EU fiscal rules: An evolution rather than a revolution

The EU Commission proposes a more transparent risk-based EU fiscal surveillance framework that differentiates between countries by taking into account their public debt challenges. Under the Commission's new proposal, both the 3% deficit and 60% debt targets will remain in place, but greater flexibility is introduced to adapt fiscal adjustment paths.

The uniform 1/20th rate of debt reduction rule would be scrapped and replaced by country-tailored pathways with a four-year time horizon. The rules would be simpler and the Commission would have wider powers if Member States fail to stick to their plans. EU financing could be suspended, if countries do not take effective action to correct their excessive debts and deficits.

The proposal is a starting point for what can still be a very long process before a new set of fiscal rules are in place. At best, it could simplify the rules and make enforcement more efficient. At worst, it could include loopholes that would allow member states to escape adequate fiscal discipline as the current rulebook does.

We think the proposal is a step to a right direction, but implementation is everything for the credibility of the new rules. We do not expect the new rules to reduce risks relating to public finances any time soon. Over time, the rules can give politicians at least a better chance to bring debt to a more sustainable level.

Obvious reform needs

For years, the EU’s fiscal framework has failed to contain the rise in sovereign debt ratios, which has led to increasing debt related risks and forced the ECB to adopt a wider role as guardian of financial stability. The framework has also failed to give proper guidelines for effective fiscal policies at the national or EU level during times of crisis, and the rules have remained suspended since the outbreak of the COVID-19 pandemic in March 2020. The rulebook is complex and yet leaves too much space for interpretation. At the same time, demands on the state have increased following the pandemic and Russia’s war of aggression against Ukraine, with investments in defence or the green transition gaining prominence. In light of all this, the EU fiscal framework is in dire need of reform, and a first proposal by the European Commission was unveiled on 9 November.

The Maastricht Treaty (1992) required that EU members keep public debt below 60% and public deficits below 3% of GDP. These limits were not based on undisputed science. A higher debt ratio would not necessarily be unsustainable. The Stability and Growth Pact (1997) elaborated these rules and their enforcement mechanisms. The rules were considered necessary to avoid mutualisation of sovereign liabilities, limit the potential spillovers from a sovereign debt crisis to the banking system, and to allow for fiscal policy flexibility during times of economic crisis. Without fiscal rules and limits, independence of the ECB would also be at risk. All these targets have been missed in one way or the other. Yet, rules are still needed for the EU to function effectively, as a union that brings together a variety of different economies and ideas of good economic policies.

Download The Full Macro Notes