Fiscal Policy Ideas for the Belgian Presidency: Maximizing Leverage

The Council of the European Union and the European Parliament agreed on a new framework for macroeconomic policy coordination on 10 February and the final compromise text was published ten days later.

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Fiscal Policy Ideas for the Belgian Presidency: Maximizing Leverage

The Council of the European Union and the European Parliament agreed on a new framework for macroeconomic policy coordination on 10 February and the final compromise text was published ten days later. This agreement is a major achievement for the outgoing Spanish rotating Council Presidency and the start of the agenda for the incoming Belgium Presidency. The challenge now is to focus attention away from the narrow but important task of ensuring fiscal sustainability and to turn attention to the many and powerful ways that European policymakers at all levels of government can assert fiscal leverage.

A different context

The new framework is a compromise text, not a perfect arrangement. Nevertheless, it operates in an evolving institutional environment where the challenge of fiscal stability is easier to address. In contrast to the crisis years that followed the 2007 collapse of sub-prime lending markets in the United States, the European Union has a European Stability Mechanism (ESM) to act as lender of last resort for member states in need of assistance. Once Italy ratifies the new ESM treaty, that organization will also be able to backstop the Single Resolution Mechanism and so help sever the bank-sovereign nexus. And the euro area benefits from a robust Single Supervisory Mechanism and a strengthening Single Resolution Framework. Europe’s Banking Union is not complete. The Single Resolution Board could be strengthened, and a European Deposit Insurance Scheme could be created. But the institutions in place help stabilize public finances in ways that previously did not exist.

The creation of new financial instruments for temporary support to mitigate unemployment risks in an emergency (SURE), to facilitate the green and digital transformation of the European economies (NextGenerationEU), and to help member states re-engineer their energy economies in the aftermath of Russia’s full-scale invasion of Ukraine (REPowerEU), also help to stabilize public finances by ensuring a more level playing field across member states and by financing European public goods from which all member states will benefit. These instruments are temporary and purpose-built, but the problems they address are structural and the potential they unlock to strengthen underlying economic performance is significant. And stronger economic performance is vital to any fiscal consolidation.

This greater financial stability and potential for growth creates the space for greater differentiation in the approach to fiscal policy coordination, giving more national ownership to fiscal consolidation strategies and focusing attention on more country-specific reforms. That is what the new framework accomplishes. The new framework also provides important indicators for monitoring member state performance, safeguards to prevent backsliding or moral hazard, and exceptions to ensure that fiscal consolidation in the short term does not undermine the public investment necessary to ensure competitiveness and security in the longer term. This is a good starting point insofar as it lays the foundation for a new approach to fiscal policy coordination – and macroeconomic policy coordination more generally – that focuses on leverage.

Leveraging the private sector

The challenge for the Belgian Presidency is to begin the task of redeploying fiscal policy instruments to exercise a subtle but important leverage over the private sector that no other set of macroeconomic policy instruments can manage. Monetary policy and exchange rate policy are too blunt to tackle complex challenges related to the green and digital transitions, they cannot foster startups or fuel innovation, they will not restructure supply chains, and they do not channel resources into areas of vital importance for which there is only inconsistent demand – like defence. Only fiscal policy can create the incentives to shape private investment. And only private investment can muster the resources necessary to complete these huge, ambitious projects.

Any redeployment of fiscal instruments to exert leverage over the private sector must take into account the different resources available at different levels of government and across member states. The active use of fiscal policy cannot be allowed to disrupt the functioning of the internal market or the result will work against – and not in favour – of the accomplishment of a successful green and digital transformation, a more secure energy economy, the creation of more robust supply chains, and the bolstering of European security. In part this means that there will continue to be need for temporary and targeted European fiscal initiatives like SURE, NextGenerationEU, and REPowerEU. These instruments will come under different names and operate for different purposes, but they will build on the same financial infrastructure created to float common European debt instruments.

At a deeper level, exerting greater leverage using fiscal instruments will depend on strengthening the absorption capacity of the public sector at all levels of government. It is no good raising funds at the European level if other levels of government are unable to use them efficiently. This means national governments will need to invest not only in new technologies and infrastructures but, and perhaps more importantly, in stronger national administrations. A European initiative to bolster the training of public officials and to strengthen the attractiveness of public administration as a career path will be important to help level the playing field in this area as well.

At the foundation, however, the success of any effort to exert leverage over the private sector will depend crucially on the liquidity afforded to private sector investments. No European initiative can succeed without strengthening Europe’s Banking Union to rebuild confidence in cross-border finance and completing the European Capital Markets Union so that private capital can flow to those parts of the internal market – either sectoral or geographical – where it is most needed. The need to push forward this agenda to strengthen financial markets is hardly limited to Europe. National governments struggle with the same issues everywhere. But the general nature of the problem does not make it any less imperative. For fiscal policy to exert leverage over the private sector, private sector capital has to move.

A better policy mix

The Belgian Presidency cannot complete such an ambitious agenda, but it can set the debate on the most effective focus for macroeconomic policy coordination in the right direction. With a new institutional environment to underpin the stability of public finances and a more robust framework for preventing fiscal imbalances, the task now is to use fiscal policy instruments to help channel private sector resources to meet Europe’s major challenges. In doing so, European policy makers can not only foster greater growth and competitiveness, but also take pressure away from those macroeconomic policy instruments – and monetary policy in particular – so that they can focus on other tasks. The Spanish Presidency has laid the foundations for the Belgian Presidency to start building a stronger macroeconomic policy mix.

(Photo credit:  Ibrahim Rifath, Unsplash)