EU Economic Policy and Architecture after Covid

The role of fiscal rules is to ensure debt sustainability and predictability of fiscal policies. It is possible to make them simpler and more friendly to countercyclical policies. Rather than allowing for different investment priorities, this column argues that the Covid crisis, the climate emergency, and Russia's invasion of Ukraine and subsequent security concerns may require a holistic approach where better compliance with fiscal rules could be combined with a holistic definition of sustainability that would also include macroeconomic and green sustainability.

Debt ratios of EMU member states, which were already high in some cases, have increased significantly during the pandemic. This column argues that the current review of the European fiscal framework should not only discuss the design of the framework, but also how to strengthen enforcement and increase compliance with the fiscal rules. Increasing the political costs of non-compliance – through a reduction of complexity of the framework, an increase in national ownership and transparency, as well as simplicity of assessment – could help achieve this. Adding more flexibility, exceptions, and discretionary judgement would be counterproductive.

The European fiscal governance framework has grown into an arcane machinery. Yet, experts’ convergence on the need for a more effective and simpler system falls on political deaf ears. Greater reliance on national fiscal frameworks could significantly strengthen European fiscal governance while passing political hurdles. The authors of this column see value in further strengthening national ownership of fiscal responsibility while keeping central safeguards against risky fiscal behaviour.

Over the last few years, there has been a growing consensus that the current rules of the Stability and Growth Pact are outdated, too complicated, and not countercyclical enough. The authors of this column present a proposal to strengthen the European fiscal framework based on two elements: a revision of the fiscal rules, and a plan to create a European Debt Agency to absorb the debt accumulated during the pandemic. This first of two parts focuses on the fiscal rules and proposes setting a ceiling on the growth rate of primary spending, to be revised over three-year intervals, targeting debt reduction over a ten-year horizon.

The stability and adequacy of the European monetary and fiscal frameworks are increasingly challenged by enduring changes in the economic environment. This column summarises the findings of a group of economists and lawyers specialised in EU matters who undertook a comprehensive assessment of the economic requirements and legal conditions of a well-functioning macroeconomic policy system for the EU and the euro area. They propose reforms of economic framework in line with economic necessities along three dimensions (coordination of fiscal and monetary policies, fiscal rules, and fiscal capacity at EU level) and assess their legal feasibility. They conclude that meaningful reforms that would bring legal clarity and improve economic performance are feasible within the confines of existing primary law.

The euro area’s economic policy framework was created in the early 1990s, when neutral interest rates were positive and the main risk was excessive inflation. This column argues that today’s world is very different from the 1990s, and thus requires a new  economic policy framework where monetary and fiscal policy can work together effectively to support inflation and growth. The author identifies flaws in the current euro area fiscal framework and suggests how these could be fixed and complemented with a simple, state-contingent fiscal policy rule that achieves the right balance between supporting growth and inflation and ensuring debt sustainability.

The temporary suspension of the European fiscal rules to enable member states to take emergency measures against the Covid crisis offers an opportunity for an ambitious reform of a now clearly outdated fiscal framework. This column, part of the Vox debate on euro area reform, argues that the reactivation of the rules, now foreseen in 2023, should be made contingent on a political agreement on reforming the fiscal framework, and proposes a comprehensive reform in which the new European fiscal framework would prioritise externalities arising from debt sustainability risks and demand spillovers. Fiscal targets should be differentiated depending on country vulnerabilities and implemented in a more decentralised way. 

The financial crisis of 2007-2012 was the first wake up call to the inadequacy of the euro area architecture when facing a large systemic crisis. This column explains why the Covid crisis will leave a deeper impact on the European policy system, and re-introduces the Vox debate on Europe’s economic architecture in the context of the transformations that we have witnessed over the past year. Contributions to the debate are welcome.

The desire to avoid credit and investment boom-bust cycles has led some to advocate replacing money creation through bank credit extension with direct money issuance by the central bank or a private entity, or linking money to an existing asset. This column, part of the Vox debate on euro area reform, argues that relaunching the euro as digital central bank currency could help reduce the debt of the euro states and end the sovereign-bank doom loop. It would also create a formidable competitor for other global digital currencies likely to emerge in the intermediate future.

At a leaders’ summit in June 2012, euro area governments recognised the imperative of breaking the doom loop resulting from sovereigns being exposed to bank risk and vice versa. But bank regulation still treats sovereign debt as risk-free and does not penalise concentrated portfolios. This column, part of the Vox debate on euro area reform, asks whether banks would reduce portfolio concentration in response to reforms, and whether they would reduce exposures to sovereign credit risk. Simulations show that the answer is never an unambiguous and simultaneous ‘yes’ to both questions under reforms envisaged by the Basel Committee on Banking Supervision.

Calls to complement national automatic stabilisers and the ongoing financial integration in the euro area with a common fiscal instrument have provoked a mixed response. This column, part of the VoxEU debate on euro area reform, uses a dynamic stochastic general equilibrium model of the euro area to show that fiscal risk sharing brings an additional layer of stabilisation compared to national stabilisers, particularly when monetary policy is constrained by the effective lower bound. It also argues that an unemployment reinsurance scheme could be designed in such a way that it would benefit all members of the currency area and would not lead to permanent transfers among countries.

Reforming the EU’s rules is particularly important at the present juncture – governments must take advantage of the current environment to prepare for the next crisis. This column, part of the Vox debate on euro area reform, outlines the European Fiscal Board’s proposals for a major overhaul of the EU fiscal framework, which it argues would result in a simpler and more transparent framework thanks to the use of a single budgetary anchor and a single observable operational target.

