Fiscal rules and fiscal capacity : breaking the political gridlock

Abstract

There are two possible readings of the current situation in the Eurozone (EZ). The first is to focus on the fact that we have weathered an existential crisis and come out stronger; we are in the seventh year of an economic expansion with unemployment at a 20-year low. Grexit is behind us and there are today more euro area members than at the beginning of the crisis. A slowdown is indeed ahead, but we have the tools and mechanisms to handle it; it is not likely to be a violent asymmetric shock like a decade ago. The alternative reading suggests that despite putting in place significant reforms which helped defuse the crisis, nothing much has happened in the last five years. The institutional architecture of the euro area remains frozen in its current state since 2014: the banking union is not complete, the “new” fiscal toolkit is clearly in need of an overhaul, the so-called “Euro area budget” is insignificant, and the “backstops” are not at their full potential. The doom-loop between banks and sovereigns is alive and well, and countries continue to diverge rather than converge. To cap it all, we are nearing the limits of what monetary policy and the European Central Bank (ECB) can deliver, while countries disagree strongly on using the limited existing fiscal space. In a non crisis setting, policymakers have lost momentum on reform. By doing so, however, they take a large political and economic risk: at worst, we will not be prepared for the next crisis; at best we will watch “eurosclerosis” creep back. Instead, they should rise to the occasion. The right time is now, with a new European Commission (EC) outlining its priorities and unveiling a plan for a “new Green Deal”, a new European Parliament (EP) about to discuss the EU medium-term financial framework, and a succession at the helm of the ECB which can take it further on the road so perfectly captured by the “whatever it takes” 2012 statement. And the current environment, with no inflation, negative interest rates, and new conditions for competition, is conducive to bold initiatives.