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Advances in policy frameworks are generally the result of a ping-pong between policy ideas and political needs. In the area of EU fiscal rules, there has been a lot of ‘ping’ in recent years. Academics and think tankers have criticised the rules for being ineffective—partly by design, partly due to poor implementation—while making recessions worse and constraining needed public investment. Scores of reform ideas have been proposed. ¹ See Claeys, Darvas and Leandro (2016), Benassy-Quéré et al (2018), Darvas, Martin and Ragot (2018), Feld, Schmidt, Schnabel and Wieland (2018), European Fiscal Board (2019,2020, 2021), Blanchard, Leandro and Zettelmeyer (2021), Martin, Pisani-Ferry, and Ragot (2021), Darvas and Wolf (2021), among many others.  But there has not been much of a ‘pong’, reflecting deep disagreements over the direction of reform among EU governments and the suspension of the rules until the end of next year.

Two official documents issued in the last 6 months, by the (jointly) and the , suggest that this may be changing. The papers agree on four reform objectives.

First, the core objective of the fiscal rules is to ensure debt sustainability “in a more effective and efficient manner” (Dutch and Spanish paper). This requires a set of rules that leads members to build fiscal buffers, through both the numerator in the debt ratio (fiscal adjustment) and its denominator (raising growth through improved composition of public finances and economic reforms).

Second, there can be a trade-off between building these buffers and other fiscal policy objectives, such as stabilisation and public investment (including green investment). Fiscal rules should aim at getting that trade-off right.

Third, bilateral deals between the European Commission and EU countries are not an acceptable way of figuring out the optimal compromise between fiscal adjustment, output stabilisation, and investment. In the words of the German paper, “it is essential for the fiscal framework to ensure the equal treatment (both real and perceived) of member states and to use common benchmarks”. The Dutch and Spanish paper calls for “a level playing field … to safeguard transparency and equal treatment for all Member States.”

Fourth, better implementation of the fiscal rules is critical. According to the German paper, “the further development of the fiscal framework should place a particular emphasis on the application of the rules”. The Dutch and Spanish paper emphasises “the potential to create a virtuous circle between national ownership and compliance”—and in its absence, enforcement of the rules by the Commission and the Council.

Compared to the past, in which the ‘South’ regularly called for more flexibility in applying the rules, while the ‘North’ regularly called for tougher enforcement, this is big progress. We now seem to have convergence on the main objectives of reform by at least one prominent ‘Southern’ and two prominent ‘Northern’ members.

But even if all members agreed with the objectives formulated in the two papers, this may not be enough to put a successful reform of the fiscal framework within reach, for two reasons.

First, there is potential conflict across objectives. Ensuring debt sustainability (objective 1) while also allowing compromises between fiscal adjustment, output stabilisation and public investment (objective 2) requires decisions that carefully reflect country-specific circumstances. This may conflict with even-handedness (objective 3).

Second, it is unclear whether there is any way to meet objective 4 (much better implementation than in the past)—at least not without much tougher enforcement, which is unlikely to be feasible either legally or politically. The Dutch/Spanish paper offers a potential solution: “National governments could be better held accountable if they are also empowered to propose country specific medium-term fiscal plans to reinforce fiscal sustainability in a growth-friendly manner.” But a fully empowered national government may ignore the adverse fiscal externalities of high debt, undermining the very purpose of the fiscal rules.

The critical question is hence whether there is any approach to reform that will do the trick, in the sense of simultaneously meeting the four principles described above. The answer is uncertain. However, two new papers by staff of the International Monetary Fund (IMF) and members of the European Fiscal Board (EFB) offer some hope.

A offers a response to the first challenge. Its starting point would be an annual debt sustainability analysis (DSA) using an agreed EU-wide methodology (for example, based on the by the European Commission). Based on this analysis, EU countries would be classified into three groups: high, medium and low debt risks. High risk countries would be required to enact expenditure ceilings consistent with a zero or positive overall fiscal balance over the medium term (three to five years). For medium risk countries, the expenditure ceilings would need to ensure a declining debt path over the medium term (but not necessarily a zero balance). Low risk countries would not be required to undertake any fiscal adjustment unless their current and medium-term projected debts and deficits are above 60 percent or 3 percent, respectively, in which case they would be treated like medium risk countries.

