The European Commission’s orientations for a reform of the economic governance framework (European Commission 2022, henceforth ‘the orientations’) have the important merits of making explicit and bringing under Commission control the intertemporal dimension to the policies for managing excessive debts accumulated by euro area countries during the past decade, and of opening the door to a case-by-case approach that allows appropriate differentiation between the member states based on the severity of their financial imbalances. However, in my view the orientations utterly fail to achieve the stated goal of increasing national ownership of economic policies for debt reduction. Specifically, the Commission’s attempt to extend to the Stability and Growth Pact (SGP) the policy coordination method developed under the NextGeneration Resilience and Recovery Programme (RRP) brings the identification of the national reforms and investments and the operational public expenditure path under Commission control, raising fundamental questions of democratic legitimacy in the determination of national budgetary policies that cannot be overlooked (Bini Smaghi 2023).
However, the distance between the Commission’s proposal and what is required to make it functional to its stated goals is not enormous; by accepting some (admittedly important) changes in its approach, the Commission would be able to retain the key innovative aspects of its proposal. The key for success in the upcoming negotiations in the Council is decentralisation: the programmes for debt stabilisation must be fully entrusted to the member states, under strengthened national fiscal frameworks (Arnold et al. 2022, Beetsma et al. 2022, Wyplosz 2019), so as to ensure full ownership of debt adjustment programmes at the national level.
The role of the Commission in the revised Stability and Growth Pact
There are two aspects in the orientations where in my view the Commission has overstepped its proper role. First, the orientations seek to achieve an effective common policy to put a brake on excessive public debts, which is where the current SGP framework has notably failed over the past decade (European Fiscal Board 2019, Medas and Balakrishnan 2022). In order to do so, the Commission proposes a multi-year adjustment framework, country by country, and claims the last word in the determination of the intertemporal adjustment path (see also Buti et al. 2022).
Second, the Commission has conceived the new SGP as an all-encompassing integrated policy framework covering, together with debt sustainability, the priority reform and investment commitments as well as the country-specific recommendations issued in the context of the European semester. Accordingly, for high risk and medium risk indebted countries (as defined in the orientations), all national economic policies would come under EU legal control. By claiming such broad powers, the proposal would surely not increase national ownership; the Commission would also expose itself – as happened with the present SGP – to being held responsible for national fiscal policy programme failures (Blanchard et al. 2022).
On the other hand, the Commission could have usefully gone further in its proposal regarding the aggregate demand impact of debt reduction in the euro area. Even if limited only to countries experiencing severe debt challenges – which under the orientations would include seven countries, representing about 53% of the euro area’s GDP – debt consolidation would result in a sustained deflationary impact throughout the euro area (as acknowledged by Buti et al. 2023). This is where a central fiscal capacity, or at least an explicit common policy for the management of aggregate demand and the production of European public goods, would have been required (as, in fact, proposed by Buti and Messori 2022, as well as IMF staff; see Arnold et al 2022).
The last problematic aspect in the orientations concerns the decision to keep the reference debt/GDP ratio in Protocol 12 of the Treaty on the Functioning of the EU (TFEU) unchanged at 60% – in a monetary union where the average ratio has in the meantime risen to about 90%. In this regard, while recognising the political difficulties involved, it is useful to recall that, in the opinion of some jurists, under Article 126(14) of the TFEU, Protocol 12 of the TFEU could be amended by the Council (deciding by unanimity) without a need to call an intergovernmental conference (in the same vein, see also Martin et al. 2021).
In any case, while the precise role of the 60% target debt/GDP ratio in the new fiscal framework is far from clear, its existence raises the possibility that at some stage disagreement between member states in the Council and within the governing board of the ECB on the appropriate adjustment path for any one country could generate a fresh investor run (on this, see Carmassi and Micossi 2010 for the euro area crisis experience).
Freeing the ECB of fiscal tasks
A specific difficulty, in this regard, stems from the ECB’s decision to take upon itself the task of combatting spread increases generated by re-emerging financial market fragmentation in the ongoing phase of monetary restriction, notably (but not only) with its Transmission Protection Instrument (TPI) (ECB 2022). Such interventions would in practice be acceptable to the Governing Board only to the extent that an exogenous financial shock could be seen as utterly independent of economic fundamentals, which of course would be a rather difficult condition to verify. Moreover, the Transmission Protection Instrument decision explicitly contemplates the possibility that “purchases could be terminated … based on an assessment that persistent tensions are due to country fundamentals.” Any explicit decision not to intervene under TPI would inevitably act as an open invitation to investors to run for the door.
It may be recalled, in this respect, that in the past decade the ECB intervened to enforce the Stability and Growth Pact on unwilling governments on two occasions. In the Summer of 2011, the ECB wrote letters, co-signed by national central bank governors, to the governments of Italy and Spain detailing the policies deemed necessary to ensure debt sustainability. In Italy’s case, the Eurosystem’s interventions in support of the Italian debt market were suspended after the Berlusconi government announced in Parliament that it was unwilling to comply with the policy commitments undertaken with the Commission. Moreover, in July 2015 the refusal by the ECB to raise the ceiling on emergency lending to Greek banks led to a protracted bank holiday. In both cases, national governments eventually gave way, under heavy pressure from financial markets.
In my view, the ECB mandate does not and should not be extended to the enforcement of common fiscal policies, but unfortunately the Transmission Protection Instrument has formalised that possibility.
Decentralising national debt-reduction programmes
A blueprint for the decentralisation of debt-reduction programmes in the SGP was presented by Arnold et al. (2022) and was reflected in the proposals by Martin et al. (2021) and Beetsma et al. (2022). It seems to me that these proposals offer a ready-made package to overcome the difficulties in the negotiations on the orientations that might otherwise sink it in the Council. The key elements to retain in those proposals are the following:
- The preparation of national debt reduction plans would be fully delegated to the national level. As suggested by Beetsma et al (2022), as long as medium-term outcomes remain compatible with benchmarks set by the EU fiscal rules, national multi-year frameworks could be based on nominal targets for public expenditure, the structural balance, or full discretion in setting debt trajectories; the option of direct application of the EU benchmark rules could also be maintained.
- The evolution of debt ratios and other national benchmarks would be assessed, as proposed by the orientations, over a long time interval (four to five years), thus leaving adequate room for countercyclical fiscal stabilisation. However, should ongoing developments in national policies appear to threaten the financial stability of the euro area, the country’s fiscal policies would be immediately brought back under the Commission’s surveillance procedures.
- As in Arnold et al. (2022), national fiscal councils should be assigned the central role in the surveillance of national fiscal policies, notably including operational public spending targets. Accordingly, they should meet strict requirements of independence, adequate financial means, and effective powers vis-à-vis their national authorities to foster the required reduction in debt ratios.
- A strengthened European Fiscal Board could work as the centre of a network of national fiscal councils, helping them develop the tools for debt and expenditure planning over time, including, but not only, debt sustainability models.
Under this approach, the Commission would retain independent powers to monitor national fiscal developments, concentrating on ‘gross errors’ in the implementation of national fiscal plans for debt reduction. It would also have powers to advocate surveillance over national policies under its own benchmarks whenever financial market instability would indicate that any one country’s national plans were losing credibility with market investors. All submissions to the Council by the member states of their debt reduction plans would be accompanied by the Commission’s assessment. Disagreements between the Commission and national governments would be handled by the Council.
Author’s Note: The author is grateful to Massimo Bordignon and Erik Jones for useful comments on an earlier draft, while retaining as usual full sole responsibility for the opinions expressed in the note.
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