Opinion

ECB decisions put lack of fiscal union in the spotlight

Fiscal policy in the euro area is hardly supporting the recovery and the ECB. The EU needs a a proper fiscal union in order to stabilise the economy and inflation. We see four main avenues for achieving a viable fiscal framework.

By: and Date: March 30, 2016 Topic: European Macroeconomics & Governance

This opinion piece was published in El MundoGazeta Prawna, Makronom, and Caixin.

El_Mundo_logo

Dziennik-Gazeta-Prawna-2011_ok_CMYK_bez_cienia-300x65

Makronom

caixin

The ECB is taking bold action to achieve its inflation target, but its policies are beginning to look desperate.  The euro area and the ECB are suffering from the same problem: fiscal and structural policies are not playing their part, and monetary policy alone is not enough to kick start the recovery.

This is no surprise. Once inflation expectations are low and interest rates are at zero or negative, it is very difficult for monetary policy to change those inflation expectations – short of implementing outright helicopter transfers on behalf of governments, which could involve placing ECB-created cash directly in citizens’ bank accounts.

Standard macroeconomic theory explains that in a low inflation, liquidity trap environment, lowering interest rates will help but only to some extent. The experience of Japan’s Abenomics confirms that insight: the massive purchase programme has somewhat shifted inflation expectations, but slow progress on fiscal and structural policies has prevented inflation and growth from picking up seriously.

Fiscal policy in the euro area is hardly supporting the recovery and the ECB. The euro area needs a framework that defines the role of national fiscal policies in supporting euro-area economic stability. We see four main avenues for achieving a viable fiscal framework.

First, the euro area needs to be able to reduce public debt burdens if  debt levels become unsustainable. We propose that if there is a new European Stability Mechanism (ESM) programme, the maturity of public debt should be extended by the length of the ESM programme. This  could be incorporated into existing collective action clauses for all sovereign bonds. The measure would act as a powerful stabiliser in case of fiscal trouble, as it would give breathing space to countries, allowing for slower and less painful fiscal adjustment.

However, such a step is only possible if the financial system is able to cope with such a soft restructuring. To do this, the banking system must be made less dependent on national governments. This could be achieved by a simultaneous introduction of a common European deposit insurance and the introduction of exposure limits on national sovereign debt, except for well-defined baskets of sovereign bonds that are already diversified by construction.

Second, in exceptional times like the current one, governments must coordinate national fiscal policies to achieve a euro-area wide fiscal stance. Ultimately, this will require more binding rules and more democratic decision making, for which a European treaty change is necessary.

In the short term, we argue that the European Fiscal Board should have an explicit mandate to distinguish between good times and bad times, and to give recommendations on spending policies in the euro area. With 98% of government spending at the national level, it is crucial that national governments co-ordinate their policies to ensure economic stability.

Third, national fiscal policies need to be more stabilising and more sustainable. The current rules system is very complex. Instead of adopting a “flexible” approach based on complicated rules and discretion, we propose that incremental investment spending and cyclically-driven unemployment spending be treated separately. They should be put in an adjustment account that will need to be balanced over the business cycle, but will reduce the scope of pro-cyclical fiscal adjustment in a downturn.

Finally, the euro area needs to build an additional risk-sharing mechanism for large shocks. Such a mechanism should not be left to politicians. Politically decided counter-cyclical fiscal policy has often been wrongly timed and had the opposite effect to that intended. In a European decision making context, this problem is likely to be compounded. A European risk-sharing mechanism should be automatic, designed to help countries that face very large recessions, such as for example happened to Spain.

We believe that the creation of a European unemployment re-insurance model would complement existing risk-sharing structures, and help cope with deep recessions. It could also be a useful starting point for a further structural convergence of labour markets.

The ECB’s increasingly desperate attempts to stabilise the economy and inflation show that other policy areas are not delivering. This is in large part due to the absence of a proper fiscal union.

