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Greening Europe's Fiscal Rules

There was never any economic basis for the limits on government deficits and debt that the European Union adopted in 1992 and has maintained ever since. With huge new investments needed to meet the EU's climate goals, now is an ideal opportunity for an overhaul.

BERKELEY – The European Union is about to undergo a much-needed review of its fiscal status quo. Experts at the European Commission are considering how the EU’s fiscal rulebook should be revised, and Germany’s new government has quietly signaled a willingness to consider changes – though any modifications there will most likely be limited, given disagreements within the coalition and control of the finance ministry by the fiscally conservative Free Democrats.

Arguments for reform are compelling. For starters, interest rates on public debt are only a fraction of what they were in 1992, when the EU’s fiscal rules were negotiated. In 1992, rates on ten-year German government bunds averaged 8%. Back then, 60% of GDP was considered a prudent limit for how much debt a government could safely service, with annual budget deficits capped at 3% of GDP. So surely the prudent upper limit today is higher.

In fact, post-COVID debt ratios have blown past the 60% ceiling for government borrowing. Eurozone-wide government debt is 100% of GDP. Greek government debt is more than 200%. A rule added in 2011 requires governments to eliminate 5% of the excess each year until the 60% threshold is reached. Thus, the Greek government is ostensibly required to run a budget surplus of 5% of GDP, assuming the economy grows as fast as 2% a year, which the International Monetary Fund deems unlikely. But continuing to run surpluses for decades would be unprecedented for a modern economy – which is to say that no one expects it to happen.

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