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Europe Must Fix Its Fiscal Rules

In an environment of persistently low interest rates and below-potential output, economic policymakers must rethink the prevailing approach to public debt. For the eurozone, this means creating a common budget, or at least overhauling the fiscal rules that have tied member-state governments' hands for no good reason.

TRENTO – Earlier this year, I argued that in countries where interest rates are extremely low and public debt is considered safe by investors – making it less costly from both a fiscal and economic standpoint – larger fiscal deficits may be needed to make up for the limitations of monetary policy. The eurozone has now reached this stage.

After the 2008 financial crisis and subsequent euro crisis, monetary policy played a key role in stabilizing and reviving the eurozone. It took pragmatism, creativity, and political flair on the part of European Central Bank President Mario Draghi to accomplish this feat. But while monetary policy hasn’t quite run out of fuel, it cannot be expected to serve the same role again.

By contrast, fiscal policy, the other key component of sound Keynesian macroeconomic management, has been underused as a cyclical tool, with the result that eurozone output still is not at its potential level. This is an urgent problem that cannot be solved by any one country alone; it demands a concerted eurozone response. But while the need for a common eurozone budget from which to draw additional spending is more pressing now than in the past, this would entail risk-sharing among the member states, which is a politically difficult issue.

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