ESM economists want to raise public debt limit to 100% of GDP

Logo of the European Stability Mechanism. [Kent Johansson (shutterstock 1808498860)]

In a new discussion paper, economists at the EU’s bailout fund have suggested a simplification of the  bloc’s fiscal rules. Their contribution comes a week after the Commission relaunched a review of the EU’s fiscal rules.

The European Stability Mechanism’s economists are unlikely radicals. The ESM is responsible for providing emergency fiscal support to member states in case of financial distress.

New economic reality

In their discussion paper, the authors praise the EU’s fiscal framework for having helped to improve fiscal coordination and for having contributed to a position that allowed the EU to react to the economic shock delivered by the pandemic.

Still, they see a need for the EU’s fiscal rules to change. The economists claim that a “new economic reality necessitates a fresh look at the European fiscal rules.” These new economic realities are the low borrowing costs for EU member states and the high levels of debt after the pandemic.

Moreover, the authors criticise the current fiscal framework for its complexity.

A higher limit to public debt

In concrete terms, the authors argue that the limit on public debt levels should be raised from 60% of GDP to 100% of GDP. They suggest, however, to keep the current deficit rule that limits yearly deficits at a maximum of 3% of GDP.

Additionally, the ESM economists suggest to replace the rules on the structural deficit with an expenditure rule. The rules that currently limit structural deficits have been criticised for their reliance on unobservable variables and opaque calculation methods.

The expenditure rule they suggest would limit the public expenditure of all member states. If the ESM economists had it their way, expenditures would not grow faster than the economic growth trend in these countries.

In today’s fiscal rules, countries with debt levels above 60% of GDP have to reduce their debt levels by a twentieth of the difference between their current debt levels and the 60% threshold. For a highly indebted country like Italy, this would mean that it would have to reduce debt levels by around 5% per year, thereby stifling economic growth.

Lowering debt levels is still the goal

The ESM economists argue that states should continue to adhere to the principle of decreasing debt levels if they are above 100% of GDP. To this end, countries should have primary surpluses in all years, even in times of an economic downturn.

Last week, the EU commission relaunched a review of the EU’s fiscal rules that have long been subject to intense arguments. Commissioner Paolo Gentiloni called for a broad debate “without taboos”. The Commission hopes that the debate will help to overcome the entrenched views on fiscal policy in the EU so that a compromise might become possible.

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The European Commission on Tuesday (19 October) took another step towards reforming the EU’s much-discussed fiscal rules, including the bloc’s strict debt and deficit limits enshrined in the Stability and Growth Pact.

The ESM discussion paper can be seen in the light of this broad debate. Moreover, it is not the first contribution to the debate emanating from this institution.

Shortly before the commission announced the relaunch of its review, ESM president Klaus Regling argued for a reform of the fiscal rules. Regling, who is considered one of the architects of the fiscal framework, warned that some rules might have become “economically nonsensical”.

The Commission is currently gathering feedback from member states and stakeholders and is expected to present its reform proposals in 2022.

Architect of EU fiscal rules calls for reform

Ahead of a new push by the European Commission to reform the EU’s fiscal rules, the chief of the bloc’s bailout fund, Klaus Regling pointed out the danger of sticking to rules that have become “economically nonsensical”.

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