A long journey

To think about a reform of European fiscal rules, it may be useful to go back to 1992, when the Maastricht treaty was signed. At that time, macroeconomic policy-making was shaped by the nascent New-Keynesian theory that clearly separated the long term (the “steady-state”) from the short term, with monetary and fiscal policies only having a temporary impact on the real economy. Furthermore, following up on Barro and Gordon (1983), it was believed that central bank independence would fix the time-inconsistency problem of monetary policy: separating monetary from fiscal policy, and assigning a single objective (price stability) to an independent central bank would eliminate the inflation bias, at no cost in terms of employment in the medium run. Incidentally, stabilising inflation would indirectly contribute to output stabilisation in the event of demand shocks, which were considered dominant after the disinflation period of the 1980s was over.

In this context, the European Central Bank (ECB) was assigned euro-wide price stability as its main objective, whereas national governments would use their fiscal policies to react to country-specific shocks. To ensure they had enough fiscal space to do so, and also due to the impact of a sovereign debt crisis on euro-wide financial stability (given the interconnections within the financial sector, see Eichengreen and Wyplosz, 1998), governments were asked to keep their deficits and debts below 3% and 60% of GDP, respectively. They also committed to reach fiscal balance over the medium term. In brief, the organisation of monetary and fiscal policies was considering price stability and fiscal sustainability as the two “common goods” that had to be preserved within a monetary union (see Table 1, 1st column).

Table 1. Monetary and fiscal policies in the euro area: moving away from Maastricht



Post global financial crisis

Post Covid

Policy assignment*

M for common shocks

F for country-specific shocks

M also for country-specific shocks (OMTs)

F also for common shocks (ZLB)

M, F also having to contribute to a smooth green transition


Mostly demand shocks

Also financial crises, sudden stops

Tail risks, supply shocks

Common goods

Price stability, fiscal sustainability

Also financial stability, safe assets

Also climate

*M stands for monetary policy; F stands for fiscal policy.

After the 2008 global financial crisis and subsequent euro area crisis, the assignment of monetary and fiscal policies started to depart from the Maastricht clear separation (Table 1, 2nd column). One reason was the introduction of the “whatever it takes” instrument, namely the outright monetary transactions (OMTs) whereby the ECB could buy potentially unlimited amounts of a specific country’s sovereign debts on the secondary market, conditional on an adjustment programme, in order to “safeguard an appropriate monetary policy transmission and the singleness of the monetary policy” (ECB, 6 Sep. 2012). To achieve this objective, the ECB was recognising its role to buffer idiosyncratic market shocks when the integrity of the euro area is at stake.

A second reason for departing from strict policy separation was the zero lower bound constraint on policy rates and subsequent re-discovery of the policy-mix: fiscal policy had to step in not only in case of idiosyncratic shocks, but also as a complement to monetary policy (see Draghi, 2014). However, the need for such aggregate fiscal stance remained controversial, and it took time before the pro-cyclicality of aggregate fiscal policy in 2011-2013 was recognised.

With the Covid crisis, in 2020, monetary and fiscal policies became fully congruent at euro area level, with the combination of gigantic fiscal support at national and European levels (cf. NextGenEU package and SURE instrument), and of the Pandemic Emergency Purchase Programme (PEPP) by the ECB, on top of its Asset Purchase Programme (APP). The pandemic also acted as a wake-up call concerning climate change, and the policy assignment decided in Maastricht was further rethought: shouldn’t monetary policy contribute, e.g. through its collateral policy, to the needed reallocation of private investments in favour of climate change mitigation? Shouldn’t fiscal policy secure public, green investments over a long period, at the expense of other spending and/or debt reduction? In a nutshell, joint European commitments to reduce greenhouse gas emissions had to be considered as another common good, and macroeconomic policies could not ignore this fact (Table 1, 3rd column).

The strong rebound of the economy in 2021 revealed weaknesses in global supply chains and in energy provision. The steep increase in energy prices, progressively passing on manufacturing and consumer price indices, sounded as a reminder that the economy could be hit not just by demand shocks, but also by supply shocks. Furthermore, the energy transition could well revive such cost-push shocks in the future.

