A Return To The EU’s Old Ways

by Vaibhav Tandon of Northern Trust, 10/14/23

Reverting to old fiscal rules will create a strong economic headwind for Europe.

For years, euro area countries could not agree on when it was appropriate to breach fiscal limits. The pandemic and the Ukraine war changed the game: suspension of debt and deficit limits in the wake of those events proved instrumental as Europe sought to avoid an economic and political catastrophe.

With the economy moving beyond these exogenous shocks, age-old differences in economic thinking between the north and south of Europe have come to the fore again. As a result, negotiations on reforming budget rules set out under the Stability and Growth Pact have stalled.

The European Commission’s (EC) proposal is to reinstate the original Maastricht Treaty targets of deficits under 3% and debt under 60% of gross domestic product (GDP). But the proposed reform offers more flexibility when a country breaches one or both of these thresholds. Instead of a rigid, formulaic approach, regaining compliance will be negotiated on a case by case basis. Plans will be unique to each member state and based on a debt sustainability analysis. The plan also aims to provide states four years to reduce their debt/GDP ratios, or seven years if they also undertake reforms and investments that are in line with Europe’s strategic priorities, instead of the current uniform 1/20th debt deduction rule.

There are two major sticking points around the EC’s proposition. Germany, along with other northern states, is pushing for fixed spending caps and yearly reduction targets. On the other end of the spectrum are nations like France and Italy, which favor negotiated debt reduction paths instead of a one-size-fits-all approach. Member states are also at odds over how much enforcement power the EC should have if countries fail to hit planned targets.