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23rd Jan 2022

'Frugals' renew effort to reduce excessive debt

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Finance ministers of eight EU member states released a signed letter on Friday (10 September) calling for a renewed effort to "reduce excessive debt" among member states.

It is the starting point for renewed debates on fiscal policy in Europe, specifically on the fate of the so-called Stability and Growth pact.

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The Stability and Growth pact is a disciplinary rule that limits spending by member states. It entered into force in 1998, and it prohibits countries from running a deficit upwards of three percent and limits the debt to GDP-ration to 60 percent.

Although the rules have been violated some 114 times between 1999 and 2016 without consequences, it has been an important tool for member states that run a current account surplus to discipline countries that run a deficit.

Following the financial crisis in 2008, and pressure from German and Dutch governments, Greece, Italy, Spain, and Portugal were among the countries that cut public expenditure the most - resulting in persisting economic stagnation or even contraction.

Covid changed the game

In a consequential move, the European Commission suspended the Stability and Growth rules last year to allow countries the fiscal leeway needed to battle the Covid-19 crisis and prevent an economic shutdown.

Now that the Covid-19 crisis is subsiding and the economic outlook has improved, debates on fiscal rules are set to return.

The commission has said it wants to keep the fiscal rules suspended into 2022, echoing Italian prime minister Mario Draghi's calls in June not to reintroduce the pact without reforms.

Now, the so-called frugal 'northern' countries argue for a quick return to the pact. Economists were quick to respond.

"They can't see how economically destructive this would be," Philipp Heimberger, an economist at the Vienna Institute of Economic studies who has studied inflation, tweeted.

"[ECB president] Christine Lagarde presented the best macroeconomic outlook in years," said Jacob Funk Kirkegaard, senior fellow with the Peterson Institute for International Economics, in a discussion attended by EUobserver on the future of the stability and growth pact.

"Do they really want to break all that by reintroducing dramatic fiscal austerity? Do they want the EU to become like Japan? Because that will happen with an unreformed pact."

Lucas Guttenberg, deputy director of the Jacques Delors centre, said in response that the letter is "intellectually dishonest". "I do not think The Hague [the government seat of the Netherlands, the biggest of the frugal states] really wants that. My reading is they don't want to put in the political capital to explain to the electorate why the rules don't work anymore," he told the meeting.

Whatever the political reason for maintaining a hard line on the Stability and Growth pact is, a return to austerity poses another dilemma.

Fiscal austerity vs green investment

In what MEP Paul Tang called a "taboo-breaking report", authors Zsolt Darvas and Guntram Wolff presented the fiscal debate in Europe in the light of the climate crisis.

Their study A Green Fiscal Pact: Climate Investment in Times of Budget Consolidation argues that green investments should be excluded from fiscal restrictions.

If governments exceed agreed-upon rules on deficits and debt to GDP ratio, this should not hamper much-needed investments in green technology and infrastructure.

"To reach the intermediate goal of a 55-percent emissions reduction by 2030," the researchers write, "annual investment needs to increase to €1040bn on average, up from €683bn per year invested over the last decade."

A large proportion of this money will be private investment from banks or other investors. But according to data compiled by the European Investment Bank, 28 percent must be financed by governments themselves.

In real money terms, that means an additional annual public investment of €100bn, or 0.8 percent EU GDP.

Although the authors point out climate change is inherently uncertain, and this number is an estimate based on incomplete data, they warn that an abrupt return to strict fiscal rules can "trigger a new recession".

They conclude that green investments should be excluded from fiscal regulations and should even be increased in the coming years.

On Friday, the research was presented to the Dutch finance minister Wopke Hoekstra. At the time of writing, there was not yet an official response.

Commission warns Italy over high debt level

The Italian government must demonstrate it is making an effort, or the EU will consider launching a procedure. France and Romania are also under scrutiny.

Debt relief talks mar Greek bailout exit

While the Greek government has committed to fulfill the last creditors' requirements in the coming month, Europeans and the International Monetary Fund are still far from an agreement on measures to reduce the country's debt in the future.

Analysis

Will the new Dutch government be more pro-EU?

The new Dutch government has taken office, with left-leaning liberal Sigrid Kaag taking over the influential ministry of finance from fiscal hawk Wopke Hoekstra.

EU re-launches mammoth fiscal debates

The EU Commission has restarted its effort to rewrite European fiscal rules, but some countries, such as Italy, are off the charts on debt in terms of an existing pact.

EU's Mr Austerity: No need to change debt ceiling

Austrian official and fiscal hawk Alfred Katterl has said the EU's 'stability and growth pact' on national debt-limits should remain sacrosanct, but some economists disagree.

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