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EU Needs Budget-Rule Overhaul To Return to Growth, Bruegel Says

  • Spending rules should replace emphasis on structural balance
  • Scrapping current system would be best but not practical

The European Union might be able to grow faster by overhauling its budget rules to focus on spending instead of structural budget deficits, according to a study by the Brussels-based research group Bruegel.

Tightening at the wrong point in the economic cycle “might be one reason for the anemic economic recovery in Europe, raising questions about the effectiveness of the EU’s fiscal framework,” Gregory Claeys, Zsolt Darvas and Alvaro Leandro wrote in the Bruegel paper. “In practice, the implementation of the rules is hindered by badly-measured indicators and incorrect forecasts, which can lead to misleading policy recommendations.”

Scrapping the current system would be the best way to help but isn’t feasible, the authors said. Instead, they propose a focus on revenues, which would generally block tax cuts unless they are matched by spending cuts and likewise make it harder to permanently increase spending without increasing levies. In contrast, they said, the current focus on structural balance is harder for governments to control and tough to calculate properly.

Fiscal Council

The new system would benefit from an independent European Fiscal Council that could weigh in when special circumstances require greater flexibility, according to the paper. This would “eliminate the perception of a possibly improper or politically motivated application of the rule,” the authors said. Under the current system, “the threat of sanctions is not credible” and would have a big backlash if ever used, they said.

The Bruegel authors said their proposed system would have disciplined Spain, Ireland and the United Kingdom in the run-up to the financial crisis, because of housing booms and rapid public spending increases that may have made the economic cycle worse. Italy also would have been told to reduce its public debt, while Germany and Sweden could have spent more from 2004 to 2007, the paper said.

“After 2009, our rule would have allowed much more counter-cyclical fiscal policies than those that were actually implemented in many EU countries,” the authors said. “The growth rate of public expenditure was inferior to our limit in Germany, Ireland, Spain and the United Kingdom, while the setback in the public expenditure growth rate in Italy in 2010 was justified.”

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