EU fiscal rules: Time for a reboot

Policy Study

The EU fiscal rules are one of, if not the most discussed aspects of EU economic policymaking. With the impact of COVID-19 and the impending climate catastrophe, it is almost unanimously agreed that they are in need of reform. Midst the pandemic, fiscal rules have been suspended thanks to the General Escape Clause, state aid has been temporarily permitted, and joint borrowing was framed within the NextGenEU: the EU put in place a series of unprecedented measures in Europe’s history, but for the moment no change to the treaties took place, just interim measures.

The EU’s regime of fiscal governance, enshrined in the Stability and Growth Pact and the Fiscal Compact, is perhaps the strictest of any region in the developed world.

This policy study by Robert Sweeney and Rosa Canelli aims to assess what reforms can be made to ensure the sustainability of public finances across the EU, and prevent sovereign debt stress by following several guiding rules:

• Ensuring the sustainability of public finances across member states and preventing sovereign debt stress
• Facilitating Europe’s public investment challenges, especially in relation to climate change
• Preventing macroeconomic policy from magnifying inequalities within or between countries

Any reforms proposed should be politically feasible.

Tailoring the debt-reduction path to country-specific circumstances, as advanced by the EU Commission, is a positive step forward but remains insufficient to tackle the high debt and investment needs of some countries. An empirical analysis presented in this study shows how looking at debt servicing rather than at debt levels is a better predictor for public debt sustainability; consequently, the authors recommend replacing fiscal rules with fiscal standards focused on debt servicing. Furthermore, a series of other reforms are put forward to correct the sub-optimal investment level affecting Europe:

1. Focus on observable variables, for which the ESM proposal of 100% debt-to-GDP is identified as a valid option
2. Consider more thoroughly debt maturity profile and composition
3. Move from structural deficit target to an expenditure benchmark
4. Revise the calculation of potential outputs
5. Establish a permanent climate investment fund, by building on the NextGenEU architecture