bne IntelliNews – GLOBSEC: No debt ratio is safe for small EU countries


Shortly after the arrival of the COVID-19 pandemic in Europe more than a year ago, the European Union (EU) triggered the escape clause of the Stability and Growth Pact (SGP), removing the EU public debt and budget deficit ceilings. The SGP clause supposes a return to the status quo after the disappearance of the effects of the pandemic. Nonetheless, there is a consensus among economic observers that the disruption caused by the pandemic provides a window of opportunity to reform these fiscal rules before they are restored, building on the common fiscal response to the pandemic that was previously unimaginable.

SGP rules – designed to ensure that EU members commit to sound public finances and coordinate their fiscal policies – cap countries’ budget deficits at 3% of GDP and public debt at 60% of GDP. But the suspension of the rule gave member states the freedom to pursue different macroeconomic policies – rekindling the debate around these goals.

One of the reasons the PSC has been criticized is for imposing fiscal austerity during recessions. Critics argue that it should more effectively balance debt sustainability and fiscal stabilization in the event of a shock, but such an endeavor would require even more complex rules. Research suggests that the inherently pro-cyclical corrective arm of the SGP is an important driver of euro area fiscal policy. It is the preventive arm – designed to avoid resorting to such procyclical policies – based on synthetic and difficult to measure indicators such as the output gap – where reform efforts should be concentrated.

No formal proposal from the European Fiscal Council or the European Commission has so far been submitted for consideration. But Olivier Blanchard and his colleagues provided ideas on how to redesign the EU’s fiscal rules, with an emphasis on a shift to qualitative standards that leave room for judgment to replace existing rules that are invariant by country and in the weather. In this way, each member state would manage its own fiscal issues with debt sustainability in mind, in line with New Zealand’s “Responsible Fiscal Management Principles”.

The obvious advantage of such a standards-based approach is that it could solve measurement problems in the current framework. Instead, countries would essentially target “debt sustainability with high probability”, taking into account changes in the primary fiscal balance, cost of debt, nominal growth rate and existing policies.

But this brings with it the complications of surveillance, enforcement and arbitration, as well as the fact that significant political capital is needed to effectively adopt and maintain such a fundamental reform. The moral hazard argument is essential: Unless accompanied by an additional enforcement channel, the concern is that “soft” fiscal rules could be misused by creative politicians guided by short-term populist goals.

In addition, growth differentials of negative interest rates (the difference between the average (implicit) interest rate governments pay on their debt and the (nominal) growth rate of the economy) have since become commonplace. the global financial crisis and are expected to persist for some time. . The usual link between persistently high inflation and fiscal lavishness no longer seems to hold, as evidenced by euro area inflation which has hovered well below the ECB’s target over the past decade, despite the loose policy orientation. This generally improves the prospects for debt sustainability, but can also mislead policymakers into concluding that debt sustainability is not an issue at a given level of primary deficit.

From the perspective of smaller EU countries, especially new EU members, easing tax standards has additional implications. New, smaller EU members face higher risk and greater uncertainty with the development of interest rates. Any possible increase in the sum of debt of EU countries affects them disproportionately, and their relatively greater dependence on foreign sovereign debt financing, which stems from the relatively small size of their markets. financial institutions and the high degree of foreign ownership, gives them less freedom to maneuver in times of stress.

Indeed, we’ve been here before: The issue of dominant foreign ownership in the financial markets of small EU member states surfaced during the euro area sovereign debt crisis in 2011, when foreign owners have resorted to domestic bond financing in times of financial turmoil. All of this means that, when assessing debt sustainability in small countries, no debt ratio is absolutely safe for small countries, even if the interest-growth differential remains negative.

The return to health of the euro zone economy after the pandemic will necessarily be accompanied by new deficit spending. This period would be followed by a period of fiscal rebalancing. EU states will ideally realize that negative interest rate differentials will not last forever and will try to do so before the ECB moves towards normalizing monetary policy.

At the same time, the broader context of the current European tax architecture will be revisited, and rightly so. While a redesign towards a ‘one-size-fits-all’ approach may not currently be viable, targeted reform is desirable, along with instruments that have emerged as a result of the SGP, such as the more recent Clawback and Clawback Mechanism. resilience, which could be transformed into a real counter-cyclical fiscal instrument in times of shocks. But, when considering these reforms, we need to do so from the perspective of all Member States, and keep in mind that even small economies have the potential to trigger much bigger upheavals.

Ivan Šramko is a former Chairman of the Council for Fiscal Responsibility, Governor of the National Bank of Slovakia and Ambassador of the OECD. Soňa Muzikárova is Chief Economist at GLOBSEC, a leading think tank in Central Europe.

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John A. Bogar

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