The European Fiscal Board, the EU’s finance watchdog, wants clearer rules and real sanctions to punish profligate member states and limit the European Commission’s discretion to interpret the Stability and Growth Pact.

Looking ahead, the board adds that a fiscal capacity – or budget – for the eurozone would be “useful”, echoing calls from French President Emmanuel Macron.

While unemployment reinsurance and rainy day funds could have “greater potential for stabilisation” in Europe, a fiscal capacity to maintain investment levels in times of sudden shocks “is the most promising way to build a stabilisation function in the medium term”, the board wrote in its first annual report, published on Wednesday (15 November).

Created in late 2015, the EFB is an independent advisor to the European Commission, which evaluates the implementation of EU budget rules under the bloc’s Stability and Growth Pact (SGP).

The Stability and Growth Pact, which limits debt and spending in eurozone countries, has “imperfections” and there is “scope for improvements”, the Board’s chair Niels Thygesen, told reporters.

Despite the flexibility introduced by the European Commission in 2015 – and  controversial decisions to let France, Spain and Portugal off the hook – Thygesen believes that the rules contributed overall to the stabilisation of the euro area.

“Imperfectly implemented rules  can,  in  our  view,  sometimes  prove preferable to the ‘gross errors’ of either a very lax or a very narrow application,” the report reads.

But the Danish economist pointed out that the implementation of the rules over the last year, the period analysed, raised some “suspicion”, in particular as regards to equal treatment between the member states.

The Commission has been criticised from various sides – including the Eurogroup Presidency, member states, the ECB and the IMF – for applying fiscal rules with great discretion.

Former German finance minister Wolfgang Schäuble even proposed removing fiscal oversight from the EU executive’s remit.

As the board noted, the “credibility and effectiveness” of fiscal rules also depend on their “enforceability”. And the sanctions were designed in a way that makes them quite unlikely to be enforced on member states. When Portugal and Spain were sanctioned for the first time last year, the Commission granted its ‘pardon’ to the two Iberian economies.

Independent advice

In order to correct the “complexity and opacity” of  the rulebook, the board proposed “more methodical use of escape clauses” to avoid imposing cuts in times of crisis or under “exceptional economic circumstances”.

And in a warning note to Jean-Claude Juncker’s Commission, self-branded as the most political ever, the board stressed that “guaranteeing that escape clauses are used transparently and non-opportunistically requires independent advice”.

Thygesen also indicated that the forthcoming assessments of the national budgets should give more emphasis to debt indicators.

The eurozone’s deficit is expected to rise to 1.1% of GDP at the end of 2017. But despite a reduction of the deficit below the 3% threshold, debt-to-GDP ratio remains at 89.3%, a relatively high level.

The IMF has also called for a simpler but “more binding” fiscal framework for the eurozone, based on a debt rule and an expenditure rule.

Given the weak enforcement of the Stability and Growth Pact in the past, the board also supports using access to existing EU funds to ensure the rules are respected.

“The aim of conditionality  is  not  to  punish,  but  to  safeguard  the effectiveness  of  public  funds,” the report said.

People familiar with the Fund’s thinking believe that access to new EU funds – for example, a future eurozone budget – could be made conditional to compliance with the revised fiscal rules.

Investment mechanism

Thygesen presented the report to the College of Commissioners on Tuesday (15 November).

The presentation came ahead of the Commission’s package to bolster the Economic and Monetary Union to be released in early December. It will include a proposal to introduce a fiscal capacity for the eurozone.

The board also supports a “stabilisation function” for the eurozone.

Among the three options considered by the Commission and the member states for the fiscal capacity, the board sees as the most viable, technically and politically, an investment protection scheme to compensate national expenditure in times of sudden shocks.

An unemployment reinsurance and rainy day funds “may have greater potential for stabilisation”. But the board pointed out that they require clarification as to how they fit in the current rules and the means to finance them.

In the case of an EU reinsurance plan to top up national unemployment schemes, the board’s report notes that temporary transfers between countries should be based on unemployment changes around the affected country’s equilibrium level.

But these levels “are not directly measurable”, the report says, and there is little appetite among the capitals to use vague indicators.