The decision last week by the European Commission to extend its unprecedented moratorium on enforcing member state fiscal discipline is a measure of how profoundly the coronavirus pandemic is challenging the EU's attempts to consolidate an economic union. At the heart of those efforts has been the often difficult semester process of mutual budget surveillance; Brussels policing the euro zone's mandatory debt and deficit targets.
In March the commission activated for the first time an escape clause in the union’s budget rules to allow suspension of those targets which will now not apply again until 2022 at the earliest. The rules – based around the core requirements for budget deficits to be smaller than 3 per cent of gross domestic product and public debt to be lower than 60 per cent of GDP (currently 14 member states are above) – are seen by many as over-severe and responsible for austerity, and were often broken.
But they have been part of the architecture of the euro since its inception, guiding structured discussions between Brussels and national capitals – often fraught – on how to put their public finances in order. Italy and Greece will breathe a sigh of relief.
The commission move is seen largely as a recognition of the reality that member states were simply going to break the rules in the face of a crisis, and that they would be unenforceable. It is not by any means an encouragement to break them or a repudiation of the underlying economic rationale. And member states like Ireland – Pascal Donohoe is notably now chairman of the Eurogroup – will maintain that the long-term discipline is a continuing requirement. They will insist to national parliamentarians – with their long shopping lists – that national spending must be contained so that a return to those targets and disciplines is possible in the near future.
Persisting uncertainty
Valdis Dombrovskis, the executive vice-president of the commission who oversees financial services, told the Financial Times that, while Brussels was planning to review the situation in the autumn and is currently looking again at the package of rules with a view to simplifying them, it was "relatively safe to assume" that the commission would not seek to reactivate the rules at that point "because the crisis continues, uncertainty continues".
The message is clear – the conservative Bundesbank economic model remains the order of the day. But the suspension of fiscal rules, to give countries more space for expansionary fiscal policy, allows space to ask whether that old model is right in the long term.
A recent article in these pages by economist Paul Sweeney made a strong case that Ireland should embrace not just the short-term Keynesianism that its massive coronavirus stimulus plan represents but a longer-term vision in which expanded State spending and investment plays a central part.
Ireland should embrace not just the short-term Keynesianism that its massive coronavirus stimulus plan represents but a longer-term vision
“Suspending the fiscal rules is therefore essential, but not sufficient,” Financial Times columnist Martin Sandbu argues. “Tentative reforms need new momentum so they can be replaced by a framework fit for a post-pandemic, low-interest-rate world that does not put outdated notions of fiscal responsibility in the way of economic growth.”
Rescue fund
It is a debate that needs to be engaged with at both European and national level and already has support in countries like Italy, Greece and Spain, and to an extent France. Ireland’s allies in the fiscally conservative New Hanseatic League are, however, unlikely to be moved. At EU level, the decision to raise the €750 billion coronavirus rescue fund marks an important milestone in the argument for once-taboo European fiscal solidarity, bringing a new dimension to economic union – at domestic level, there is also a need for new economic thinking.
The commission expects the euro zone economy – which grew by 1.3 per cent in 2019 – to contract by 8.7 per cent this year. It lost one-sixth of its output in the first half of the year; in Spain, the fall was 22 per cent. Germany did better, with a first-half contraction of "only" 12 per cent.
The hope has always been, Sandbu notes, that because the collapse was due to enforced lockdowns, economies could rebound quickly once those restrictions were lifted. The most recent numbers give ground for optimism. In June, industrial output grew faster than expected in the euro zone’s four largest economies. Retail sales have already recovered to pre-pandemic levels.
But the pandemic is not yet under control, and levels of debt and the risk of withdrawing support too fast are likely to make for increasingly, and politically contentious, difficult decisions in the near future. And even quick recovery may leave permanent scars on the long-term capacity of businesses and whole economies.