Last but not least, European economies are recovering from the crisis with new legacy debts, and debt-to-GDP ratios have sometimes reached levels that are far from the Maastricht, 60% benchmark.

Which landing area?

It is tempting to assign a long list of objectives to fiscal policy. Despite the multiplication of challenges, though, the objective of fiscal rules remains to ensure fiscal sustainability and raise the predictability of fiscal policy. Adding other objectives would weaken the ability of fiscal rules to reach any of them.

That said, fiscal rules need to adapt to the landscape of high debts and low real interest rates. They also need to enable or even incentivize counter-cyclical policies both in economic downturns and upturns. Finally, they need to be simpler, better enforced and less dependent on unobserved variables (notably the output gap), while at the same time leaving room for judgement and taking into account country-specific situations – somewhat conflicting requirements.

The way to reform fiscal governance in the euro area has been hotly debated among experts since the introduction of the Stability and growth pact, in 1997, and after each reform (mainly 2005 and 2011). After the Covid crisis, some convergence is now visible around four lines (see, e.g., “7+7” report, 2020; European Fiscal Board, 2020; Martin, Pisani-Ferry and Ragot, 2021):

The need to rethink the debt objective: a gradual decline of the debt-to-GDP ratio is warranted to rebuild fiscal buffers and protect governments from self-fulfilling crises as well as large exogenous events. Depending on long-term growth, the same deficit can lead to different debt dynamics, hence to different assessments in terms of fiscal sustainability. This explains the need to focus on debts rather than deficits. However the debt ratio is only partially in the hands of the government, hence the need to complement the debt path with a more operational rule.
An expenditure rule in place of structural balance: in order to fulfil the debt adjustment target, capping expenditure growth seems more appropriate than monitoring the reduction of the structural deficit, since (i) it is easier to communicate and less prone to measurement errors, (ii) it leaves more room for counter-cyclical fiscal policy during a downturn, and (iii) it enforces counter-cyclical fiscal policy also when the economy is booming (see e.g. IMF, 2018).
A differentiation across countries: the 60% debt threshold, dates back to a time where nominal growth was believed to be around 5% yearly on average (hence debt could be stable at 60% of GDP with a 3% deficit). This uniform debt benchmark is now widely recognised to be inappropriate as a medium-term guideline: potential growth is down, debt levels are up, and the never-ending world demand for “safe assets” suggests that higher debt levels can meet a stable demand with still low real borrowing costs. The 60% threshold is especially problematic when combined with the “1/20th rule”, which requires that 1/20th of “excess debt” be eliminated each year. This combination could end up in excessive, pro-cyclical and/or unrealistic fiscal tightening in some countries. In fact, different positions in the cycle and different growth perspectives require different deleveraging speeds.
Compliance and ownership: although the 3% threshold seems to have exerted a “magnet effect” (see Caselli and Wingender, 2018), compliance with the debt rule and medium-term objectives has been somewhat disappointing (European Fiscal Board, 2019). One reason has been the lack of ownership at national level, which itself can be explained by (i) the complexity of the rules, (ii) the limited credibility of the sanctions, and (iii) the “one size fits all” feature of the rules. Simplifying the rules, turning sanctions into incentives, and giving more leeway to governments to propose a debt trajectory are different ways to raise national ownership.

Safeguarding investment

Previous experience of fiscal adjustment in the euro area has demonstrated that sharp spending cuts frequently fall on public investment disproportionally. In reaction, an “investment clause” was introduced in 2015 as a flexibility of the Stability and growth pact, but with very strict strings attached. To start with, only those investments that are co-financed by the EU are eligible. Furthermore, the clause can be called only when the output gap is below -1.5%. Finally, only limited and short-lived deviations of the structural deficit are allowed (less than 0.5 pp, the financial deficit having to stay below the 3% boundary). In brief, the existing investment clause seems to be of little help for the problem at stake, which is to heavily co-invest (along with the private sector) in the green transformation of the economy.

