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Europe Needs a New Fiscal Framework

Even before the COVID-19 pandemic, the European Union's fiscal rules were excessive and increasingly unworkable, reflecting the motives of distrustful member states more than economic common sense. If there is a silver lining to this crisis, it lies in the opportunity to debate and develop a new blueprint.

PARIS – In the mid-1980s, only seven countries had fiscal rules. In 2015, when the International Monetary Fund last counted, 96 did. Most had provisions limiting public debt, budget deficits, or both, and some had additional rules on public expenditures.

This circumscription of fiscal discretion was partly a response to traumatic experiences such as Latin America’s “lost decade” following the debt crises of the 1980s; the painful adjustment suffered by countries caught off-guard by rising interest rates in the early 1990s; and the European sovereign-debt crisis of 2010-12. But the adoption of fiscal rules also owed something to growing distrust of fiscal activism.

In 2000, John B. Taylor of Stanford University captured the spirit of the time when he wrote that it is “best to let fiscal policy have its main countercyclical impact through the automatic stabilizers” – in other words, to put it on automatic pilot. The consensus then was that monetary policy is a nimbler and more effective policy tool, because the key decisions are made by an independent central bank and implemented with the stroke of a pen.