The EU is once again tightening fiscal discipline

European Union finance ministers have agreed on the general principles of reforming European fiscal rules to bring them in line with post-pandemic economic realities, but a document said key details had yet to be agreed upon, Reuters reported. The draft conclusions of the meeting of the EU’s 27 finance ministers showed that EU countries support a large part of the European Commission’s proposal presented last November, but its practical implementation is still a challenge.

Under the proposal, the EU’s existing limit of 3% of GDP on the budget deficit and 60% of GDP on the debt would remain unchanged.

Governments with higher debt will negotiate with the Commission individual debt reduction plans related to reforms and investment, deviating from the universal rule of annual debt reduction of 1/20 of the excess above 60% of GDP.

Due to the fact that many EU countries have debt that significantly exceeds the EU limit, they will have a period of four to seven years to reduce it, which will be agreed upon with the Commission based on the Commission’s analysis of debt sustainability.

The debt will be reduced gradually through limits set on annual net primary spending – spending that excludes one-time income, interest, or cyclical unemployment costs – which the government directly controls. This would be an improvement over the unobservable and revisional structural deficit that is the focus now and which finance ministers strongly dislike.

In the event of shocks to the economy beyond a government’s control, there would be a “derogation clause” that would allow it to temporarily deviate from the agreed debt-reduction deal, although it would have to be approved by other governments. While EU finance ministers agree on these issues, there are many others where they disagree.

Chief among them is the methodology of the Commission’s debt sustainability analysis, on which much of the debt reduction deal hinges and which would limit the government’s borrowing and spending powers. Equally controversial is the question of whether there should be any numerical criteria for debt reduction that are common to all countries, even if they negotiate individual paths, and if so, what they should be.

Other open questions include the new framework’s requirements for those countries that do not have serious debt problems, how to determine the spending package, exactly when a government should be given more time to reduce debt and how to implement the agreed plans.

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