The pandemic seems to be, for the moment anyway, under control and with it the exceptionality that has marked economic policy in recent years. In the European Union, this return to normality has resulted in positive interest rates for the German 10-year bond for the first time since 2019. It has also brought an end to the fiscal free-for-all that has permitted record public deficit in the Eurozone and increases of more than 20 percentage points in public debt. It now seems clear that European tax rules – the Stability and Growth Pact – will be applied again next year and the debate on the need to amend them is already underway.
It is reassuring that Spain is keeping abreast of this debate, although the interesting contribution made more than informally by a group of economists under the auspices of the Elcano Royal Institute is, in my opinion, flawed by a series of errors that refer to the justification of the reform and to its specific content.
Long before the financial crash 12 years ago, technical consensus has been widespread on the need to reform the Eurozone’s fiscal governance framework. Current rules are not transparent and are overly complex. They are subject to discretionary, politically controversial application, are pro-cyclical, and have no real clout in preventing reckless budgetary behavior in years of prosperity. However, the authors have succumbed to the temptation to justify their approach with the need for a more dynamic fiscal policy, greater public interventionism in the economy, a brave new world of zero inflation, and secularly rock-bottom interest rates. This supposedly new post-Covid neo-Keynesian macroeconomic orthodoxy does not sit well with an overheated European economy with inflation at a twenty-year high and market interest rates on the rise.
Public investment has not fallen in Europe because of strict fiscal rules, but because of the funding constraints that mark every recession. This is a well-established stylized fact in every financial, fiscal, exchange rate, and balance of payments crisis. Unless, of course, central banks resort to debt monetization. This is a crucial issue because the elimination of restraints on public spending that this new governance aims, is only feasible if the ECB maintains its quantitative easing indefinitely, though it has already announced that this policy will expire in March. Ultimately, it is not new fiscal rules that are being proposed, but “fiscal dominance” i.e., the guarantee that the ECB is on hand to provide “superior” public goods such as decarbonization, digital transformation, social integration and to fight inequality. Fiscal expansion cannot be open-ended in recessions, as proposed, without threatening the independence of the central bank, even after accepting amendments in the current rules and allowing the Commission to borrow indefinitely.
Fiscal rules must be neutral so that policies can be adjusted to the political and economic cycle.
The centerpiece of this para-official group’s proposal is the conversion of the European Recovery and Resilience Facility (ERRF) into a permanent, centralized fund for investment in European public goods. This strikes me as a mistake because it turns it into a structural fund, in addition to or replacing existing facilities. Moreover, a structural investment fund does not usually operate through transfers but through concessional loans, to ensure the borrower’s interest, the skin in the game requirement. On top of that, it is always associated with strict conditions, to ensure its effectiveness, and it is unviable as a countercyclical policy instrument. A structural investment fund as proposed is not and cannot be the macroeconomic stabilization facility that the EMU, like any other monetary union, needs. In fact, the best example is the actual ERRF, which did not stop the punches from raining down when the pandemic broke out in 2020, nor did it speed up the recovery in 2021, yet it is to be disbursed throughout 2022 and especially 2023 with the EU growing above its potential, with EU unemployment at historical minimus and running the risk of fueling dangerous inflationary pressure.
There are many other interesting proposals, although they all start from the confused premise of trying to define a governance framework and a compulsorily expansionist fiscal policy at the same time. Thus, for example, proposals include making the preventive arm of the deficit procedure only applicable once the member state in question has achieved fiscal stability, which makes this instrument irrelevant. Another suggests doing away with the requirement to reduce debt in the excessive deficit procedure, and to concentrate solely on reducing the deficit’s structural factors, rendering it unobservable and discretionary, since today we already have as many measurements of structural variables as there are economists. And there is no mention of ensuring compliance with fiscal resolutions or the potential imposition of penalties. Discipline is replaced by permanent dialogue between institutions and that sugar-sweet concept of national “ownership” of any adjustments to ensure that they are effective. In short, there are no clear, binding mechanisms to prevent opportunistic behavior, which leads us to believe that this proposal will have little traction in Europe, given the public positions of many governments, beyond cyclical parliamentary majorities. This is because fiscal rules must be neutral so that policies can be adjusted to the political and economic cycle. And they must be binding, to ensure the right balance between solidarity and responsibility. This is even more pertinent in an EU of such diverse sovereign states.
I understand the argument of expediency and political economy that drives the authors to suggest converting the ERRF into a permanent facility. It is the argument of the lesser evil: let’s make the most of what we already have and tweak it to make it a bit better. This is the same argument that has led them to propose changes in European fiscal governance to circumvent unanimity in the Council or changes in the Treaties. Yet, this attempt leads them to a very complex decision-making process, adding even more institutions to what is already an ungovernable, gridlocked framework that can only exacerbate the already familiar delays in implementing fiscal policy. It is a futile attempt, as they finally concede, if we wish to guarantee the democratic legitimacy of ensuing EMU governance.
The type of fiscal union required by monetary union involves a change in the EU Treaties. It is a fiscal union that would facilitate fiscal stabilization policies at the European-wide level in the wake of asymmetric shocks, while not curtailing fiscal competition between national economies. It is a fiscal union of automatic transfers in predefined circumstances, linked to falls in economic activity and employment, yet with simple, transparent rules that curb increases in public spending to prevent negative externalities. A spending growth rule that can be tailored to debt stock/GDP to ensure the creation of fiscal space during upturns in the economic cycle. A rule that can be enforced automatically, which requires an additional transfer of fiscal sovereignty similar to the transfer of monetary and financial sovereignty implemented in the banking union after the financial crisis.
This article was originally published in Spanish in Expansión.
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