Policy brief

European fiscal rules require a major overhaul

In this Policy Contribution prepared for the French Conseil d’Analyse Économique, the authors assess current European fiscal rules and propose a major

Publishing date
24 October 2018

This Policy Contribution was prepared for the French Conseil d’Analyse Économique.

The reconsideration of the complex set of European fiscal rules should be a priority in terms of euro-area reform. The rules contributed to excessive fiscal austerity during the crisis, thus helping to aggravate and prolong its economic, social and political consequences. Moreover, either because countries did not abide by the rules or because the rules were not sufficiently strictly applied during good years, there was insufficient debt reduction in many countries in the 2000s, which reduced their fiscal capacity during bad years. In addition, the rules suffered from large measurement problems. They are based on a valid theoretical concept – the structural budget balance – but this is not observable and its estimation is subject to massive errors.

The post-2010 pro-cyclical fiscal tightening caused by the fiscal rules also led to the European Central Bank becoming overburdened as the main remaining stabilisation instrument. The fiscal framework has also put the European Commission in the difficult position of enforcing a highly complex, non-transparent and error-prone system, exposing the Commission 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 manifestation of centralised micro-management which infringes on national sovereignty.

However, fiscal rules to ensure debt sustainability in the euro area are a necessity because the no-bail-out clause in case of fiscal crises is not credible in a monetary union. The fiscal rules need a major overhaul. They are not a silver bullet and cannot be substituted for the national democratic debate on fiscal choices and debt sustainability, but should help frame this debate. They should be as transparent and simple as possible, should set targets under the direct control of the government, should allow countercyclical fiscal policy and should incentivise the reduction of excessive public debt.

This Policy Contribution assesses the current framework and proposes a major simplification. We recommend substituting the numerous and complex rules with a simple new rule: nominal expenditures should not grow faster than long-term nominal income, and they should grow at a slower pace in countries with excessive debt levels. Our simulations suggest that this rule would help reconcile fiscal prudence and macroeconomic stabilisation of the economy. We set out a national and European institutional framework that could implement such a rule. We advocate the credible enforcement of fiscal rules, mixing several instruments pertaining to surveillance, positive incentives, market discipline and increased political cost of non-compliance.

Finally, one example of a country in which the national fiscal framework could be improved is France: we recommend the better integration of the French independent fiscal council (Haut-Conseil des finances publiques) into the national budget process by broadening its mandate to include endorsement of fiscal forecasts and debt sustainability analysis, by increasing its capacity to independently produce fiscal and macroeconomic forecasts.

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.

  • Philippe Martin

    Philippe Martin is Professor of Economics at Sciences Po in Paris. He currently serves as the head of the Department of Economics at Sciences Po and is a research fellow at the London-based CEPR (Centre for Economic Policy Research). He previously taught at the University of Paris 1 Pantheon-Sorbonne and the Paris School of Economics. From 2001 to 2002, he served as an economist at the Federal Reserve Bank of New York.

    Martin's research focuses on international trade and macroeconomics, in addition to economic geography. In 2002, he was awarded the Prix du meilleur jeune économiste de France, a prize awarded yearly to a French economist under forty years of age "who has combined recognized expertise with an active participation to the public debate," along with Thomas Piketty.

    He also works as a columnist for the French daily Libération.

  • Xavier Ragot

    Xavier Ragot, a researcher at the CNRS-PSE, is the president of the French Economic Observatory  (the economic research centre of Sciences Po. He is a member of the Economic Analysis Council and the National Economic Committee. Now an Associate Professor at the Paris School of Economics, he carried out a dissertation at the School for Advanced Studies in the Social Sciences and a post-doc at the Massachusetts Institute of Technology after his studies at University of Paris 10.
    He was previously an Economist at the Bank of France. From 2012 to 2013 he was an Economic Advisor at the Ministry of Industry.
    His research focuses mainly on monetary and financial macroeconomic questions.He has been published in French and international economic journals such as the Journal of Economic Theory, Economic Journal, Journal of Monetary Economics, la Revue Economique, European Economic Review et Annales d’Economie et de Statistique.

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