The pandemic prompted a government spending spree on a scale rarely seen outside of wartime. Unfortunately, stimulus programs created demand that outstripped supply, contributing to today’s inflationary excesses. Rising interest rates have resulted, making it more difficult to service new peaks of national debt.
For these reasons, fiscal policy is now in retreat. The exact pace and design of achieving this end varies considerably across countries, but the direction is clear. One interesting case study in the series will come from Europe, which has approached debt and deficits more formulaically. It will be interesting to see if the European Union (EU) can solve this difficult equation.
The European Commission (EC) is seeking to restore and reform its long-standing fiscal rules. The Maastricht Treaty of 1992, which laid the foundation for the euro, requires member states to keep their public deficits below 3% of gross domestic product (GDP) and their debt below 60% of GDP. These standards were intended to enforce budgetary discipline and avoid the debasement of the common currency.
Violation of the deficit or debt criteria and failure to initiate corrective measures will trigger the excessive deficit procedure (EDP). The EDP entails steps ranging from a fine of up to 0.5% of GDP to suspension of commitments or disbursements from EU programs. A nation whose debt or deficit is above the targets is still considered compliant if it is making progress toward reducing excess debt by at least 5% of GDP each year and its deficit by 0.5% of GDP per year.
But a rule without enforcement is hardly a rule at all. Almost all of the bloc’s economies have breached the thresholds at one point or another. Yet no EU member state has ever been fined, including those which had ended up in an EDP. Germany and France both breached the 3% deficit limit almost two decades ago but never faced the threat of penalties. Portugal and Greece were threatened but never penalized.
The patchwork of rules and exceptions has made the EU’s current framework the world’s most complex rules-based fiscal policy; its handbook runs over 100 pages. Supporters assert that the framework has helped to facilitate economic growth and financial stability in Europe. Critics point out that the pact failed to prevent the debt crisis experienced by the continent in the last decade, and the strict rules have limited public investment by many member states. The austerity required of violators has often been painful, and has contributed to the rise of nationalist and populist forces.