EU financial rules need green amendment

The arguments for reform are compelling. For starters, interest rates on the public debt are only a fraction of what they were when EU financial rules were negotiated in 1992. In 1992, rates on 10-year German government bonds (called the Bund) averaged 8%. At the time, 60% of gross domestic product (GDP) was considered a prudent limit on how much debt the government could safely repay, with the annual budget deficit capped at 3% of GDP. So of course the prudent upper limit is higher today.

In fact, the post-Covid debt ratio has exceeded the EU’s 60% threshold for government borrowing. Eurozone-wide government debt is now 100% of GDP. The debt of the Greek government is more than 200%. A rule added in 2011 requires governments to eliminate an additional 5% each year until the 60% threshold is reached.

Thus, the Greek government is required to run a budget surplus of 5% of GDP, assuming that its economy grows as fast as 2% annually, which the International Monetary Fund considers impossible. But continuing to run a surplus for decades would be unprecedented for a modern economy – meaning no one expected it to happen.

And there’s no good reason it should be. The reference values ​​for a country’s debt and fiscal deficit are 60% and 3% of GDP, lacking any economic basis. The figure of 60% in 1992 was the average debt-to-GDP ratio, and 3% of GDP. Given current interest rates and growth, the deficit corresponded to keeping the debt ratio constant at 60%. ,

drivers follow traffic rules that make sense; They defy rules that are arbitrary and capricious. We have seen similar behavior from fiscal policy makers in Europe.

These are reason enough for reconsideration. Now, however, there is another: the need to make room for climate-related public investment. Cutting Europe’s greenhouse-gas (GHG) emissions by 55% by the end of the decade would cost more than €5 trillion ($5.6 trillion, that is). Because curbing GHG emissions is a public good, companies that are left to their own devices will invest less. Furthermore, where infrastructure has network characteristics, such as in transportation, one has to coordinate the respective investments. It follows that the majority of this spending will be done by governments.

So where will European governments get the better of the €5 trillion they need? Should they borrow it? And should EU rules be modified to encourage them?

In the past, various governments have adopted a ‘golden rule’ that exempts public investment from self-imposed limits on deficit spending, the argument being that public investment pays for itself. If productive, it increases the denominator of the debt-to-GDP ratio. If very productive, it generates enough tax revenue to pay off and pay off additional debt.

Investing in a green economy can be doable. Even if it doesn’t spur economic growth, it could avert a climate-related disaster in which GDP falls and the debt burden becomes unbearable.

The current low level of interest rates creates a presumption that many green investment projects will meet the test. Of course, there is no guarantee that interest rates will remain low. If they increase, the case for borrowing to finance green investments will get tougher.

If some green investments fail that test, that doesn’t mean they shouldn’t be made. Climate change is an ethical as well as a narrow economic issue, and how much to spend to combat it is up to society to decide. But it argues for raising taxes or cutting other expenses to make green investments without running a deficit and jeopardizing debt stability.

Thus, government decisions about how much to borrow and how much to rely on taxes and other spending cuts should turn on interest rates and growth rate forecasts, and how these variables will be affected by green investment. There is certainly uncertainty surrounding such forecasts. such is life.

Indeed, wouldn’t it be better to subject other forms of public expenditure to this assessment as well?

European governments can systematically determine how their various spending programs will affect GDP and tax revenue and thus how the debt ratio develops. They can accept the uncertainty surrounding their forecasts and specify up and down scenarios. They can delegate responsibility for evaluation to independent national experts and the European Commission. Disputes may be decided by a special chamber of the European Court of Justice.

But wait, these proposals already exist. Unfortunately, they are likely to be a bridge too far for a new group of cautious policymakers in Germany, the EU’s largest economy. ©2021/Project Syndicate

Barry Eichengrin is Professor of Economics at the University of California, Berkeley and author of In Defense of Public Debt.