In order to safeguard investment, two routes have been proposed:

A (green) golden rule (Darvas and Wolff, 2021): excluding “green” investments from the calculation of expenditure (or deficit) ceilings would encourage governments to cut current expenditure rather than public investment expenditures. Aside from the risk of “greenwashing”, the main objection to such proposal is that it would lead to departing from the prime objective of the fiscal rules, which is debt sustainability. Granted, accumulated GHG emissions are also a liability and unmitigated climate change would undoubtedly lead to large damage costs and lower GDP, and hence also be a threat to debt sustainability. However, it remains that national debts will have to be served with national budget resources and continuous debt rollover, regardless of the type of expenditures that have been financed through debt. Another problem is that excluding a category of spending would alleviate the pressure to make these expenditures efficient (as measured for instance by their abatement costs) and introduce inefficient distortions between different kinds of spending (e.g. public funding for housing retrofitting would be considered as a green investment but not professional training in this area). Finally, a (green) golden rule would depart from the necessity to simplify the rules and it would require a common and precise definition of what constitutes a “green” investment.
A climate investment fund (Garicano, 2022): since green investment is mostly targeted to achieve a common commitment concerning greenhouse gas emissions (Paris agreement, Fit-for-55 package), a common funding of related investments makes sense. Such an approach would allow to prioritise investment projects across Europe based on their abatement costs, using a single methodology, and building on the experience of NextGenEU. Such a fund could be transitory, ending for instance in 2050 in line with the horizon of EU emissions commitments. It would require a new increase in own resources, which in turn would raise the question of the transfers across the member states. Absent such transfers, a climate investment fund would be close de facto to a golden rule, each Member state financing its own investment (see Darvas, 2022). However, it would allow for financing a key economic and political ambition with a common fiscal tool, safeguarding the simplicity of fiscal rules and incentivising all Member states to invest more in the green transition. Another possibility would be that those countries with lower abatement costs achieve more ambitious reductions in GHG emissions and receive more funding for this purpose. Last but not least, the access to the fund could be conditioned to compliance with fiscal rules, turning existing sanctions into incentives.

The debate on how to safeguard investment will not be settled overnight. The problem is that the commitments to invest in climate change mitigation and adaptation need to be taken without delay. How to square the circle? One possibility could be to include “green” reforms and investments (both physical and human) as one element that would modulate country-specific fiscal requirements upstream, together with the debt level, foreseeable growth prospects, and existing non-fiscal imbalances (the latter should not be forgotten when assessing fiscal sustainability, see e.g. Koll and Watt, 2022). Each Member state would propose a comprehensive strategy to the Commission that would include three elements: (i) a fiscal adjustment path (debt anchor and expenditure growth limit); (ii) concrete green investments and reforms; and (iii) a credible response to macroeconomic imbalances as identified in the country-specific recommendations. After agreement with the Commission, this comprehensive strategy would be considered as a hard commitment from the Member state. The translation of the process across multiyear and yearly commitments would still need to be worked out. Such an approach would be more holistic than the golden rule approach. For instance, a country experiencing tensions in its construction sector and a current-account deficit could be asked to reduce public subsidisation of house retrofitting and accelerate fiscal adjustment accordingly. Conversely, a country with excess savings could be asked to accelerate its investment programme, even though this may temporarily increase its government deficit. Such an approach would be compatible with the introduction of a common investment capacity if that capacity was to be agreed on, but the latter would not be a precondition.

Since monetary unification, much has been learnt about the functioning and deficiencies of the initial setup. Concerning fiscal rules, there has been a tendency to progressively add layers of complexity. The challenge of decarbonisation should not be another occasion to add a layer. Rather, it could be used as an opportunity to adopt a broad approach to sustainability, encompassing its fiscal, financial, macroeconomic and environmental dimensions, and providing the right incentives at national level. Raising ownership upstream could help stricter enforcement downstream.


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