An open book next to a laptop ©Dieter Roosen

Bundesbank calls for reform of European budgetary rules

In the current issue of the Monthly Report, experts from the Bundesbank have criticised the common European budgetary rules and their implementation as becoming less and less comprehensible and predictable. They point out that the application of these rules is the result of a process of political negotiation, and instead of binding quantitative rules, there are moving targets. According to the experts, this allows the reduction of debt to be continually delayed in violation of the originally agreed rules. Admittedly, they believe that the underlying quantitative targets are, in principle, both sensible and viable and do not need to be readjusted. However, changes are required in order to strengthen the binding force of the rules.

Transfer fiscal surveillance to an apolitical institution

The Bundesbank’s experts propose making the quantitative targets more binding again. In addition, the rules would need to be structured transparently and implemented in a predictable way. The large number of exceptions – for instance, regarding non-compliance with quantitative provisions – and the scope for discretion – for example, in the final overall assessment – should be reduced.

Furthermore, surveillance of European government budgets should be transferred from the European Commission to an independent, less political institution. According to the experts, fiscal surveillance by an institution closely tied to politics is unfavourable because the rules are intended to counteract the strong political incentive to take on excessive debt. However, the European Commission views itself as a political institution that fulfils a number of other tasks and objectives alongside fiscal surveillance. The Bundesbank’s experts believe that the very high degree of flexibility and the wide scope for discretion, in particular, mean that there is a risk of the objectives of the fiscal rules fading into the background. The economists recommend that the authority that could be given the responsibility for fiscal surveillance should have a clear and narrow mandate and should not pursue any competing objectives.

Expenditure rules: structure is key

Another possible reform discussed in the article is the option of linking deficit ceilings to expenditure limits. This could indeed streamline the rules in various instances, note the experts. However, when structuring these new rules, care must be taken to ensure that no new possibilities of circumventing the upper limits are created. Accordingly, the experts advise that any potential expenditure limits should be derived from the underlying provisions on each country’s medium-term budgetary objectives. In this regard, the Stability and Growth Pact envisages that Member States achieve budgets that are structurally almost balanced in order to promptly lower their debt ratios.

In addition, the Bundesbank’s experts recommend that expenditure targets should always be set out only for the coming year and not for the next several years. Setting expenditure targets for the duration of a legislative period – which is a proposal that is currently being discussed amongst experts – would be problematic in this regard. According to the Bundesbank’s economists, this would potentially allow the deficit to rise over this period without any countermeasures being taken. In any case, it would be sensible to make use of control accounts to determine the extent to which budget targets are exceeded or missed. If a large deficit is built up, this would have to be reduced again in accordance with the rules. An undesirable rise in debt could be avoided in this way.

Building up rainy day funds

Furthermore, the article discusses adopting “rainy day funds” in the fiscal rules. The basic idea of such funds is to build up financial resources in good times to prepare for hard times in the future. Initially, the funds should be able to be built up through overcompliance with the requirements of the rules. In future, resources could be withdrawn from the funds in order to more easily adhere to targets. It would be advisable for such buffers to be used only to cover unexpected expenses in a rule-based manner, stress the economists, who nevertheless remain unconvinced by proposals currently being discussed in specialist circles of introducing a European rainy day fund. According to the Bundesbank’s experts, in the current regulatory framework of the monetary union, national solutions generally appear more appropriate given that the Member States are responsible for their own fiscal policy.

Caution when financing investments with deficits

Another topic discussed in the article is what are known as “golden rules”. These allow governments to run up debt in order to be able to invest. The European fiscal rules do not provide for this. According to the experts, comparable budgetary rules that have been in force in Germany for many years have not proven successful. If a “golden rule” were to be contemplated despite the associated problems for the European budgetary rules, the risks should be minimised as far as possible. Furthermore, the Bundesbank’s experts urge that investment should not permit unlimited additional deficits. The reduction in high debt ratios should also not be less ambitious than is currently envisaged.