EU Urged to Scrap Old Fiscal Rules and Avoid Damaging Austerity

The European Union should scrap rules that could force countries to hit strict budget targets even while their economies haven’t fully recovered from the pandemic, according to the Organization for Economic Cooperation and Development.

As the bloc’s finance chiefs start to debate the issue, the Paris-based OECD recommended adapting the EU’s long-contentious fiscal framework, saying it needs less complex targets, more focus on the long-term, and flexibility for individual countries as needed. That would help prevent a repeat of errors in the aftermath of the 2008 financial crisis, when governments were forced into damaging austerity, hampering already-weak economies.

EU Urged to Scrap Old Fiscal Rules and Avoid Damaging Austerity

The EU’s rules, designed to prevent a pileup of debt, were suspended during the pandemic to allow countries to fund emergency health measures and economic stimulus, and few believe they can ever return in the same form. 

While that crisis spending has pushed debt-to-output ratios to record highs, the OECD urged countries to avoid “premature tightening” of fiscal policy.

“There is a need for the EU to evaluate its fiscal framework with the aim to better ensure sustainable government finances, sufficient counter-cyclicality and greater ownership,” the OECD said. It added that the fiscal needs of countries are “very diverse and there should not be expectation that a single rule could represent a good fit for all.”

The OECD cited the following factors for consideration:

  • An expenditure rule anchored to a debt target
  • Sustainability should be assessed from a longer run perspective, rather than the short-term view prevalent today
  • Preserving the ability to invest in the future
  • Rules should respond to citizens’ needs, including fairness among generations

On monetary policy, it said the European Central Bank -- which recently overhauled its strategy -- could consider the following options for its next review planned for 2025: 

  • Average inflation targeting
  • Price-level targeting
  • Yield-curve control, possibly targeting an asset linked to Next Generation EU
  • Linking bank financing costs to the achievement of lending targets; this could strengthen the pass-through of policy
  • Publishing Governing Council members’ expectations on the path of the policy rate
  • Introducing an explicit bias toward green assets in QE, though this could politicize central bank actions

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