Plea for solid public finances

The ECB’s hands would be tied. It could not act against the recent massive rise in inflation risks, or against the dangerously rapid rise in house prices for years. The rules for limiting national debt, which are unpopular in many EU countries, were suspended at the beginning of the pandemic. Before they apply again at the beginning of next year, they should be revised. The EU Commission will present its plans in spring.

But both politicians set the wrong priorities. The real problem with the regulatory framework is not too little, but too much flexibility. After all, many countries could get into excessive debt for years.

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Their preventive arm shows how lax the budget rules are already today. With it, the EU wants to ensure a budget deficit adjusted for cyclical fluctuations of no more than 0.5 percent of gross domestic product in the medium term. If the deficit ratio is above this threshold, it should be reduced by 0.5 percentage points every year until the goal of a budget that is almost in balance in the medium term is achieved. So far so good.

The consolidation goal has already been softened

However, there are numerous exceptions to this consolidation path, which is not ambitious in any case. Reforms that have already been planned are sufficient for this, even if they only hold the prospect of increasing future economic growth and thus the debt sustainability of a state. Investment expenditure can also be deducted from the deficits, provided it is co-financed by EU funds.

If a state does not achieve such a softened consolidation goal itself, that in no way automatically means sanctions. Because the EU Commission can classify a failure to meet the budget target as insignificant without there being any specific criteria.

And even if the Commission should discover a serious violation, in the end the EU heads of state and government would have the last word, who naturally find it difficult to pillory one of their own. It is not surprising that no member country has yet been sanctioned.

The corrective arm of the budget rules, which does not address the planned budget deficits, but primarily relates to the actual deficit of the previous year, which should not exceed three percent of the gross domestic product, is similarly weak. Here, too, no sanctions have yet been imposed due to numerous exceptions and discretionary leeway, although many countries have systematically borrowed too much since the introduction of the euro.

All in all, the EU budget rules suffer from the fact that they have been massively weakened. It is wrong for France and Italy to want even more flexibility. If a functioning monetary union requires solid national budgets as a counterpart, then the many exceptions to the fiscal rules must be cut along with political discretion. In addition, only a few budget metrics should decide whether a country adheres to the rules or is sanctioned for violations.

EU Commission does not enforce budget rules

As with the debt brake of our Basic Law, the focus should be on the budget deficit adjusted for cyclical fluctuations. On the other hand, skepticism is appropriate with the proposal to relate the fiscal rules to government spending planned for several years. There is a great risk that income will be overestimated and expenses will rise too quickly for too long without countermeasures being taken.

In addition to simplifying the budget rules and making them binding, further reforms are conceivable: First, the EU Commission should no longer be the central authority for monitoring the budgets. Because she is apparently unwilling to enforce the budget rules.

This has never been clearer than the then Commission President Jean-Claude Juncker justified exceptions for a French budget deficit that was too high with the sentence “Because it is France”. Part of a reform pact should therefore be entrusting an independent European budgetary supervisor with monitoring the rules.

Second, an active economic policy should be made possible within the framework of the budgetary rules. It is true that the rules for cyclically adjusted budget deficits allow additional expenditure, which becomes due in a bad economic situation, for example because of increasing expenditure on unemployment benefits.

But many member states want to go beyond these so-called automatic stabilizers to pursue economic policy. In order to ensure that the necessary funds do not lead to even higher debts, reserves should be built up beforehand in good times so that they can be used to stabilize demand in bad economic times.

Third, budget rules can be designed to encourage investment. Politicians often prefer to increase social spending rather than investing in infrastructure, because this regularly comes up against the prostate of affected citizens and requires lengthy approval procedures.

This distortion at the expense of investments could be mitigated by the fact that in the preventive arm of the fiscal rules, a cyclically adjusted budget deficit of 0.5 percent of gross domestic product is only allowed if the state makes investments of at least the same amount in addition to the necessary depreciation.

Adjust budget deficits for Brussels transfers

This proposal, which goes back to the Bundesbank, deliberately limits the amount of eligible investments. Finally, government investment can crowd out private investment, which is usually more efficient. It is also important to only consider real state investments in the sense of the national accounts and not, for example, consumer expenditure re-labeled as investments.

Fourth, budget rules should take into account the Corona Recovery Fund. Financed by EU debts, it not only grants loans to the member states, but also provides large-scale grants. These transfer payments from Brussels are revenue of the member states and reduce their budget deficits.

But economically they do not change the budgetary position, because the states later have to repay the EU transfers like loans – either through higher national contributions to the EU budget or through new EU taxes that citizens would have to pay. As part of the EU budget rules, the national budget deficits should therefore be adjusted by the Brussels transfers.

More: The euro’s debt burden.

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