Opinion

Fiscal rules and the role of the Commission

The proposals on fiscal frameworks and rules in the recent CEPR Policy Insight on euro-area reform showcase the multiple dimensions of the fundamental dilemmas we are confronted with in the governance of the euro area. This column, part of the VoxEU debate on Euro Area Reform, looks at the challenges to the central role of the Commission that have arisen as the rules-based fiscal framework has been severely compromised.

By: Date: May 22, 2018 Topic: European Macroeconomics & Governance

This column is a lead commentary in the VoxEU Debate “Euro Area Reform

VoxEU logo

The 14 French and German economists have put forward a well-argued Policy Insight on reforms of the euro area (Bénassy-Quéré et al. 2018). One of its merits is that it could be a practical blueprint for a set of reforms that are doable even in the short run, and offers important trade-offs for both Calvinists and Catholics.

Amongst others, the proposals on fiscal frameworks and rules deserve a wider discussion as they showcase the multiple dimensions of the fundamental dilemmata we are confronted with in the governance of the euro area. Important amongst these issues are the challenges to the central role of the Commission that have arisen as the rules-based fiscal framework has been severely compromised.

The present situation is well characterised in the Policy Insight. Absent a political union, an internal market – let alone a monetary union – requires a set of rules that governs the fiscal behaviour of member states. Markets alone are not suitable for the task as they react too late and then overreact. They may play a certain role at the margins to the extent that sovereign debt restructuring is not ruled out ex ante.

The present rules-based system of the Stability and Growth Pact (SGP) has become nearly unmanageable due to its complexity, and the constant addition of exceptions, escape clauses, and other factors. This has had negative repercussions on the role and standing of the Commission and its ability to operate as a guardian of the Treaty – even beyond issues of fiscal policy governance. Needless to say, the Council has also proven unwilling to play its role under the Treaty.

The set-up of rules and procedures forces the Commission into actions designed for grief: fiscal adjustment paths are designed on the basis of forecasts of potential output growth, and thus deviations occur with remorseless logic. The choice is thus of proposing sanctions on the basis of shaky forecasts, or of not proposing sanctions despite the rules requiring them. If the Commission does not wish to sanction such deviations, it again and again has to devise a new rule that explains why fiscal reality is in conformity with rules. Whatever the Commission ends up doing is seen as contravening its role and duties under the Treaty by some member states.

This ‘political’ behaviour contrasts with a fairly stable rules-based system, up to around 2010, where the Commission by and large executed the rules without an overly use of discretion. Under the old system the member states took a fairly active role in the discussions, sometimes even the voting, on individual country cases. Under the new system, with a considerably stronger role of the Commission, member states have turned passive, in the meetings largely accepting whatever the Commission proposes. Outside the room, however, they complain bitterly about whatever the Commission proposes.

Streamlined rules

The present system produces fiscal policy short-termism, fine tuning of the rule book, and political loss of legitimacy. Bénassy-Quéré et al. propose a system of streamlined rules, based on debt levels and an expenditure rule, stronger national institutions, and market-based incentives, leading up to possible debt restructuring.

The proposed simplified rules are in accordance with proposals made by a wide variety of economists and institutions, including detailed work on the issue by the IMF. The details are not so important in the context of this comment. Such rules, however, should be able to deal with the tension of:

  • providing a steady medium-term framework that does away with the present system of permanent readjustment of targets in light of reality,
  • while preventing that fiscal prudence only occurs in the medium term, and never in the short term.

This can rest on political enlightenment of the individual actors, on the threat of market sanctions, on the threat of Treaty-based sanctions, or by increasing the political costs of ‘bad’ fiscal policies. Political costs increase with transparency and information, and through critical dialogue.

How to stick to the rules: Increasing political costs

This should be a two-way system. For one, finance ministers should regularly explain their fiscal policy to a hearing in the European Parliament – less frequently if policies appear to be well on track, more often if not. If there are repeated or significant deviations the European Parliament may also wish to invite heads of state or government to such a hearing.

Transparency should also work better from Brussels to capitals. Both the commissioner in charge of this dossier, as well as the president of the Eurogroup, should be regular visitors to national parliaments in order to explain the euro area dimension of national fiscal policies. In the case of the latter that might well call for the installation of a full-time president of the Eurogroup.

The proposal by Bénassy-Quéré et al. relies on the good offices of national fiscal councils, which would be under the auspices of a central fiscal council. Experience to date with the fiscal councils has been quite mixed. Few have been able to establish themselves as independent, well-staffed institutions that increase critical transparency over national fiscal policies. Relying too heavily on such institutions appears mostly as another swing of the pendulum, handing back more responsibility to the member states as disenchantment with the Commission has spread.

