In comments made at The Paris Finance Summit on 10-11 February, the French Economy & Finance Minister Bruno Le Maire expressed his continued desire for reform of the EU’s fiscal rules, echoing President Emmanuel Macron’s comments two months prior.
The EU’s fiscal rules, known as The European Union Stability and Growth Pact, are a set of fiscal limits placed upon all member states. Signed into law in 1999, the policy aims to control the risks of moral hazard that may result from the use of a shared currency – the Euro. Domestic political temptation to overspend, with little regard for EU-wide inflation, could pose a major threat to the strength of the economic bloc.
Member states’ budget deficits are limited to 3% of GDP, and public debt capped at 60% of GDP. If either limit is breached for a sustained period, a fine of up to 0.5% of GDP can be levied as punishment.
With the outbreak of Covid-19, the ‘General Escape Clause’ in the pact was exercised. This temporarily suspended the caps, permitting EU member states to spend far more freely than they would otherwise have been able to, and enabled successful stimulus packages across the continent. The clause does, however, state that the limits will come back into force in 2023. As this deadline comes closer, there has been growing opposition to the resumption of the old rules. Many nations across Europe believe now is the time for reform.
The main motivation for a rule change is the record-breaking national debts accrued over the last 24 months. Germany, France and at least 12 other EU member states find themselves over the 60% threshold and are unlikely to rein in this borrowing before 2023. This debt is largely the result of extremely high government spending since spring 2020, with isolation payments and furlough schemes costing billions. Further, with the market now pricing in an earlier-than-promised European Central Bank rate hike in 2022/3, debt reduction is looking harder than it did before the pandemic.
On top of this, Europe is becoming increasingly willing to spend its way out of the problems it finds itself in. EU countries are aware of the need to finance a ‘green transition’ away from fossil fuels, which will require large amounts of spending on everything from subsidies for public transport to new wind farms. The pursuit of ‘Digitalisation’ across Europe, too, will be very expensive. As European nations seek to remain competitive globally, further spending and tax cuts will be aimed at bolstering the European tech environment.
There is no definitive political agreement over the proposed changes to the fiscal rules, but there have been growing murmurs of support in recent months across European capitals.
Macron has publicly supported reform of the current rules. In December 2021 he argued they are “no longer up to the task” and has expressed openness to two major fixes. Firstly, the exemption of certain types of investments, such as those mentioned above, from the pact, and secondly the upping of the overall spending caps.
In the same month, German Chancellor Olaf Scholz indicated support for a ‘stretching’ of the current rules. This would mean an extension to the suspension of the cap, rather than a total replacement. In February 2022, however, Jörg Kukies, German State Secretary for Financial Market and European Policy, expressed his belief that the pact may be destined to a death of a thousand cuts.
The Italian government, too, has indicated its support. With the ex-ECB president Mario Draghi in power, the country has increasingly aligned its agenda with that of the Bundestag, which has also been heading in a new direction. The new German coalition has expressed a commitment to intensive growth and shown itself to be more comfortable with public debt than its predecessors. Accordingly, there is likely to be greater cooperation between North and South.
Overall, the Eurozone finds itself in the midst of a high spending period, through both choice and necessity. Whilst Covid may have provided the initial impetus to increase investments, new governments in the most powerful European nations have decided that public spending is no longer something to shy away from.
The multiple challenges faced by member states as they emerge from the pandemic create a growing imperative for them to increase the health and competitiveness of their economies. Given the constraints on domestic fiscal policy imposed by the EU Stability and Growth Pact, this looks set to change in the near future.
Analyst: Otto Rutter
Sector Head: Edward Raftery