The European Commission’s April proposal for reforming the EU’s fiscal rules seems to be inching towards a political agreement in the Council. Spain proposed a ‘landing zone’ for the negotiations earlier this month, reflecting similar recommendations we made in September on how to improve the proposal. This includes giving more substance to the ‘no backloading’ condition that is supposed to prevent countries from postponing adjustment as well as a ‘debt safeguard’ which requires a fall in the debt ratio to the length of the four-to-seven-year adjustment period rather than mechanically to the first four years. The creation of a dedicated working group that reviews the debt sustainability analysis (DSA) used by the European Commission is also proposed, as well as to make the DSA fully transparent. This is an encouraging development.
The proposal also gives something to all sides. Italy would get flexibility to exempt 2025-26 spending related to the recovery and resilience fund from the tougher ‘no-backloading condition’. Poland would get explicit recognition of defence spending as a ‘relevant factor’ when triggering an excessive deficit procedure (EDP). Germany and other fiscally conservative members would get two additional safeguards: a new minimum debt reduction requirement after the adjustment period, and a requirement for countries to reduce their deficits by a yet-to-be specified ‘safety margin’ below the 3% of GDP benchmark.
There are however three remaining concerns.
The first is that the additional safeguards might undermine the main purpose of the reform, which is to tailor fiscal adjustment to the debt risks of each member. Requiring significantly more adjustment than what can be justified by the DSA will undermine country ‘ownership’ of the adjustment. This worry could be addressed by calibrating the proposed safeguards so that they are not normally binding. Safeguards should be like guardrails that keep a car on the road if it swerves, not planks that narrow the road.
A second concern is that the negotiations seem to converge toward considering the commitments of the Recovery and Resilience Plans sufficient to fulfil the conditions of the extension in the first round of medium-term fiscal-structural plans. But the logic of offering an extension of the adjustment period from four-to-seven-year is to offer incentives for additional investment and reform efforts. Recovery and Resilience Plan (RRPs) reforms have already been agreed and financed through the EU’s Recovery and Resilience Facility. Furthermore, reforms and investment under the RRPs must be completed by August 2026, just two years into the initial seven year adjustment period. The three-year extension should therefore be contingent on convincing reforms and/or investment plans beyond the current RRPs.
The final concern is that the proposed rules are not green enough. This relates to the design of the debt and no-backloading safeguards, which could prevent debt-financed investment spending even when the latter is fully consistent with debt sustainability. Consider, for example, a 1% of GDP per year increase in investment, under an EU-endorsed programme that lasts for seven years, accompanied by a steady fiscal adjustment (say by 0.5% of GDP per year) involving reductions in current spending and/or revenue increases. After seven years, the investment programme ends, the fiscal position is in surplus and debt would fall rapidly. Nonetheless, because debt has increased in the meantime to finance the investment, this plan would be rejected under the new rules. This makes no sense.
The fiscal rules reform may be moving towards a political ending. Whether this will be a satisfactory ending or a return to a blend of overlapping targets and restrictions, many of which without basis in economics, will depend on how the proposed safeguards are quantified. And in the green investment area, the proposal that is on the table should be more ambitious. The proposal should offer incentives for investment beyond what is already financed by the RRFs and EU endorsed green investment should be exempted from the safeguards.
About the Author
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.