Counting on these institutions to play a major role in ensuring good fiscal policies may be somewhat optimistic. What would be required, as a minimum, would be an agreement on staffing, expertise, independence, access to data, and methodological toolkits. Some of these already exist on paper, but are also followed only on paper. For these institutions to function well, as envisaged by Bénassy-Quéré et al., they would need to be perceived by the member states as an irritating control mechanism that is well heard in the national political discourse. Even in Spain and Portugal, where the fiscal councils are first rate, this is only partially the case. The European Fiscal Board could play an important role at the centre of such a system. Note that its present design ensures that it cannot influence current decisions.

An important institutional suggestion in the paper deals with separating the roles of ‘surveillance watchdog’ and political decision maker within the Commission, or even by moving the watchdog out of the house. Ultimately what counts is not the analysis, but how it is acted upon. This works well in the field of competition policy, which may influence the attractiveness in using this model for fiscal policy. Most important is transparency of what the rules require in terms of adjustment to fiscal policies. Put differently: if the watchdog barks, does anybody outside the Commission hear him barking? Such transparency could be achieved without extensive institutional reforms.

How intrusive?

Finally, one needs to reflect on the degree of intrusiveness of a system of fiscal rules, also in light of constitutional issues. Every presumed breaking of the rule book has resulted in further refinement of our rules. The Vademecum now has 244 pages. Granularity does not increase discipline. There may even have been at some stage a tendency to cover every conceivable situation through detailed rules, therefore putting national fiscal policies on something of an autopilot. The world does not work this way, politics even less so. This reinforces the view that interventions should deal with gross error, or significant deviations, not with issues that are somewhere behind the comma.

How effective?

The other side of the coin is the extent to which member states are willing to change the course of fiscal policy in light of interventions by ‘outsiders’. Past experience is mixed, and has shown on balance a larger degree of willingness of smaller member states to take criticism on board. Some member states find it outright inconceivable that their constitutional sovereignty on budgetary issues may be compromised by having to follow instructions from ‘Brussels’.

These issues show that the choices we are faced with in a number of areas also surface in the fiscal area:

  • The community method versus intergovernmental cooperation: what should be the role of the Commission, and its relation with the Council (and the Eurogroup)?
  • Is the concept of (constitutional or nominal) sovereignty compatible with membership of the euro area?
  • Do we want to discipline ourselves through rules, through institutions, through market forces? Or a mixture?

In summing up:

  • As correctly analysed, the present system of fiscal rules is no longer workable and its application increasingly incurs political costs to the member states and the Commission.
  • This calls for simpler rules that actually can be understood by those who are responsible for fiscal policy in member states
  • Relying on a system of fiscal councils to act as watchdogs disregards the efforts of many member states to keep them as weak as possible. Strengthening them, and putting the European Fiscal Board at the centre of such a system, has its merits but one should not expect too much in practice.
  • Increasing political costs for governments through structured discussions at the national and euro area level would be an additional incentive for keeping to agreed fiscal paths.
  • The Commission will need to remain at the centre of the system, and needs to be strengthened. This needs to be seen in the wider context of the discussions on a ‘political’ Commission. This ‘political’ Commission should be given a wider margin of discretion of applying the fiscal rules; if there are noticeable deviations that the Commission does not act upon, then it should have to publicly explain itself before the Council, the Eurogroup and also the European Parliament.

Most actors who work with these rules agree that they are severely compromised. Governments in turn do not appear to be willing to reform them. They do not realise the costs of maintaining the status quo.

References

Bénassy-Quéré, A, M Brunnermeier, H Enderlein, E Farhi, M Fratzscher, C Fuest, P-O Gourinchas, P Martin, J Pisani- Ferry, H Rey, I Schnabel, N Véron, B Weder di Mauro and J Zettelmeyer (2018), “Reconciling risk sharing with market discipline: A constructive approach to euro area reform”, CEPR Policy Insight No. 91.


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 Download PDF More on this topic More by this author

Essay / Lecture

A new statistical system for the European Union

Quality statistics are essential to economic policy. In this essay, Andreas Georgiou demonstrates the existence of fundamental risks inherent in the European Statistical System. He argues that a paradigm shift is necessary and sets out a model that would deliver the quality statistics the European Union needs.

