A single Euro-area’s fiscal policy ?
If I am not wrong, this is what the IMF is proposing.
The IMF is proposing no less than “a new “fiscal capacity” funded by common debt issuance and new income streams, building on the experience of the temporary €800 bn Covid-19 recovery fund.”
This is, in my view, not a very good idea.
1 IMF seems to overstep its mandate. Its mandate does not consist of reinforcing the EU Commission’s power giving it the fiscal power at the European level. This decision is a political one which can only be taken by elected head of states, not by international bureaucrats. The IMF’s mandate is important, it should make an analysis of the debt viability of each developed country (what it does in its excellent art. IV). (The problem is that IMF’s debt projections are always rosy (optimist rate of growth, low interest rates). All projected debt ratios are declining… (The most important is to read all sensitivity analysis with risks associated (DSF).
2 The IMF, like a traditional politician, tries to present two contradictory views. The EU needs more funds (not very original) and reduces the debt burden. Despite very high debt ratios for some big Euro-area countries, the IMF is asking for more debt for energy investment projects and to shelter households from soaring energy prices (amazing that the IMF is asking to quell inflation through fiscal subsidies).
3 It is not very clear why a “common debt issuance” will allow more borrowing. The debt ratio will not decline because of a common debt issuance, the average EZ ratio will be lower, but the market will know that Italy, Greece, Spain, and France are weighting up the average (the deficit-prone countries are always the same, this is why a common budget is not feasible). A common EZ debt will encourage the behaviour of free riders (why to be concerned with national fiscal rules, since my debt is mixed up with everybody else debt).
4 We were told that the “Next Generation EU” was “a one-off instrument”. As usual, bureaucracies have time with them and they always come with a single idea, more power for technocrats who know better. More power for the European Commission who now wants to run a common budget for member states (logical, they argue, since a single monetary policy calls for a single fiscal policy).
6 There is no miracle solution to reduce high debt levels and IMF is supposed to know better.
a) Raise growth rate (exogenous, does not depend on monetary, nor fiscal policies).
b) Reduce the interest rate level through inflation, this is exactly what is happening today (the strategy of the ECB consists of reducing interest rates for fragile countries through targeted QE, this is a failed policy).
c) Reduce the primary deficit (what most governments don’t consider (so many reasons to raise expenditure).
It is not very clear why a common debt issuance will solve this inescapable framework?
The IMF is not very consistent; it asks for a collective debt at the Euro level but argue for country rules. There is a good idea in this article that each country (not collectively) shall make an analysis of their debt sustainability (already done in the IMF’s article IV of each country).
The second excellent idea is that each country shall set multiyear annual spending caps. This is the key fiscal rule to adopt (a fiscal deficit target is a balance between revenue and expenditure, it does not constrain high spenders (as France) to adjust its public spending at the proper level). The problem is that it is already done today (each Euro country must send to the EC its fiscal plan every year) and this is an exercise (among many) which fudges the issue.
If the existing fiscal pack failed why, on earth, a common fiscal policy would succeed? Why these new rules will be more enforced than before? Will an “independent” fiscal council change anything? All EZ countries have an “independent” fiscal council today.
The unpleasant truth is that, in front of such high-debt ratios (not only for Euro countries but also the US and the UK), due to excess deficits (even L. Summers was concerned) private agents start to understand that the present value of tax will never be sufficient to finance the service of this debt plus the high expenditure requested to governments. They don’t adopt a Ricardian behaviour (save today to pay higher taxes tomorrow), they are reducing the debt burden through inflation. Private agents are going to sell their government bonds (since central banks stop QE (except, of course, the ECB), they will spend this additional liquidity creating price increase particularly true when there is a vertical supply curve.