European fiscal rules have become overly complex over time. Some consider them too lax to ensure fiscal sustainability, while others see them as too rigid to ensure adequate smoothing of economic activity in bad times. This column, part of the Vox debate on euro area reform, argues that to make the rules more effective, they should be simplified and focus on expenditure growth, while avoiding reliance on unobservable concepts such as structural fiscal balances. Increased ownership requires more flexibility and built-in positive incentives, such as allowing deviations when financed with GDP-linked bonds, which would also improve fiscal sustainability.

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 column summarises the group's proposals and also addresses some of the points raised in a subsequent Vox debate on the topic.

Proposals for reforming the euro area back on the agenda. An overhaul of the European fiscal rules should be on high on this agenda, because the current fiscal framework has not worked well. This column proposes substituting the numerous and complex present rules with a new, simple rule focused on limiting annual growth rate of expenditures.

The proposed package of reforms from the team of French and German economists aimed at increasing the stability of the euro area has sparked a lively debate on Vox. In this column, two of the paper’s authors respond to some of the criticisms of their proposals, focusing on the broad issues of debt restructuring as ‘ultima ratio’ and regulating banks’ sovereign exposures.

The euro area debt crisis saw the region ravaged by multiple sovereign bond doom loops and has inspired several proposals for a single safe asset for the region. While a lack of political consensus has proven the main obstacle to date, technical issues relating to the complexity of splitting the existing sovereign debt stock and concerns on contagion amongst senior and junior debt structures also weigh in. This column, part of the VoxEU debate on euro area reform, illustrates how a 20-year Purple bond transition could address these issues and offer a path to genuine Eurobonds.

EU leaders addressed euro area reform at the Euro Summit on 29 June. In this column, which we add to the VoxEU debate on euro area reform, the group of 14 French and German economists behind the recent CEPR Policy Insight on the topic argue that the summit statement represents a constructive first step and crosses red lines that were considered taboos only a few months ago. However, the summit’s commitments still fall short of a comprehensive package.

The authors of the recent CEPR Policy Insight argue that the euro area needs an alternative to the current system of fiscal rules and financial penalties to discipline fiscally wayward members. This column, part of the VoxEU debate on euro area reform, argues that by not complementing their proposals with recommendations in the monetary realm, the authors have missed an opportunity to provide a balanced reform package that would not only increase fiscal discipline and risk sharing, but also enhance liquidity provision.

The euro area lacks a common safe asset, leaving banks to rely on bonds issued by their own countries and thus magnifying fiscal crises and contributing to financial fragmentation. To address this problem, an influential proposal advocates sovereign-bond backed securities, the most senior of which would play the role of safe asset. This column, which introduces a new CEPR Policy Insight, investigates whether criticism of the proposal’s reliance on securitisation is justified and compares it with alternatives that would not require tranching.

For the euro area to be stable and move forward productively, substantial improvements in its operation are required. This column, part of the VoxEU Euro Area Reform debate, argues that the proposals in the recent CEPR Policy Insight are necessary if the euro area is to avoid another catastrophic crisis and that they would go a long way towards addressing the legitimate concerns of citizens in both the core and periphery of the euro area.

Several euro area leaders have recently referred to the need to "complete the Banking Union". This column, part of VoxEU's Euro Area Reform debate, asks what would be required for Banking Union to be considered "complete", and makes the case for a modest approach to breaking the vicious circle between banks and sovereigns.

The key question in the policy debate on the next steps for the Economic and Monetary Union seems to be whether we can progress with integration in a context where some countries perceive themselves as consistently paying for policy mistakes of others, while others see themselves victims of a moral diktat. This column, adding to VoxEU's Euro Area Reform debate, argues that the policy dilemma around a central fiscal capacity can only be overcome if fiscal risk sharing and risk reduction advance in parallel. Therefore, reform of EU fiscal rules need to receive more attention. 

When thinking about what will determine the prosperity and well-being of citizens living in the euro area, five issues are central. This column, part of VoxEU's Euro Area Reform debate, argues that the important CEPR Policy Insight by a team of French and German economists makes an important contribution to two of them, but leaves aside some of the most crucial ones: European public goods, a proper fiscal stance and major national reforms. It also argues that its compromise on sovereign debt appears unbalanced.

There is currently both an economic and a political window of opportunity for reform in the euro area. This column, which forms part of VoxEU's Euro Area Reform debate, discusses the strengths and weaknesses of the proposals in the recent CEPR Policy Insight and makes recommendations for extensions and alternatives.

Deposit insurance, like any insurance scheme, raises moral hazard concerns. Such concerns arising from European deposit insurance can be alleviated through a country-specific component in the risk-based premium for deposit insurance and limits on sovereign bond exposures on bank balance sheets. This column, which forms part of VoxEU's Euro Area Reform debate, argues, however, that proposals to maintain national compartments in a new European Deposit Insurance Scheme are self-defeating, as such compartments can be destabilising in times of crisis.

The recently published CEPR Policy Insight by a team of French and German economists proposes a package of reforms to make progress on risk sharing and risk reduction in the euro area. This column, which forms part of VoxEU's Euro Area Reform debate, argues that while many of the package’s elements make sense, it leaves too many questions open and fails to address a number of central problems of EMU architecture.

Many EU-level reports have highlighted a European Deposit Insurance Scheme as a necessary component of banking union, but none of these options has met sufficient consensus among euro area countries. The authors of this column, which joins VoxEU's Euro Area Reform debate, propose to end the deadlock with a design that is institutionally integrated but financed in a way that is differentiated across countries.