Faced with a Covid-induced economic disaster last year, EU member states fired every fiscal weapon they had.
That entailed the decision in March to shelve temporarily the bloc's fiscal rules as member states embarked on massive national-level fiscal expansions, reinforced by a later agreement on a €1.8tn EU-wide budget.
The question facing EU finance ministries in 2021 is what comes next. There has been some good economic news in recent weeks, notably the removal of the risk of a no-deal Brexit. This is coupled with the prospect for a significant fiscal stimulus in the US, as Democrats take control of the presidency and both the Senate and House of Representatives.
Europe’s vaccination drive has been marred by sluggish rollouts but if member states quicken implementation, it should help stimulate economic recoveries later in the year.
Yet none of this changes the brutal truth that the financial fallout from the crisis will be lasting and painful. It will leave a fiscal legacy that pushes public debt loads to 100 per cent of GDP in the euro area as a whole, and to 160 per cent in Italy.
Portugal’s six-month EU presidency will have to tip-toe into this fiscal minefield after taking over from Germany this month. There are two major questions on the table.
First, should the escape clause from EU fiscal rules be extended? As Portugal’s finance minister João Leão said on Friday, support must not be withdrawn prematurely given the fragility of EU economies. A decision on whether to keep the escape clause suspended into 2022 will be made in the second quarter.
Second — and no less consequentially — the EU will need to ask whether it is time to push for deeper reforms to its fiscal rules. Finance ministers and the European Commission shelved this discussion last year as they focused on the immediate crisis. But Brussels will restart a review of its Stability and Growth Pact (SGP) in the coming months.
It faces a range of options from tinkering to more fundamental reforms. The direction of the debate within the economics profession is clear, however: it is time for the EU to take a very long, hard look at a framework that looks hopelessly outmoded given the current economic conditions.
As Laurence Boone, chief economist of the OECD, told the Financial Times this month, the reality of low interest rates and inflation means the scope for monetary policy to play the primary role in stabilising economies has been reduced. Given the European Central Bank has been the cornerstone of financial market and economic stabilisation policy since the financial crisis that started in 2007, the political and institutional implications of such a shift are profound.
If, as Ms Boone argues, it now falls to governments to step forward instead, this would entail some potentially serious changes to the unpopular and labyrinthine SGP.
Ángel Ubide wrote recently for Peterson Institute think-tank in Washington that “sound fiscal policy” can no longer be equivalent simply to deficit reduction. In particular, the SGP’s core targets of 3 per cent deficits and 60 per cent debt-to-GDP ratios look entirely unrealistic, he said. “The focus on debt and deficit levels, rather than on the uses of fiscal policy, is counterproductive.”
The commission’s advisory European Fiscal Board argued last year that the sensible choice is to push through any reforms before reapplying the SGP, rather than waiting until afterwards. It suggested a series of changes including giving countries with higher debt burdens more time to bring down their borrowing, and providing extra leeway for growth-enhancing spending including investment.
Discussions of any changes going beyond tweaks to commission guidelines would take the EU on to treacherous terrain, however, reigniting bitter battles between fiscally conservative states in the north and more expansionary ones in the south.
Alongside those questions lies a much longer term one that has been raised by the ECB, as well as economists including Mr Ubide: whether the EU’s temporary €750bn recovery fund, which is expected to start paying out this summer, should eventually be turned into a permanent central fiscal facility.
These debates will prove politically fraught for the EU. They are also unavoidable.
Concerns over the slow rollout of coronavirus vaccination in many EU countries erupted into a blame game last week. Denmark is the best-performing state in the bloc but others are lagging. On Friday, the European Commission announced a provisional agreement to double supplies of the BioNTech/Pfizer Covid-19 jab to up to 600m doses — but most of the extra doses will not arrive until the third and fourth quarters of this year. (chart via FT)
The European parliament gets its ratification work for the Brexit trade deal under way, starting with a debate in the assembly’s international trade committee on Monday. The EU commission will also hold a series of hearings with MEPs and seminars with national diplomats covering different aspects of the accord. National Brexit attachés will be debriefed on Monday on the agreement’s governance system and on UK participation in EU programmes, while the EU parliament's fisheries and transport committees will have presentations on relevant parts of the agreement.
The 13th European Space Conference will be held on Tuesday and Wednesday. Later in the week EU commissioners are due to meet for a seminar on the upcoming agenda and Germany’s Christian Democratic Union is due to elect a new leader.