First glance

Bringing the reform of European Union fiscal rules to a successful close

EU fiscal rules must not unnecessarily restrict green investment.

Publishing date
12 December 2023
picture of a euro sign and eu country flags in the background

The long-awaited reform of the European Union fiscal framework – the set of rules designed to ensure that debt in one country doesn’t drag down the rest – seems to be heading towards agreement. EU finance ministers will squeeze in an extra meeting on 19 December to close the deal. 

But will it be a good deal? Negotiations on the reform, proposed by the European Commission in April 2023, focused initially on the so-called preventive arm of the framework. According to the Commission’s proposal, governments would be required to put public debt “on a plausibly downward path” by the end of a four to seven-year adjustment period or keep it below 60% of GDP and bring or maintain government deficits below 3% of GDP over the same period. The main dispute between countries has been whether these requirements should be complemented by ‘safeguards’ – simple quantitative rules requiring minimum debt and/or deficit reductions – and how such safeguards should be designed. 

Disagreements on these matters have narrowed. The main outstanding issue is now the framework’s excessive deficit procedure (EDP). This requires countries with deficits above 3% of GDP to reduce their deficits by at least 0.5% of GDP per year. The question is exactly how the 0.5% deficit reduction is measured. The answer is important, because almost half of EU countries might end up in the EDP next year, and because some of their deficits are expected to be large (with those of France, Italy, Belgium, Hungary, Slovakia, Malta, Poland and Romania exceeding 4% of GDP). 

One group of countries, led by France, has wanted to exclude both interest payments and green investment expenditures from the calculation of the 0.5% adjustment minimum. This would make a big difference. France’s interest payments are projected to rise by 0.2%-0.3% of GDP per year as higher interest rates push up the average cost of borrowing. Like many other EU countries, it will need to raise green public investment by 0.5% to 1% of GDP in the next few years to meet green targets. Excluding these expenditure items would cut France’s annual fiscal adjustment substantially. As a result, it would also have lengthened the time needed to reduce the deficit to less than 3%.

This rang alarm bells for another group of countries, led by Germany. They worry that diluting the EDP would endanger the ability of the new system to ensure debt declines within a reasonable period. 

The deal that might be finalised on 19 December could be based on a reported Franco-German compromise. This would lower the minimum adjustment under the EDP up to 2027, after which it would rise to the current level of 0.5%, including interest payments. It is a bad compromise because it does not tackle the core problem. 

The challenge for the EU is to satisfy two conditions simultaneously. 

First, the new framework’s debt-sustainability requirements should apply in the same way to all member states. As envisaged in the European Commission’s April proposal, the debt ratio should fall with high probability after four to seven years in all countries with debt above 60%, regardless of whether these countries are initially in the EDP or not.

Second, the timing and pace of the adjustment within the four to seven-year period should be sufficiently flexible to allow realistic annual adjustment targets and to give space to green investment. Such investment will benefit the entire EU. Because it continues to be mainly financed at national level, there is a high risk that countries will want to invest too little, rather than too much. As long as EU fiscal rules fulfil their main goal – to ensure debt sustainability – they should not constrain extra investment. But this is what the potential Franco-German compromise would do.

To achieve both objectives, member states should agree on the following on 19 December.

First, reaffirm and strengthen a rule that was part of the Commission’s April proposal, namely that the “corrective net expenditure path” under the EDP should be subject to the same debt-sustainability criteria as would be required in the preventive arm.

Second, express the annual minimum adjustment requirement under the EDP in the same units as adjustment in the preventive arm – that is, in ‘structural primary balance’ terms, which exclude interest and cyclical revenue changes. The adjustment requirement in the EDP is supposed to ensure a minimum fiscal effort. Including items that change for reasons that are mostly outside the control of governments would obfuscate the measurement of effort.

