The EU needs to consider far-reaching legislative changes to its public borrowing rules following the pandemic-related surge in debt loads, the bloc’s economics commissioner said on Friday, underscoring the profound impact the Covid-19 crisis is having on fiscal policy thinking.
Paolo Gentiloni said in a speech member states needed to learn the lessons from the sovereign debt crisis, when excessively deep cuts were delivered to public investment, and that when it came to fiscal policy “the risks of doing too little outweigh the risks of doing too much”.
The Italian commissioner floated a number of reforms to the EU’s controversial stability and growth pact (SGP), arguing that the bloc should be prepared to go beyond minor tweaks. Possible changes included giving special treatment to growth-enhancing public spending, reconsidering the role of the region’s public debt rule, and making it easier to suspend the fiscal rules in a downturn.
“When the time does come for a gradual fiscal consolidation, member states should avoid another mistake from the last crisis, which was to allow the burden of cuts to fall to a great extent on public investment,” said Gentiloni at the annual conference of the EU’s advisory European Fiscal Board (EFB). “We need to reflect on how our fiscal rules can support sustainable growth even as they keep spending under control.”
Early in the pandemic the European Commission used its so-called general escape clause to suspend the enforcement of the SGP, responding to the prospect of plummeting output and surging public debt. The bloc faces a politically fraught debate over whether to overhaul the rules before they are reimposed, teeing up clashes between fiscally conservative states and those with weaker finances.
Any reforms of the SGP would also entail forging a consensus within a divided commission. Earlier Valdis Dombrovskis, the commission’s executive vice-president, said in a speech that it remained critical that the rules ensured sustainable fiscal positions in all member states, based on a credible debt anchor.
On Wednesday next week the commission is set to release guidance on how it will decide when to reimpose the fiscal rules, an announcement that could point towards keeping the rules suspended in 2022 as well as this year. The latest commission forecast suggests output will regain its pre-pandemic levels in the middle of next year, but this is subject to huge uncertainties.
Brussels is likely to hold off tabling formal recommendations for reform of the SGP until after German elections in September. However, Gentiloni, a social democrat and former Italian prime minister, made it clear in his comments on Friday that he wanted to be ambitious when it came to redrawing the rules.
That does not mean seeking to reopen the bloc’s treaties, but he explicitly said in his speech that the EU should not rule out legislative reforms, rather than tweaks to interpretative guidance, saying: “If not now, when?”
The intervention comes after the eurozone suffered a 6.8 per cent contraction last year, with a rebound of just 3.8 per cent pencilled in by the commission this year and next. The slump is set to push average debt levels to 100 per cent of GDP; Italy is facing a burden approaching 160 per cent.
The scale of the fiscal challenge is prompting senior economists to radically rethink their views on how to handle public spending and debt. Policymakers at the World Bank and IMF, for example, have urged countries to spend their way out of the crisis. Carmen Reinhart, the chief economist at the World Bank, has urged: “First you worry about fighting the war, then you figure out how to pay for it.”
Gentiloni reflected that philosophy in his speech, arguing that EU member states should take advantage of the low interest rate environment to “grow out of debt” via reforms and investments.
“Once the health situation is fully under control and the economic situation has solidly improved, member states will need to achieve a gradual and realistic reduction of high public debt ratios.”
This implies changes to the SGP, which imposes a 60 per cent of GDP debt ceiling on member states. One possible reform, said Gentiloni, would be to allow member states to get special dispensation for “growth-enhancing” public spending. Among the ideas discussed in the past have been changes to encourage green-related expenditures.
In addition, the role of the bloc’s debt rule needed to be considered, the commissioner said, ensuring a “credible mechanism to steer debt on to a gradual and steady downward trajectory”. One idea previously floated by the EFB is the use of country-specific paths for capitals to bring debt ratios back down.
Finally, the EU should consider changing the general escape clause, which is currently reserved for major crises. “We should have a reflection on whether there is a need to turn to the general escape clause more often in economic downturns,” said Gentiloni.
A more “readily usable” escape clause could be paired with the elimination of the complex exceptions and carve-outs that the current rules contain to cater for downturns.
Source: Economy - ft.com
