Standards vs rules
The modification of EU fiscal rules is a subject that has been debated for a few years but it has become more prescient now that COVID-induced debt levels are so high. In this paper, Blanchard and al. suggest a modification to EU fiscal rules for when they get reinstated by the end of 2021.
What are the issues with the current rules:
- Appropriate debt limit depends on both first and second moments of the distribution of r-g. Yet, the EU rules are still based on an invariant debt target of 60% of GDP. The rules allow movements in (r-g) to have a minor effect on the speed of adjustment to the debt target but if the expenditure rule is binding, then there is no flexibility in adjusting the primary balance.
- The most the rules allow for is a suspension of the required adjustment if the output gap is large and negative or if growth is negative, never a reversal. There is no accommodation of the case where the ECB is at the effective lower bound and fiscal policy becomes the main macroeconomic tool.
Reform of the EU fiscal framework by moving from rules to standards:
An alternative approach is necessary, one that allows the EU to meaningfully constrain the fiscal policies of its member states when needed: one that looks at each case individually, taking into account country and context specificities, and comes to a judgment on whether fiscal policy needs to be adjusted.
At the highest level, the EU’s current fiscal standard “Member states shall avoid excessive government deficits” (Article 126 TFEU), could be maintained. Below that level, a guideline would explain that deficits are excessive when debt does not appear to be sustainable with high probability. An additional guideline could state that when this is the case and an adjustment is needed, deficits should be reduced in a way that balances the risks to debt sustainability with the output costs of adjustment.
The primary tool for assessing whether the fiscal standard is satisfied would be stochastic debt sustainability analysis which will generate a distribution for the debt ratio n years out, for the actual primary balance and for the debt stabilizing primary balance.
Redesigning the EU Fiscal Rules: From Rules to Standards
Authors: Olivier Blanchard, Alvaro Leandro, Jeromin Zettelmeyer
From: Peterson Institute for International Economics, CaixaBank Research, IMF
Differentiating debt reduction
Another approach put forth by the European Fiscal Board calls for the differentiation of the pace of debt reduction which would allow better tailoring to countries’ needs and capacities for those far above the Treaty reference value, while easing the monitoring of those well below it. At the same time, countries would be required to demonstrate stronger commitment to the new debt reduction paths.
Take as an example Italy’s debt reduction trajectory: the first panel of the figure below depicts the debt reduction path under the current Stability and Growth Pact. The second panel depicts the debt trajectory with differentiating reduction adjustments: in 2021 the speed of adjustment is 0.05 (i.e. 1/20) and in 2027, at the second revision of the expenditure ceiling, a slower adjustment speed of 0.04 is implemented. While the debt ratio remains on a steady downward trajectory, the required primary surplus profile appears more evenly distributed along the adjustment path.
Reforming the EU fiscal framework: Now is the time
By: Niels Thygesen, Roel Beetsma, Massimo Bordignon, Xavier Debrun, Mateusz Szczurek, Martin Larch, Matthias Busse, Mateja Gabrijelcic, Eloïse Orseau, Stefano Santacroce – European Fiscal Board, Catholic University of Milan, IMF, Polish Monistry of Finance
