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Rethinking the EU’s Fiscal Framework

Proposed reforms of the European Union’s Stability and Growth Pact presuppose the desirability of fiscal discipline in a monetary union, but the arguments for this are weaker than they once were. Policymakers should instead focus on turning the EU’s new Recovery and Resilience Facility into a proper counter-cyclical policy tool.

MILAN – Soon after the COVID-19 pandemic hit in spring 2020, the European Union activated the Stability and Growth Pact’s general escape clause, thereby suspending the Union’s limits on member states’ fiscal deficits and government debt. The clause envisages an almost automatic return to the SGP’s rules once the crisis is over, but EU policymakers should chart a different course.

The economic desirability of the SGP – which caps countries’ budget deficits at 3% of GDP, and public debt at 60% of GDP – has come under increasing scrutiny during the pandemic. Two broad camps have emerged. One advocates reforming and simplifying the fiscal rules. The second favors moving from rules to qualitative standards, whereby each member state manages its own fiscal affairs with an eye toward debt sustainability.

The EU’s fiscal rules are already partly concerned with debt sustainability, mostly under the SGP’s so-called preventive arm. Eurozone countries are judged by their capacity to target a structural fiscal balance, calculated by subtracting the cyclical component from the debt-stabilizing level of the nominal deficit.