European Fiscal Governance: A Proposal from the IMF
IMF Blog, September 5, 2022
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- Authors: Vitor Gaspar, Alfred Kammer, Ceyla Pazarbasioglu
- Published: September 5, 2022
Context and rationale
- High debt and rising interest rates increase the premium on improved governance to anchor fiscal policy in EU member states.
- Fiscal policy is essential for supporting households and firms after large shocks (for example, the pandemic) and when monetary policy is constrained.
- The EU needs revamped fiscal rules that:
- have flexibility for bold and swift policies when needed, and
- do not endanger the sustainability of public finances.
- Building greater fiscal buffers in normal times is critical to avoid debt crises that could destabilize the monetary union and put the EU at risk.
- The general escape clause was triggered in March 2020, enabling temporary deviation from EU fiscal rules; its extension through 2023 provides a window for reform.
Diagnosis: shortcomings of the existing framework
- The existing rules increased public awareness that fiscal deficits should be below 3 percent of gross domestic product, improving government accountability on deficits.
- Despite refinements, the framework has not prevented an undesirable buildup of public debt and fiscal sustainability risks among some members; many countries now have debt levels above the Maastricht Treaty reference value of 60 percent of GDP.
- Contributing factors:
- Weak national institutions and political pressures.
- Large negative shocks.
- Design limitations of the framework—ceilings on deficits in bad times without sufficient incentives to build buffers in good times.
- Poor performance at stabilizing output and lack of tools to provide common public goods for member countries.
The IMF proposal: three interconnected pillars
- Risk-based EU-level fiscal rules
- The 3 percent deficit and 60 percent debt reference values remain.
- The speed and ambition of fiscal adjustments would be linked to the degree of fiscal risks, identified by debt sustainability analysis using a common methodology.
- A new and independent European Fiscal Council (EFC) would develop the methodology in consultation with other stakeholders.
- Countries with greater fiscal risks would need to converge to a zero or positive overall fiscal balance over the next three to five years.
- Countries with lower fiscal risks and debt below 60 percent would have more flexibility but still must consider risks in their plans.
- The framework would incentivize buildup of fiscal buffers and allow significant flexibility to respond to adverse shocks and conduct countercyclical policy.
- Strengthened national fiscal institutions
- All EU countries would enact medium-term fiscal frameworks and set multi-year annual spending caps consistent with their overall balance anchor over the period.
- Independent national fiscal councils would play a stronger role, including:
- making or endorsing macroeconomic projections,
- assessing fiscal risks, and
- ensuring consistency of expenditure ceilings and fiscal plans.
- The European Commission would continue key surveillance responsibilities.
- The EFC would serve as the central node for a network of national fiscal councils, promote good practices, and provide an independent voice on debt risks and framework execution.
- A well-designed EU fiscal capacity
- Would serve two key roles:
- improving macroeconomic stabilization, especially when monetary policy is operating at the effective lower bound, and
- allowing provision of common public goods at the EU level, such as climate change and energy security infrastructure.
- A dedicated climate investment fund is an important part of the proposal.
- Delivering these roles is urgent due to the green transition and common security concerns.
Implementation and political economy
- The proposal is a package of interlinked elements requiring:
- a mutually reinforcing relationship between EU rules and national implementation,
- greater domestic ownership of the rules, and
- better alignment between country frameworks and EU rules.
- The risk-based approach balances member countries’ needs with safeguarding them from negative spillovers; stronger national frameworks and enhanced independent fiscal institutions are necessary to achieve this balance.
Policy urgency and timing
- Amid extraordinary economic uncertainty and fiscal challenges, reform cannot wait.
- The extension of the general escape clause through 2023 provides a window of opportunity; further delays would force countries to revert to the old rules with their existing problems.
Vitor Gaspar, Alfred Kammer, Ceyla Pazarbasioglu, September 5, 2022 — European Fiscal Governance: A Proposal from the IMF