21st Mar 2018

EU rules should focus on debt not deficit targets, says IMF official

  • "Plenty of room for improvement," to eurozone rules, Olli Rehn conceded at the Brussels Economic Forum

The EU’s rules on cutting national budget deficits discourage public investment and "imply procyclicality," prolonging the effects of a recession, a senior IMF official has said.

Speaking on Tuesday (10 June) at the Brussels Economic Forum, Reza Moghadam said that reducing national debt piles should be the focus of the EU’s governance regime, adding that the rules featured “too many operational targets” and a “labyrinth of rules that is difficult to communicate.”

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“Debt dynamics i.e., the evolution of the debt-GDP ratio, should be the single fiscal anchor, and a measure of the structural balance the single operational target,” said Moghadam, who heads the Fund’s European department.

“The rules are still overlapping, over specified and detract focus from the overall aim of debt sustainability,” he said.

The bloc’s stability pact drafted in the early 1990s, and reinforced by the EU’s new governance regime, requires governments to keep to a maximum deficit of 3 percent and a debt to GDP ratio of 60 percent.

However, six years after the start of the financial crisis, the average debt burden has swelled to just under 90 percent of economic output, although years of prolonged budget austerity have succeeded in reducing the average deficit exactly to the 3 percent limit.

But critics of the rules say they were drawn up when countries were anticipating prolonged economic growth at rates of between 3 and 5 percent, a far cry from the EU’s expectations post-financial crisis.

Others argue that the regime is inflexible and forces governments to slash public spending when it is most needed at the height of a recession.

“Fiscal frameworks actively discourage investment....and imply pro-cyclicality and tightening at the most difficult times,” commented Morghadam, who noted that “they had to be de facto suspended during the crisis.”

Procyclical policies are seen as those which accentuate economic or financial conditions, as opposed to counter-cyclical measures which can stimulate economic output through infrastructure spending during a recession.

Italian prime minister Matteo Renzi has indicated that he will use his country's six-month EU presidency, which starts in July, to push for the budget rules to be temporarily loosened for governments who invest in growth-fostering reforms such as infrastructure projects or research and innovation.

Italy remains within the 3 percent deficit limit, but a stagnant economy has pushed its overall debt level to 133 percent of GDP, second in size only to Greece in the EU.

However, the idea of having an investment 'golden rule' in the regime was left out of the EU’s revised economic governance regime.

For his part, Morghadam said that a mechanism to exclude public investment from deficit calculations “would not be desirable and encourage creative accounting”.

Instead he called for the EU to have a greater role in funding public infrastructure projects through public/private partnerships.

In response, economic affairs commissioner Olli Rehn, a chief architect of the new regime, conceded that there was “plenty of room to simplify the rules,” but added a caveat.

“If you simplify the rules excessively it is difficult to avoid making them pro-cyclical,” he said.


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