Il Stability and Growth Pact is obsolete. He was suspended to allow governments to respond to the pandemic, which speaks volumes about his ability to ensure stability. Some countries would like to restore it in 2023 as if nothing had happened and especially as if they hadn't passed 20 years since its creation, of which the last 10, after the financial crisis, have gone on to ignore it with one excuse or another.
The Pact did not prevent the financial crisis (recall that the debt/GDP ratio in Ireland was at 25% one minute before rising to 100% and having to call the troika for help) nor that of the sovereign debt.
I two updates of the Pact in the sovereign debt crisis have NOT improved the picture, they have only complicated it (270 pages of Vademecum to calculate the output gap). The sum of the country recommendations ended up being restrictive when instead a coordinated reflation action it was necessary to reconnect with the pre-crisis growth trend, such as the US which had also been the epicenter of the crisis. A study by the Banque de France in 2017 calculated lloss of growth at 2-3 percentage points, or 200/300 billion euros in losses due to the lack of coordination of fiscal and structural policies.
Macroeconomic imbalances procedures (MIP) indicators that did not align with the European political balance, such as the macroeconomic imbalance created by the foreign trade surpluses of Germany and the Netherlands, were ignored.
The fiction that the Pact worked used i Relevant factors before and the flexibility then to ignore the conclusions that would have damaged countries like Italy. Finally the pandemic forced to put it aside, while leaving several teams of officials to deal with it diligently, but without operational consequences. Having served as international officials for two decades, I feel a strong sympathy for capable professionals who are prevented from supporting the conclusions of the analyzes conducted. In a debate in Brussels I happened to point out the contradictions of the output gap. The answer I received was "we are the guardians of the rule book". Without any attempt to justify the same.
The Covenant makes me think of Javert, the policeman par excellence described by Victor Hugo: serious, austere, he had introduced the straight line into what is most tortuous in the world. When Javert has to admit that he fails to linearize his own actions, he commits suicide.
For the Pact there is no need to commit suicide: in 2023 you don't need to resurrect it with all the ravages of time and the fashion frills of a generation and two world crises ago.
It suffices to ask what the purpose of fiscal coordination is in the legal context of the division of tasks between member countries which have the power to decide their own fiscal policy and the ECB which manages monetary policy.
Up to and including the financial crisis, monetary policy ensured price stability and also economic growth. The measures taken by all the central banks of advanced countries to limit the effects of the financial crisis on the economies have reduced the policy interest rate to around zero.
In the post-financial crisis recovery, at the first signs of a rising inflation which later proved to be temporary, the European Central Bank (pre-Draghi) raised the interest rate. The consequence was the sovereign debt crisis in Europe which reduced the growth of the area up to the pandemic, while the USA maintained all the monetary and fiscal support policies and continued to grow despite being the epicenter of the financial earthquake.
After the interest rate hike, which did not last long because the central bank corrected quickly, they were added in addition to the MES, the six packs and the Fiscal Compact. The latter had to contain public debts which instead grew together with austerity and populism against Europe.
However, thanks to the monetary policy under Draghi's leadership, the interest rate has decreased and the average maturity of the debt has increased. So debt sustainability has increased.
With the pandemic crisis, supply and not just demand limits and the near-zero interest rate limiting the effectiveness of monetary policy, but decreasing the costs of fiscal policy, they called for expansionary fiscal measures to absorb both the health and economic shock. After having acted strongly for the purchase and distribution of vaccines, the European Commission has finally created with NGEU central spending power with clear priorities for supporting the unemployed and the energy and digital transition in Europe.
This new framework should be kept in mind as background of the reform of the Pact. The desire of northern European politicians to reduce public debts so that the debt remains sustainable is acceptable. If they added "in good years" it would be better. Also the limit of 3% of the deficit compared to GDP is useful for containing the deficit bias of politicians. But 2023 is too close for this change of gear, with the PNRR still in action to support the energy and digital transition and the recovery of productivity which will make debt truly sustainable in the medium and long term. Political desire does not automatically turn into sensible economic actions. The effects of a restoring the Pact as it was could be even more severe than the 2011 tightening. Waiting until 2026 could instead allow us to count on a new space for monetary policy created by the growth of productivity and the labor supply, which increases the equilibrium interest rate.
Timing is not the only point at issue. The new covenant must be simple to be calculated and reported, do not include unobservable variables, such as the output gap, in the target or calculation method. The expenditure rule, which has worked very well in the Netherlands, could require the computation of potential, unobservable output if it were to be used for all countries. The debt rule is important, but it becomes absurd if the same numerical target is adopted for Italy (with a debt/GDP ratio of 153%) and Estonia (19%).
Why not take example from the monetary policy approach who saved our economic systems twice in just over 10 years? Even if there is one Taylor rule for the conduct of monetary policy, which determines the policy interest rate based on the inflation rate and the output gap, has never functioned as a “rule”, but as a “valuable descriptive device” in Bernanke's definition. Which reminds us that time cannot be wasted in agreeing on the size of the output gap, which is difficult to measure and on which there are different opinions. Taylor's rule offers no guidance when the equilibrium interest rate is negative, as it has been since the financial crisis. And there is no agreement on the weights to be attributed to inflation and the output gap. In fact, those weights depend on the preferences of politicians, on the structure of the economy and on the transmission channels of monetary policy. Bernanke concludes that he does not expect to replace the Federal Open Market Committee with robots in the foreseeable future. So there is no need for rules fixed ex-ante.
In conclusion, in the long overdue update of the Pact, the 3% deficit/GDP rule must be integrated with the possibility of large deficits for priority investment spending, climate and digital transition in primis, but also all the investments of the PNRR until its conclusion. There debt rule it needs to be articulated with country-specific targets, as recommended by the European Tax Council.
Pending a central fiscal capacity for growth and stability, to be built on the basis of the NGEU experience, it would in any case be desirable consider these objectives as standards, as proposed by Blanchard and many others. Not rules fixed ex-ante and equal for all situations. They are not dreams of academics, they come from the experience of how monetary policy decisions are made which until now has absorbed shocks and guaranteed growth, but now must be accompanied by an equally effective fiscal and structural policy.
