## Future of Fiscal Rules in the Euro Area

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**Canonical URL:** [Future of Fiscal Rules in the Euro Area](https://www.imf.org/-/media/files/news/speech/2020/f-vitor-gaspareabrusselsfiscal-rules.pdf)

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### Why fiscal rules?
- Rationale: address "Debt Bias" as shown by rising General Government Debt relative to interest rate-growth differentials in the Euro Area and advanced economies.
- Historical context: key milestones include 1989 Delors’ Report; 1992 Maastricht Treaty; 1997 Stability and Growth Pact; 1998 Preventive Arm; 1999 Corrective Arm; 2005 Structural Balance; 2010 First European Semester; 2011 Six Pack; 2012 Fiscal Compact; 2013 Two-pack; 2015 Communication Flexibility.
- Observed outcomes:
  - Recurrent sovereign debt crises in the Euro Area evidenced by volatility in 10-year Government Bond Yields.
  - Poor compliance with multiple rules (Deficit rule, Debt rule, Medium-Term Objective rule, Fiscal effort rule) across euro area countries, with assessments illustrated in Eyraud, Gaspar, and Poghosyan (2017).
  - Fiscal balance distributions indicate that rules act as an effective pulling force (Caselli and Wingender (2018)).

### What have we learned over 30 years?
- Complexity and layering: the EU fiscal rules have evolved into "Layers over Layers of Complexity" through successive additions to the framework.
- Cyclicality:
  - Euro Area fiscal policies are "Mostly Procyclical" with procyclical observations at 30% and 29% in two cited series, and countercyclical observations at 23% and 18% in two cited series (source: IMF WEO; Andrle and others (2015)).
  - Relationship illustrated between change in General Government Structural primary balance and Output gap (percent of potential GDP).
- Macroeconomic environment:
  - Weak and fragile recovery in industrial production compared historically (sources: Eichengreen and O'Rourke (2010), League of Nations Statistical Yearbooks, Federal Reserve Bank of St. Louis, Haver Analytics, IFS, IMF staff estimates).
  - Divergence within the Euro Area: examples shown for Italy vs. Germany in Real GDP per Capita in PPP (1999=100).
  - Declining public investment: Public Investments (in percent of GDP) show declines for United States and Euro Area (source: IMF WEO).
  - Increasing debt and declining general government net worth: Euro Area General Government Net Worth (in percent of GDP) and Changes in General Government Net Worth and Gross Debt, 2000-16 (IMF Public Sector Balance Sheet Database).
- Long-run liabilities and interest rates:
  - Low nominal interest rates and instances of negative nominal interest rates across advanced economies (chart series, December 27, 2007 and December 27, 2019).
  - Interest rate-growth differentials in advanced economies documented (Jing and Mauro (2019)).
  - Future pension and health spending pressures summarized as Net Present Value of Pension Spending Change, 2018–50 and Net Present Value of Health Spending Change, 2018–50 (national authorities; IMF staff estimates and projections).

### What are the policy options?
- Strengthening Euro Area architecture:
  - Complete Banking Union.
  - Advance Capital Markets Union.
  - Establish a Central Fiscal Capacity.
- Improving the fiscal framework:
  - Consolidate the Preventive and Corrective Arms.
  - Shift to a Single Fiscal Anchor (public debt) and a Single Operational Target (nominal spending target).
  - Consider the intertemporal implications of population dynamics, and green and digital transformations in rule design.
- Institutional reforms:
  - Reinforce the role of independent fiscal institutions:
    - Strengthened system of independent national fiscal councils.
    - An independent European Fiscal Board at the center of the network.
  - Enhance fiscal information and measurement:
    - Better information based on accrual accounting and the PSBS approach.
- Technical considerations on debt anchor:
  - Given the debt dynamics equation presented, lower interest rates do not necessarily create more fiscal space if headline balances (primary balance) do not adjust accordingly.
  - The relationship between interest rate savings and headline balance improvements is highlighted in the slide on "Shifting to a Single Fiscal Anchor—Public Debt."

### Conclusions and recommendations
- Priority structural reforms: completion of Banking Union, Capital Markets Union, and creation of a Central Fiscal Capacity.
- Monetary policy: review of the ECB’s monetary policy strategy is timely.
- Fiscal rules simplification: ample room to simplify euro area fiscal rules by using a single debt anchor and a single operational (nominal) spending target.
- Measurement and governance:
  - Move toward better accrual-based information and public sector balance sheet (PSBS) approaches.
  - Reinforce a system of independent national fiscal councils with an independent European Fiscal Board at its center.

*Vitor Gaspar, "Future of Fiscal Rules in the Euro Area", Workshop on “Fiscal Rules in Europe: Design and Enforcement”, DG ECFIN, Brussels, January 28, 2020.*

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_Source: https://www.imf.org/-/media/files/news/speech/2020/f-vitor-gaspareabrusselsfiscal-rules.pdf_