“A comprehensive reform of the rules and the fiscal framework of the European Union cannot wait any longer. Further delays will force countries to return to the old rules with all their problems. The opportunity must not be missed.” With these unusual and difficult words, the senior officials of the International Monetary Fund (IMF) summarize a comprehensive report published today (Monday) with a clear and sharp recommendation to significantly change, expand and strengthen the fiscal (budgetary) rules and frameworks of the Union which, according to the authors, have quite failed in their mission.
“The existing rules did not prevent the unwanted accumulation of public debt and fiscal risks among some members,” the report said. “Weak national institutions, political pressures and major shocks led to poor compliance. Combined with design limitations of that fiscal framework that sets ceilings on deficits in bad times without providing sufficient incentives to build ‘retaining walls’ in good times, this has led to cumulative fiscal imbalances. The existing framework also failed to stabilize growth and lacks the tools to finance public goods common to all member states.”
The Maastricht Treaty that effectively established the European Union established two main fiscal rules that were a milestone for the rest of the developed world: EU countries must avoid annual deficits of more than 3% (deficit ceiling); And the GDP debt ratio of any country cannot exceed 60% of GDP (debt ceiling).
The fund’s executives show that European governments have failed time and time again, and especially during periods of crisis or recession, the golden rules of Maastricht were neither properly enforced nor respected.
In fact, the Union’s average GDP debt ratio jumped during this period from 62% of GDP in 2007 on the eve of the global crisis, to more than 90% of GDP in the year of Corona. “High public debt and rising interest rates make it difficult for governments to deal with the many challenges of today, including dealing with extreme increases in the cost of living and dealing with the climate crisis,” the IMF writes.
“As we have seen in the past, these risks threatened the stability of the monetary union in the past and continue to create weak points today. This is despite many efforts to refine the rules and strengthen central supervision over the years,” the report states.
The fund proposes three main policy measures that seek to achieve different goals. The first is the establishment of a new and independent fiscal council that will keep the Maastricht rules (3% deficit and 60% debt) but the need for fiscal adjustments will be related to the degree of risks. Countries with greater fiscal risks will have to converge to budget balance and even surplus over the next three to five years. On the other hand, countries with lower fiscal risks will benefit from greater flexibility.
The second step is to strengthen national fiscal institutions (within the countries) with a recommendation to enact medium-term fiscal rules and define annual and multi-year spending ceilings (as in Israel). Independent national fiscal councils that will be established (this is also a recommendation) will supervise the process and the execution or approval of macroeconomic forecasts, assessment of fiscal risks and compliance with rules (ceilings) and plans.
The third step is to establish a common framework to support the countries to achieve these goals but also to provide common public goods at the level of the Union, such as those that call for the fight against the climate crisis and the construction of infrastructures for energy security. A dedicated fund for green investments is an important part of the proposal.
The report is surprising because such reports that combine both criticism and operative measures for immediate action are more characteristic of developing countries and not developed countries such as the European Union countries. The second surprising element is the report’s two authors: Dr. Vitor Gasper, one of the fund’s senior executives and director of the entire fiscal field at the IMF, together with Alfred Kammer, director of the European department at the IMF.