Our proposals, which do not require treaty change in the short run, would strengthen governments’ ability to stabilise our economies with fiscal policy, and reduce the burden for the ECB. Structural policies, in turn, can play a crucial role if they manage to change expectations of future productivity growth, triggering inflation and investment today.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: The case for a legislative remedy for recessions

Bruegel's Maria Demertzis welcomes Yale Law School professor Yair Listokin to this Director's Cut of 'The Sound of Economics', to discuss how law might be deployed as a macroeconomic tool to counter financial crisis.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: March 12, 2019
Read article More on this topic More by this author

Blog Post

Greening monetary policy: An alternative to the ECB’s market-neutral approach

The ECB’s market-neutral approach to monetary policy undermines the general aim of the EU to achieve a low-carbon economy. An alternative tilting approach would foster low-carbon production, accelerating the transition of the EU to a low-carbon economy, and could be implemented without undue interference with the chief aim of price stability.

By: Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 21, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: A greener monetary policy approach for the ECB

Bruegel fellow Dirk Schoenmaker walks Sean Gibson and 'The Sound of Economics' listeners through his latest working paper, focusing on how to make monetary policy in Europe more climate-friendly

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: February 21, 2019
Read article More on this topic

Blog Post

Whose (fiscal) debt is it anyway?

The authors map how much fiscal debt is in the hands of domestic and foreign holders in the euro area. While the market for debt was much more international prior to the crisis, this trend has since been reversed. At the same time, central banks have become important holders of fiscal debt.

By: Maria Demertzis and David Pichler Topic: European Macroeconomics & Governance Date: February 6, 2019
Read article More on this topic

Blog Post

The higher yield on Italian government securities is becoming a burden for the real economy

Francesco Papadia and Inês Gonçalves Raposo have recently written on Italian fiscal policy and the increase in the spread between Italian (BTP) and German (Bund) government. Since then, two developments have taken place: one good, and one bad. This blog post reviews them.

By: Francesco Papadia and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 5, 2019
Read article More on this topic More by this author

Blog Post

Is public debt a cheap lunch?

The fiscal and welfare costs of public debt, following Olivier Blanchard's presidential lecture at the American Economic Association, in which he suggested both might be lower than expected. We review his paper, along with several scholars' comments, and provide a quick comparison with the European context.

By: Jan Mazza Topic: European Macroeconomics & Governance Date: January 21, 2019
Read about event More on this topic

Past Event

Past Event

Empirical trends in markups and market power: implications for productivity and growth

Empirical trends in markups and market power: their implications for productivity and growth

Speakers: Chiara Criscuolo, Fabien Curto Millet, Jeffrey Franks, Jan De Loecker, Reinhilde Veugelers and Georgios Petropoulos Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 15, 2019
Read article More by this author

Blog Post

What 2019 could bring: A look inside the crystal ball

Economic performance prospects in Europe, the US and Asia in 2019. We start off by reviewing commentaries and predictions about the euro zone, which many commentators expect to perform below potential as uncertainties continue to dampen a still robust recovery.

By: Michael Baltensperger Topic: European Macroeconomics & Governance, Global Economics & Governance Date: January 14, 2019
Read article Download PDF More on this topic

Policy Contribution

The euro as an international currency

Is a more important international role for the euro worth pursuing? What measures would achieve this result, if it is worth pursuing?

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 18, 2018
Read article More on this topic

Blog Post

Does the Eurogroup's reform of the ESM toolkit represent real progress?

The deal reached on euro-zone reform at the December 4th Eurogroup is not ground-breaking. However, it contains a number of incremental but potentially key technical reforms – in particular regarding the ESM toolkit. Some constitute an improvement, but there are also clear flaws that should be corrected at the Euro Summit.

By: Grégory Claeys and Antoine Mathieu Collin Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article Download PDF More on this topic More by this author

Policy Contribution

Forecast errors and monetary policy normalisation in the euro area

What did we learn from the recent monetary policy normalisation experiences of Sweden, the United States and the United Kingdom? Zsolt Darvas consider the lessons and analyse the European Central Bank’s forecasting track record and possible factors that might explain the forecast errors.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: Consequences of European Central Bank forecasting errors

Bruegel senior scholar Zsolt Darvas speaks about his review of systematic errors in ECB forecasting, in another instalment of the Deep Focus podcast on 'The Sound of Economics' channel

By: The Sound of Economics Date: December 12, 2018
Load more posts