Thread by @AndrewWattEU

Completely agree with @sjwrenlewis economic analysis of EU fiscal rules. Fiscal policy should be about macroeconomic stabilisation not government-debt limitation. Happily, I disagree somewhat on the politics: Feasible reforms cd get us nearer where we need to be.
Thread 👇
1/19

https://twitter.com/sjwrenlewis/status/1387325369305415681

The basic economic insight is:
“<when> the economy is growing rapidly relative to the EU average individual countries need to contract fiscal policy, and in relative downturns … need fiscal stimulus <because> monetary union takes away effective national monetary policy.”
2/19

I'd just make more explicit what is implicit: countries in the former (latter) situation tend to have above-average (below-average) inflation, thus below (above) ave real interest rates, a loss (gain) in competitiveness & thus a tendency to current acc. deficits (surpluses).
3/19

Then Simon makes the crucial point that an economy where fiscal policy stabilises inflation near target will tend to stabilise its government debt. (I’d add: and also its eternal balance, at least within the monetary union.) An additional debt orientation is not needed.
4/19

Lastly on the economics, when the MS orient policy not just to relative inflation, but to the ECB target, aggregate fiscal policy works in support of monetary policy (and this in turn has a positive feedback on government budgets).
5/19

Turning to the politics Simon is pessimistic. “Of course nothing like this <sensible reform> will happen. The mindset of policymakers in much of Europe is dominated by the failed ideas that depart from basic macro, and that were hard-copied with the formation of the Euro.”
6/19

Happily there is a way fwd that, while it requires a change in mindset, is institutionally undemanding. In the so-called 6 pack, alongside the strictu sensu fiscal rules, the EU introduced 2 little-known Regulations establishing the Macroeconomic Imbalance Procedure.
7/19

It explicitly recognises the importance of competitiveness/macroecon imbalances, & monitors indicators such as inflation, nominal unit labour costs and current account positions. Formally it is similar to the fiscal rules, sporting an “excessive imbalance procedure”.
8/19

In principle, then, it is based on the macroeconomic rationality that Simon argues is sadly missing. This begs the question why we are not in a much better econ-policy situation thanks to the MIP. In a nutshell: because the MIP has 3 important weaknesses.
9/19

1. Alongside the key indicators the MIP contains numerous others of dubious relevance: as a result the MIP lacks focus and a forward looking approach
2. The indicators are not symmetric but skewed in favour of surplus countries and dampening down inflation and demand.
10/19

Third, and partly as a result of the first two, the MIP is the poor cousin to the fiscal rules. It has been largely ignored by policymakers and also in public debate.
11/19

The reform path is then obvious. Revise the MIP so as to a) focus the indicators on fwd-looking variables under policy influence (unit labour cost, inflation, current account), b) render them symmetrical, & c) use MIP as the prime yardstick to evaluate the fiscal stance.
12/19

MIP reform would bring pressure to bear on the fiscal rules strictu sensu. (Commission and EU Fiscal Board have identified the tension between them as in need of reform as part of the ongoing economic governance review.)
13/19

As far as politically possible they should then be changed to increase counter-cyclicality (e.g. an expenditure rule oriented to nominal GDP growth, where the nominal bit = ECB target rate), some form of golden rule to protect investment, and sideline any fixed debt rule.
14/19

This approach has an additional plus. For fiscal policy is the most important, but not the only way to achieve national stabilisation. Macroprudential regulation can play a role. And social partners & govts can cooperate to influence nominal outcomes, esp. (wage) inflation.
15/19

Depending on their institutional set-up, countries can use a mix of fiscal, macropru. measures & “incomes policies” (social pacts, extensions of collective bargaining agreements, minimum wage or public-sector wage policies) to keep the economy close to the inflation target.
16/19

Here another little-known EU institution could play useful role if it were reformed. The Macroeconomic Dialogue brings together at EU level precisely the actors needed to engage in policy cooperation. It must be strengthened by having similar structures in each MS.
17/19

A balanced and cooperative policy mix of this type, keeping price and wage inflation in each MS near target would ease pressure on the ECB, avoid “rotating slumps” & debt buildups and – as Simon argues – create the best conditions for stabilising government debt.
18/19

Some literature:
imk-boeckler.de/de/faust-detai…
imk-boeckler.de/de/faust-detai…
imk-boeckler.de/de/faust-detai…
Other colleagues who have focused on inter-MS imbalances include:
@agnesbq1 @GuntramWolff @SDullien @pisaniferry @ojblanchard1 @CreelJer @GustavAHorn @SDullien
19/19