Economic and monetary union

• Author: Directorate-General for Parliamentary Research Services (European Parliament)
• Pages: 70-94

EPRS | European Parliamentary Research Service

70

ECONOMIC AND MONETARY UNION

10. Better coordination of fiscal policy

Potential efficiency gain: €30 billion per year

Key proposition

Unless fiscal policies are effectively coordinated, there can be significant negative 'spill-over' effects

between the Member States participating in Economic and Monetary Union (EMU), and across the

European Union more widely. For countries sharing the same currency, there is a need to pursue

credible and sustainable control and coordination of public finances. If budget responsibility is not

ensured, some countries might engage in excessive public expenditure paths taking advantage of

a crowding-out effect within the monetary union. Better ex-ante fiscal coordination should thus

increase sustainability and resilience in Member States and confidence between them. It would also

make solidarity easier and more efficient, should it be needed in case of a new economic and

financial crisis.

While the framework for the coordination of fiscal policy has been substantially reinforced and

improved, in particular, following the 2008 crisis, the complexity of the current rules-based system,

notably the addition of rules and exemption clauses in the Stability and Growth Pact (SGP), seems

to be a challenge for its effective functioning. Moreover, the reliability and the opacity of the

underlying indicators used in the framework have also been criticised. Issues linked to enforcement,

in particular the institutional and the political difficulties of ensuring that coordination is effective,

have not disappeared. Looking at previous analysis by the European A dded Value Unit of EPRS and

taking into consideration some recent estimates available from the ECB, IMF and European

Commission, we conclude that the potential annual efficiency gain of improved coordination of

fiscal policy within the European Union could amount to around €30 billion on an annualised basis.

More detailed analysis of potential benefits

In a monetary union with well-designed incentives and governance, countries move away from

individual free-riding policies to a set of common policies that allow everyone to fully benefit from

cross-border externalities. Moreover, during the recent crisis it appeared than an optimal policy

coordination in the euro area would have required a differentiation of consolidation efforts

depending on the fiscal space to minimise negative spill-overs. For countries sharing the same

currency, there is thus a need to pursue credible and sustainable control of public finances. The

challenge is to determine which level and type of instrument should be put in place to achieve such

an optimal outcome.

At EU level, the European Semester provides a framework for the coordination of economic policies

across the European Union. It allows EU countries to discuss their national economic and budgetary

plans and monitor progress. The Macroeconomic Imbalance Procedure aims to identify, prevent and

address the emergence of potentially harmful macroeconomic imbalances that could adversely

affect economic stability. Finally, the SGP - reformed in 2005, in 2011 (six pack) and in 2012 (fiscal

Europe’s two trillion euro dividend: Mapping the Cost of Non-Europe, 2019-24

71

compact) - requests Member States to coordinate their budgetary policy and to avoid excessive

deficits. It aims at achieving macro-economic stability in the EU and at ensuring sound budgetary

policy on a permanent basis, by specifying a series of fiscal rules. In essence, the purpose is to ensure

long-term sustainability of public finances while supporting counter-cyclical fiscal policy.

Many researchers have stressed the complexity of the current arrangements248, with the frequent

addition of rules and exemption clauses resulting in an extremely elaborate framework. In practice,

this means that the effective application of the rules can be affected by optimisation behaviour by

some Member States. Moreover, beyond the complexity of the current framework, its reliability has

also been questioned. For instance, the computation of potenti al output, output gap and structural

balances appear as too opaque, while also being subject to large ex-post revisions249. A final issue

concerns the enforcement of the rules, and the related political and institutional difficulties. First,

the evolving interpretation of the Pact has not been mirrored by developments in national rules,

giving rise to potential inconsistencies. This has substantially complicated enforcement250. Second,

the flexibility and need to take account of economic circumstances and specificities has often been

detrimental to enforceability, with political considerations sometimes undermining better

coordination of fiscal policies251.

As a result, EU fiscal policy has not exerted the full expected counter-cyclical effect. It has rather

remained pro-cyclical or a-cyclical. In turn, the lack of effective resilience and confidence has not

allowed for the full materialisation of the expected stabilisation in case of a severe crisis. One

solution to improve the coordination of fiscal policy would be to have a common stabilisation tool.

Many proposals have been made,252 such as a common unemployment insurance scheme (see

below). Here, however, we look at the potential benefits that could be obtained by improving the

current framework used for the coordination of fiscal policy.

Regarding a sustainable fiscal policy, there is still disagreement amongst economists on a threshold

from which the level of debt starts to be a drag on growth. However, evidence underpins the

importance of reducing public debt to restore fiscal sustainability and support stronger

fundamentals. In particular, recent research confirms that Member States displaying high debt levels

are more heavily affected by output losses in a crisis, are adversely affected in terms of potential

growth rates, have less scope for counter-cyclical fiscal policy, and are more affected by spill-over

effects253. Building upon this analytical framework, an IMF study has estimated the size of the

potential spill-over effects from a better coordination of fiscal policies to be around 0.25 per cent of

GDP254. For the EU as a whole, this would imply a potential total benefit of some €37.5 billion per

248 T Wieser, Fiscal rules and the role of the Commission, VoxEU.org, 21 May 2018; A Bénassy-Quéré et al. Reconciling risk

sharing with market discipline: a constructive approach to euro area reform, CEPR Policy Insight 91, 2018.

249 Z Darvas, P Martin and X Ragot, European fiscal rules require a major overhaul, Notes du conseil d’analyse économique

47, 2018.

250 S Deroose et al, EU fiscal rules: Root causes of its complexity, VoxEU.org, September 2018.

251 C Wyploz, The Eurozone crisis: A near-perfect case of mismanagement. Economia Marche Journal of Applied

Economics, XXXIII (1), 2014.

252 See for instance ESM-ECFIN-GCEE. Enhancing fiscal integration in the EMU? Discussion paper 082, Jul y 2018, and N

Carnot et al. Fiscal stabilisation in the Euro-Area: a simulation exercise, CEB working paper 17/025, October 2017.

253 C Checherita-Westphal, P Jacquinot, Economic consequences of high public debt and lessons learned from past

episodes, ECFIN workshop, Brussels, January 2018.

254 A Ivanova, S Weber. Do fiscal spillovers matter?, International Monetary Fund (IMF) Working Paper, 2011.