Catching up with Rebecca Christie
A Conversation on Fiscal Governance Reform
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In this conversation with François Valentin, Reuters Columnist and Bruegel Non-resident Fellow Rebecca Christie walks us through everything you need to know the current discussion about the past and future of the EU’s sacrosanct debt-and-deficit rulebook. You can find all of Rebecca’s work at Bruegel here.
Covid-19 really wasn’t really the ‘Hamiltonian’ moment some thought it would be for Europe’s fiscal governance, but the EU never wastes a crisis and sang something along the lines of ‘I am not throwing away my shot’ — click on the link if you’re not familiar with Hamilton, the music hall.
Walk us through the basics — why did the EU equip itself with debt and deficit rules in the first place and what does it say?
Going back to the Maastricht Treaty, the EU tried to put some rules and guardrails around how countries put their budgets together in hopes of keeping everyone on firm footing. The EU now has what is called the ‘European semester’, with country specific conditions, and excessive deficit or debt procedures. It's all very nerdy if you're not actually part of the Brussels bubble.
The idea is that if one country suffers, it might bring down the rest of the group with it. We certainly saw that with the Greek crisis and the contagion that followed at the same time. If Italy, which has huge amounts of government debt, runs into trouble on financial markets, and there's a question about whether it will be able to keep borrowing, then the rest of the euro area either has to think about bailing Italy out or has to risk contagion.
These rules have become more and more and more complex since they were put in place. Now they have turned into these laundry lists of long and detailed requirements.
Overall, compliance with the rules is low. The countries nod and then they do more or less what they were going to do anyway, and the Commission more or less goes along with it with various amounts of stern wording.
After two years during which the Stability and Growth Pact (SGP) was put on pause, the EU pondering on whether these rules are still fit for purpose. In November 2022, the Commission published a Communication setting out its proposal for reforming the SGP. What’s in it?
The new proposal simplifies things, puts a lot more emphasis on negotiation between the Commission and the countries, and it also gives the Commission a lot of flexibility in deciding whether a country is trying hard enough. This flexibility is the real flashpoint between people who support the proposals and people who think they're going in the wrong direction.
The idea is that it's not practical to just dictate your ratio of debt to GDP and then process it through the output gap, which is the difference between theoretically how fast your economy could grow and how your economy is growing. This is how they fudged the numbers in the past.
The Commission would come out and say “OK, your debt to GDP is this, but we take away the temporary factors because of this output gap, so we only judge you on your structural deficit.” This leads to Member States immediately saying “Oh well, if you just change the output gap, my numbers look fine”.
Moving away from that, the Commission wants to acknowledge that life is complicated and that debt can be too high, no matter how you fudge the numbers. So the idea is that by acknowledging upfront that we're going to be a little more flexible about it, the countries themselves will accept that the principles are sound and work harder to meet them.
The big advantages of the proposal are the flexibility and the ability for the countries to take a really active role in setting their own targets. If Member States design their own targets, they're more likely to meet them and focus on the medium term because it's the three to five year horizon where markets really want to see that things are getting better and moving in the right direction.
The debate over flexibility versus rigidity has been going on for a while. Is it fair to say it has been mostly unproductive over the last decade or so?
The debate between rigidity and flexibility has been going on forever. And it's never helped by the fact that the big countries — Germany and France — are rarely held accountable to the letter of the law. You get in a situation where if you tell Germany “OK, your trade surplus is technically too big. But we're not going to cause a fuss”. How can you come down on somebody else? Likewise, if the French don't meet their budget targets in terms of their deficit to GDP, or their debt to GDP, France isn't really in that much trouble. Then, what kind of precedents do you set?
The question is how do you juggle setting an example with being practical and keeping things going? The more detailed you get, the longer your list gets, the more it becomes patently impossible for any country to check off every item on that list.
People have known this for a long time since the COVID pandemic and since the dramatic change in fiscal policy that came from that, everybody had to start spending to get their economies through and now with the war in Ukraine, everybody has to keep spending to preserve their energy security for this winter and the one after that.
Each crisis that the euro area has had going back for the last 10 or 15 years has brought a tiny step forward or in some cases a bigger step forward on fiscal integration. The lesson for the EU is never to waste a good crisis.
In the US, the TARP program put together at the height of the global financial crisis was $750 billion. In the end they spent about a third of that on the banks. They spent a little more on housing in the automobile companies. But about a third of that came back in a few years later. One of the reasons it worked was because they obviously had enough capacity to deal with the need
The euro area did not originally do that. When Greece was first in trouble during the eurozone crisis, the initial reaction was debating what is the smallest possible help we can provide to Greece to get the markets off our back but also set an example that we're not just going to hand out money. What they learned was that trying to ration the amount of aid to the amount of need that tightly was a recipe for failure. If you try to cut it that close, with no margin, the first thing the markets are going to do is push you over the edge, even if they might not have otherwise. The second bailout for Greece was closer, but also too small. The bailout that was most successful was the one for Spain. Why? Because the EU gave Spain 100 billion and Spain spent less than 40.
Do you think the European Union now is getting to a point where it is just more comfortable with those larger stimulus packages to support economies that are in trouble? Or is this really sort of only a short-term reaction to the emergency circumstances of Covid-19?
Covid-19 absolutely made EU countries feel more comfortable spending money because it was a clear external threat. Nobody was going to argue that the virus was a thing that Europe had brought on itself. The EU is moving toward investment and towards stimulus in hopes of not needing bailouts and rescues. And that's good. There is a difference between stimulus and bailout. And there is a difference between investment and economic rescue.
What we saw was the euro area first decided to borrow money using an intergovernmental series of guarantees. That was called the EFSF. It worked, but markets didn't really love it because it was clearly just a collection of people borrowing together. And so the credit rating was very much dependent on how many AAA countries were part of the club at.
Then Europe moved to the ESM, which was also intergovernmental and dependent on the votes of the biggest Member States, but the difference was that it had its own money. The ESM had some paid in capital, which meant that the markets could count on at least some money sitting there in the bank as opposed to being entirely reliant on guarantees.
When Covid-19 came around, many Member States had realized that they didn't like this intergovernmental way of making decisions. When you do it outside the EU institutions, you also give up the checks and balances that people have gotten used to between the big Member States and the smaller Member States. So at that point people were finally ready to bring it into the institutional solutions even if this also meant they had to take more responsibility for the debt together. It's still a club. It's still not a sovereign borrower, it's still what they call a super national borrower. The money that the EU borrows on public markets is still a collection of countries and not one joint thing like the United States.
The fact that people have gotten comfortable with these iterative incremental joining of forces means that now they can go to the markets for a lot more money and just breathe easier that the system is going to work as planned.
When the EU eventually issued common debt in the wake on Covid-19, comparisons were drawn with James Hamilton, who created common federal debt in the US as a means to make sure the states would stick together.
It was a great move. It showed a lot of leadership. And a lot of willingness to reverse policy on the part of the Germans. The Germans realized that after years of emphasizing fiscal responsibility that they were going to have to spend to get through this and they did it. I give them enormous credit for that and therefore showing the leadership that allowed other people to follow in their place.
It was a Hamiltonian moment in that the EU went from borrowing very small amounts to borrowing substantial sums on capital markets — going from 20 or 30 billion a year to 100+ billion a year. It was not a Hamiltonian moment in that it is temporary.
Markets are hoping it will become permanent. As long as it's temporary, the EU is going to be paying more to borrow than it would otherwise, and it's going to be lacking that confidence that could get it through the next crisis more easily. Doing a series of temporary programs is not the same as having something permanent.
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