All countries would commit to a medium-term fiscal framework that sets binding expenditure ceilings consistent with these rules and with keeping the fiscal deficit below 3 percent ex ante. To avoid counterproductive fiscal adjustment following large recessions—which may initially require tolerating a deficit of higher than 3 percent and/or a longer adjustment time than 5 years—there would be an escape clause. Like today, this would be outside the control of the government (specifically: it would be approved by the European Commission, upon request by a government, taking into account the assessment of the independent national fiscal council). But unlike today, it could be triggered by a country-specific (rather than EU-wide) downturn.

Unlike , the IMF’s proposal does not envisage changing either Article 126 of the Treaty on the Functioning of the European Union (the Excessive Deficit Procedure, EDP) nor Treaty Protocol 12 defining the 60 and 3 percent reference values. Instead, these reference values would be integrated into risk-based rules, as described above. A deficit would be considered “excessive” (in the meaning of Article 126) when these rules are violated.

The IMF proposal may meet the first three objectives laid out by the Dutch/Spanish and German governments (Disclosure: I contributed to the IMF proposal in my past capacity as an IMF staff member. This may bias my judgment in its favour).

First, debt sustainability is clearly the primary objective. The proposed rules would encourage building fiscal buffers—the more so, the higher debt risks. This arguably meets the Dutch and Spanish proposal’s requirement of delivering “on the core objective of debt sustainability in a more effective and efficient manner.”

Second, the proposed rules leave room to pursue additional objectives—fiscal stabilisation and investment. Even high-risk countries would be given some leeway on how fast they want to get to the required zero balance (3-5 years). Since only expenditures would be subject to a hard year-by-year ceiling, not deficits ex post, unexpected output shocks could be accommodated (governments would not be required to cut spending or raise taxes to offset lower revenues). For severe downturns that may require longer adjustment, there is an escape clause. While there is no ‘investment clause’, a country could undertake an investment push that temporarily raises deficits and debt provided that its medium-term anchor is respected, and the 3 percent deficit ceiling is not violated in the interim. This would not be enough for a sustained green investment push, but the IMF proposal envisages a separate instrument for this purpose: a central fiscal capacity funded by common debt issuance and serviced by a dedicated income stream.

Third, the proposal meets the “equal treatment” and “use of common benchmarks” requirements of both papers. The existing 60 and 3 percent benchmarks would remain. Initial debt risks assessments would be based on an agreed EU-wide methodology. Like any debt sustainability framework, this would leave some room for judgment, but a set of checks and balances would ensure that this is not abused (see below). And importantly, there would be identical minimum fiscal adjustment requirements for all countries in the same risk group—for high-risk countries, to reduce the nominal deficit to zero within 5 years.

This leaves the final and most daunting challenge: better implementation. An initial answer, emphasised in both the and papers—building on earlier proposals by as well as Bruegel authors—is to make national-level independent fiscal institutions the first line of defence against government transgressions. The argument is that voters and other national constituencies are more likely frown upon a violation of the rules if a respected national institution, rather than ‘Brussels’ blows the whistle. As the EFB observes, this requires “a substantial strengthening of the IFIs in many, if not all, countries”—likely via an EU directive laying out minimum standards.

A second answer, emphasised particularly by the , it to focus EU-level surveillance only on the correction of “gross policy errors”. Doing so would make enforcement by the Council — ranging from peer pressure to fines under the EDP — more credible. The European Commission would focus on (1) the adequacy of national fiscal frameworks; (2) establishing whether an excessive deficit is present and conducting the EDP when this is the case. Where national fiscal frameworks meet minimum requirements, the implementation and surveillance of the fiscal rules would be largely delegated to the national level, with the EDP acting as EU-level backstop. The envisages additionally upgrading the EFB to a European Fiscal Council, which would develop the common methodology for assessing debt risks (in consultation with the European Commission, national fiscal councils and other stakeholders), and provide an independent view of the compliance of national and EU-level actors with the framework. This could give additional comfort to member countries concerned about the even-handed application of the fiscal rules.

To summarise, the Dutch/Spanish and German papers on the reform of the SGP represent an important step forward, politically, and intellectually. Designing a reform that meets the requirements of these papers will be very challenging. But it is not a hopeless endeavour: recent proposals by the EFB and the IMF contain elements that arguably rise to the challenge.

All eyes are now on the European Commission, whose Communication on the reform of the rules is expected in the next few weeks. If this is technically and politically at least as convincing as the IMF and EFB proposals, a meaningful reform before the 2024 EU elections stands a chance. If not, the EU will muddle along with a discredited system for perhaps another four or five years. Given all else that is on its plate, this is a challenge it can do without.