: Global Economics & Governance Date: July 9, 2021
Load more posts