VIDEO
Common Fiscal Policy in the EU: The Sooner the Better
Fiscal Policy and Macroeconomic Stabilization in the Euro Area: Possible Reforms of the Stability and Growth Pact and National Decision-Making Processes
The budgetary problems of some member states in the EU have focused attention on fiscal policy and the fiscal rules in the EU. A key issue is the need to combine long-run sustainability of fiscal policy with short run flexibility, because fiscal policy is the only remaining stabilization instrument in the case of country-specific cyclical developments.
The fiscal policy should play a larger role as a stabilization tool than envisaged by the conventional wisdom that has prevailed in recent years. The group highlights that the problems of using fiscal policy in this way are not due to technical ineffectiveness but to problems of political economy.
There is a continued need for fiscal rules at the EU level to ensure fiscal discipline. In view of the future strains on government budgets arising from ageing populations, the present “close to balance or in surplus” budget targets for the medium term should not be relaxed, although the targets should be set explicitly in cyclically adjusted terms. It would be unwise to introduce a golden rule, according to which government investment can be financed through borrowing. The underlying rationale for a golden rule is that public projects are expected to generate a flow of tax revenues as high as the interest payment on the additional debt incurred to finance them. There is, however, no reason for this to be true:
Many public projects are desirable for reasons that are independent of tax revenue considerations. Moreover, the classification of expenditure among different categories is arbitrary. Allowing budget flexibility via a golden rule is likely to cause massive re-classification to take advantage of the rule. This is not to deny that there may be sound reasons to allow for larger deficit financing of public investment – such as efficiency of the tax regime or intergenerational fairness, as also future generations will benefit from public capital. But experience shows that these good reasons seldom are primary concerns in the actual budget processes.
The amendments from the European Commission from July 2005 aim at increasing the flexibility of the EU fiscal rules through changes in the interpretation of the Stability and Growth Pact but without revisions of the Maastricht Treaty. The agreed changes involve more discretionary decisions on the fiscal goals. The idea is to allow temporary deviations from the medium-term budget objective of “close to balance or in surplus” on a case by case basis if they can be justified in terms of growth-enhancing expenditure increases or tax cuts, or as a consequence of structural reform.
A loosening of medium-term budget objectives without doing anything about the maximum deficit ceiling of three percent of GDP increases the risk that this ceiling will be breached, which is likely to cause more conflicts among member states. Also, the more complicated the rules become and the more discretionary judgments’ are involved, the greater is the danger that the credibility of the fiscal rules is undermined.
Instead, EEAG suggests that there is a strong case for more fundamental reforms of the fiscal rules involving Treaty. These changes should focus on the excessive deficit procedure and the deficit ceiling, as they form the backbone of the rules. A simple and transparent reform would be to let the deficit ceiling depend explicitly on the debt level of the country: countries with low debt (less than 55 percent of GDP according to the EEAG proposal) should be allowed to run larger budget deficits than three percent of GDP. The lower the debt-GDP rating the higher the maximum deficit for these countries should be. This would serve both to give low-debt countries greater scope for stabilization policy in recessions and to enhance the incentives for long-run fiscal discipline, preventing pro-cyclical fiscal policies in booms.
Changes in the fiscal rules must not, however, accommodate the current budgetary problems of some countries. This would ruin the future credibility of clear fiscal rules at the EU level. If France, Germany, Italy or Portugal were to breach the three percent deficit ceiling for more than a single year, sanctions must be imposed, as a natural consequence of earlier insufficient fiscal retrenchment, in the common interest of establishing credibility for the rules.
The present fiscal policy framework at the EU level suffers from the fundamental problem that the ultimate decisions on excessive deficits are political.
The threat of sanctions has low credibility, as governments are likely to try to avoid political conflicts with each other. This is an argument for transferring decisions on deposits and fines from the political level of the Council to the judicial level of the European Court of Justice. The events have shown that there are limits to how much fiscal rules at the EU level can achieve on their own. It would be impossible to uphold these rules if governments repeatedly came into conflict with them. This consideration suggests that one should rely much more on national institutions that are conducive to both long-run fiscal discipline and effective short-run stabilization policy. One possibility would be to require the member states to adopt national laws on fiscal policy that set well-defined long run sustainability goals, but also outline clear principles for the use of fiscal policy as a stabilization instrument.
In this respect, economists have begun to discuss whether there are lessons for fiscal policy to be learnt from the recent development of theory and institutions of monetary policy. A parallel could be drawn between delegation of monetary policy to independent central banks, and delegation of decisions about fiscal stabilization policy to an independent fiscal policy committee.
The underlying idea is to separate decisions aimed at stabilization from other aspects of fiscal policy concerning distribution and social efficiency. Such separation would reduce decision lags as well as politico economic risks of pursuing pro-cyclical policies and deficit bias. At the same time, it could help the government to define more clearly the political goals of alternative policy measures. Such a development has taken place in other areas of economic policy-making in addition to monetary policy: examples include competition policy as well as market regulation and supervision. The idea of delegation of fiscal policy stabilization decisions may be unfamiliar to many people, and is not on the current political agenda.
There is, however, a case for starting to think about the possibility of such a reform, and exploring the extent to which it would be compatible with generally accepted principles of democratic governance. In line with the principle of subsidiarity, national delegation could be seen as an alternative to the recent proposals of the European Commission, according to which it should be given greater discretionary powers in assessing fiscal policies of member states.
One idea would be for member states to establish an independent fiscal policy committee at the national level. A politically realistic way to move in this direction in the next few years is to set up independent fiscal policy committees at the national level that play an advisory role. Governments could be required to seek the advice of these committees before making their budget decisions and to use the committees’ estimates of cyclical conditions, government expenditures and tax revenues as a basis for budget calculations.
The task of these committees could be to propose how much the actual budget balance in a given year should deviate from the cyclically adjusted budget balance and to make recommendations on specific tax or expenditure changes with the aim of stabilizing the business cycle. The general goal of such reform would be to lessen many of the problems that now hamper the use of fiscal policy as an effective stabilization tool, such as long-decision lags, deficit bias, irreversibility of decisions, and confounding of objectives.
