The International Monetary Fund has called for an overhaul of Europe’s fiscal rules, saying the system which was reinforced at the height of the debt crisis hampers effective monitoring and public communication.
Officials in the Washington-based fund said in a 20-page paper that EU leaders should introduce a simpler framework, bolster enforcement and bring in a single fiscal anchor with a single operational rule.
They argued for a “two-pillar approach with a single fiscal anchor (the public debt-to-GDP ratio) and a single operational target (an expenditure growth rule, possibly with an explicit, that is, formal and deterministic, debt-correction mechanism) linked to the anchor”.
Such an approach, they said, would help to safeguard fiscal sustainability and macroeconomic stability while also facilitating monitoring and public communication.
“Several additional steps would improve implementation of the simpler fiscal framework and support compliance,” said the paper.
“These include: (1) greater automaticity in enforcement with a gradual step-up of monitoring and constraints; (2) a more credible set of sanctions that better reflect prevailing economic circumstances; and (3) a better co-ordination of fiscal policy monitoring between national fiscal councils and the [European] commission.”
Pointing out that public debt was at a record high, the paper sought a redesign of the fiscal governance framework to prevent a further build up of fiscal imbalances.
National ownership
“The elaborate set of fiscal constraints that make up the overall framework complicates effective monitoring, public communication, as well as national ownership and implementation,” the paper said.
Implementation was hampered by overlaps that may lead to inconsistencies or redundancy in actions implied by the rules. “The sheer number of rules poses an implementation burden on EU member states, hindering transparency. The EU imposes a larger set of constraints on member governments than most federations do; while the EU is not a federation, these are the closest comparators,” it said.
The paper went on to say changes in underlying economic fundamentals led to inconsistencies in the current configuration of numeric targets.
“For example, a 3 per cent deficit target is consistent with a 60 per cent debt level over the medium term only if nominal growth is slightly more than 5 per cent.
“However, potential growth has been revised down since the crisis, with medium term nominal growth now thought to be about 3 per cent in many euro area economies. This implies a 100 per cent of GDP debt level over the medium-term, resulting in an inconsistency between the existing debt and deficit targets; in other words, the action path implied by the deficit target diverges from that required by the debt target.”
Public debt
The paper said EU states were ill-prepared when crisis hit in 2008. “A severe economic downturn and large private-sector imbalances, which in part turned into public-sector liabilities, led to dramatic surges in debt ratios: public debt soared to an average of 95 per cent in 2014 – almost 30 percentage points above average pre-crisis levels.
“This further strained fiscal rules, especially those that were set in nominal terms and did not foresee exceptional circumstances. Failure to build sufficient buffers in good times led to the need to tighten fiscal policies in bad times.”