Third, exclude green investment spending from the calculation of the annual minimum adjustment effort under the EDP, provided that:

  1. The green investment programme is approved by EU countries and monitored by the Commission, and

  2. Total adjustment is high enough to bring the overall deficit below 3% and ensure a falling debt ratio, including any debt used to finance investment, after the adjustment period.

These principles would give EU members the flexibility to increase green investment temporarily to meet European Green Deal objectives without endangering fiscal sustainability. In years of high green investment, deficits could remain higher than would otherwise be permitted. Deficits might be allowed to increase in years in which investment increases, and debt might continue to rise for a few years, even in countries that are subject to the EDP. But by the end of the adjustment period, the overall deficit (including interest and investment spending) must be below 3%, and the primary balance must be high enough to meet all debt sustainability conditions.

About the authors

  • Zsolt Darvas

    Zsolt Darvas is a Senior Fellow at Bruegel and part-time Senior Research Fellow at the Corvinus University of Budapest. He joined Bruegel in 2008 as a Visiting Fellow, and became a Research Fellow in 2009 and a Senior Fellow in 2013.

    From 2005 to 2008, he was the Research Advisor of the Argenta Financial Research Group in Budapest. Before that, he worked at the research unit of the Central Bank of Hungary (1994-2005) where he served as Deputy Head.

    Zsolt holds a Ph.D. in Economics from Corvinus University of Budapest where he teaches courses in Econometrics but also at other institutions since 1994. His research interests include macroeconomics, international economics, central banking and time series analysis.

  • Jean Pisani-Ferry

    Jean Pisani-Ferry is a Senior Fellow at Bruegel, the European think tank, and a Non-Resident Senior Fellow at the Peterson Institute (Washington DC). He is also a professor of economics with Sciences Po (Paris).

    He sits on the supervisory board of the French Caisse des Dépôts and serves as non-executive chair of I4CE, the French institute for climate economics.

    Pisani-Ferry served from 2013 to 2016 as Commissioner-General of France Stratégie, the ideas lab of the French government. In 2017, he contributed to Emmanuel Macron’s presidential bid as the Director of programme and ideas of his campaign. He was from 2005 to 2013 the Founding Director of Bruegel, the Brussels-based economic think tank that he had contributed to create. Beforehand, he was Executive President of the French PM’s Council of Economic Analysis (2001-2002), Senior Economic Adviser to the French Minister of Finance (1997-2000), and Director of CEPII, the French institute for international economics (1992-1997).

    Pisani-Ferry has taught at University Paris-Dauphine, École Polytechnique, École Centrale and the Free University of Brussels. His publications include numerous books and articles on economic policy and European policy issues. He has also been an active contributor to public debates with regular columns in Le Monde and for Project Syndicate.

  • Jeromin Zettelmeyer

    Jeromin Zettelmeyer has been Director of Bruegel since September 2022. Born in Madrid in 1964, Jeromin was previously a Deputy Director of the Strategy and Policy Review Department of the International Monetary Fund (IMF). Prior to that, he was Dennis Weatherstone Senior Fellow (2019) and Senior Fellow (2016-19) at the Peterson Institute for International Economics, Director-General for Economic Policy at the German Federal Ministry for Economic Affairs and Energy (2014-16); Director of Research and Deputy Chief Economist at the European Bank for Reconstruction and Development (2008-2014), and an IMF staff member, where he worked in the Research, Western Hemisphere, and European II Departments (1994-2008).

    Jeromin holds a Ph.D. in economics from MIT (1995) and an economics degree from the University of Bonn (1990). He is a Research Fellow in the International Macroeconomics Programme of the Centre for Economic Policy Research (CEPR), and a member of the CEPR’s Research and Policy Network on European economic architecture, which he helped found. He is also a member of CESIfo. He has published widely on topics including financial crises, sovereign debt, economic growth, transition to market, and Europe’s monetary union. His recent research interests include EMU economic architecture, sovereign debt, debt and climate, and the return of economic nationalism in advanced and emerging market countries.    

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