By: Andreas Georgiou Topic: European Macroeconomics & Governance Date: December 12, 2018
Read article More by this author

Blog Post

Economic policy challenges in Southern and Eastern Mediterranean

For a long time, southern and eastern Mediterranean countries struggled with serious socio-economic challenges and dysfunctional economic systems and policies. Marek Dabrowski reviews the challenges the region has to face to get out of a low growth trap.

By: Marek Dabrowski Topic: Global Economics & Governance Date: December 11, 2018
Read article Download PDF

External Publication

European Parliament

How to provide liquidity to banks after resolution in Europe’s banking union

Banks deemed to be failing or likely to fail in the banking union are either put into insolvency/liquidation or enter a resolution scheme to protect the public interest. After resolution but before full market confidence is restored, the liquidity needs of resolved banks might exceed what can be met through regular monetary policy operations or emergency liquidity assistance. All liquidity needs that emerge must be met for resolution to be a success. In the euro area, this can only be done credibly for systemically important banks by the central bank.

By: Maria Demertzis, Inês Goncalves Raposo, Pia Hüttl and Guntram B. Wolff Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 22, 2018
Read about event More on this topic

Past Event

Past Event

Reviewing the EU fiscal framework

What are the positive and negative developments and is there scope for improvement?

Speakers: Niels Thygesen and Anne-Laure Delatte Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 22, 2018
Read article More on this topic

Blog Post

Euro-area sovereign bond holdings: An update on the impact of quantitative easing

Since the European Central Bank’s announcement of its quantitative easing (QE) programme in January 2015, national central banks have been buying government and national agency bonds. In this post the authors look at the effect of QE on sectoral holdings of government bonds, updating the calculations published initially in May 2016.

By: Michael Baltensperger and Bowen Call Topic: European Macroeconomics & Governance Date: November 20, 2018
Read article Download PDF More on this topic More by this author

External Publication

Euro area reform: An anatomy of the debate

A year ago, a group of 14 French and German economists joined forces with the aim of forging common proposals for euro area reforms. Their report gave rise to a lively discussion among officials and academics. This Policy Insight summarises the group's proposals and also addresses some of the points raised in a subsequent VoxEU.org debate on the topic.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: November 5, 2018
Read article More on this topic More by this author

Opinion

Plädoyer gegen eine Politik der Scheinlösungen

Der Daueraufschwung verdeckt, dass Deutschland für die nächste Krise schlecht gerüstet ist. Und das Zeitfenster für Reformen schließt sich.

By: Jochen Andritzky Topic: European Macroeconomics & Governance Date: October 31, 2018
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: How to improve anti-money laundering efforts in Europe

In this episode, Bruegel senior fellow Nicolas Véron joins Sean Gibson to discuss the recent Policy Contribution on how to better the European Union anti-money laundering (AML) regime, a paper he has co-written with Joshua Kirschenbaum.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: October 30, 2018
Read article Download PDF More on this topic

Policy Contribution

A better European Union architecture to fight money laundering

A series of banking scandals in multiple EU countries has underlined the shortcomings of Europe's anti-money laundering regime. The impact of these shortcomings has been further underlined by changing geopolitics and by the new reality of European banking union. The imperative of establishing sound supervisory incentives to fight illicit finance effectively demands a stronger EU-level role in anti-money laundering supervision. The authors here detail their plan for a new European unitary architecture, centred on a new European anti-money laundering authority that would work on the basis of deep relationships with national authorities.

By: Joshua Kirschenbaum and Nicolas Véron Topic: European Macroeconomics & Governance Date: October 25, 2018
Read article Download PDF More on this topic

Policy Contribution

European fiscal rules require a major overhaul

In this Policy Contribution prepared for the French Conseil d’Analyse Économique, the authors assess current European fiscal rules and propose a major simplification. They recommend substituting the numerous rules with a new simple one, which would help reconcile fiscal prudence and macroeconomic stabilisation of the economy.

By: Zsolt Darvas, Philippe Martin and Xavier Ragot Topic: European Macroeconomics & Governance Date: October 24, 2018
Read about event More on this topic

Past Event

Past Event

Europe: Back to the future of a political project

This event will feature a discussion on different ideas for reforming European Governance.

Speakers: Ulrike Guerot, Adriaan Schout and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 23, 2018
Read article More on this topic More by this author

Opinion

Can Eurozone Reform Help Contain Trump?

The Trump administration knows that a key source of US economic leverage is the dollar’s role as the world’s dominant reserve currency. Countering America’s disproportionate power to destabilize the global economy thus requires reducing the share of international trade conducted in dollars.

By: Jochen Andritzky Topic: Global Economics & Governance Date: October 17, 2018
Load more posts