Read the full blog post here A desperately needed reform of the EU’s fiscal rules is finally underway. However, the proposed rules put forward by the Commission are irresponsible – they jeopardise the public investments needed to combat climate change. The inclusion of uniform debt and deficit rules, advocated by Germany and other frugal countries, would instil the same failed economic principles that have made Europe poorer for over a decade. Moreover, these rules would lead to some countries having to reimplement the failed austerity of the past. But this is unnecessary: at least €135bn per year could be spent on green investment by the EU’s most indebted countries with debt still falling by the 2030s.
To effectively address the climate crisis, early investments that rapidly cut emissions are essential. Unfortunately, the proposed fiscal rules prevent the fiscal stimulus that would reduce emissions. This is particularly counterproductive, as green spending has an outsized multiplier effect when compared to other public investments.
The EU’s proposed fiscal rules will also lead to greater economic divergence between countries. Wealthier countries, which have a greater capacity to borrow within fiscal rules, will be able to leverage green public investments to address climate challenges and effectively stimulate economic growth. Less wealthy nations will be more restricted.
The EU’s fiscal rules are built upon the so-called Maastricht criteria require governments to maintain budget deficits and public debt below 3% and 60% of GDP, respectively. The Commission’s proposal for new fiscal rules however introduces a new approach to categorise countries based using a Debt Sustainability Analysis (DSA), dividing them into high‑, medium‑, and low-risk groups.
High and medium-risk countries are required to reduce their debt and/or deficits, while low-risk countries are expected to maintain debt levels below 60% and deficits below 3%. This country-specific approach, which suggests negotiated adjustments with governments, replaces the previous uniform reductions mandated – the 1/20th rule, which required a 0.5% reduction in debt for excess debt above the 60% debt-to-GDP limit.
The Debt Sustainability Analysis is based on a complex model that uses a range of indicators and uncertain assumptions including growth rates, interest rates, inflation, and 10-year debt forecasts. However, the impacts that spending cuts could have on growth and debt trajectories are omitted, and the costs of austerity on social outcomes and the environment are ignored.
In addition to the 3% deficit limit remaining a hard limit, the Commission’s proposed rules include other one-size-fits-all rules. These benchmarks entail reducing the deficit by 0.5 percentage points of GDP per year after breaching the 3% limit, decreasing debt within a four-to-seven-year timeframe, and keeping expenditure below potential GDP growth. Some countries, led by Germany’s Finance Minister Christian Lindner, continue to advocate for additional uniform rules to accelerate debt reductions.
Our analysis shows the risks associated with the proposed fiscal rules. Specifically:
3% deficit hard limit: While the 60% debt-to-GDP limit serves as a target, the 3% deficit limit is a hard limit, which means only four countries would be able to invest sufficiently to limit global warming to 1.5°C.
Somewhat arbitrary (leaked) Debt Sustainability Analysis outcomes: We find that 10 out of the 15 member states with debt-to-GDP ratios exceeding 60% would experience faster debt reduction compared to the current 1/20th rule.
Numerical benchmark requires member states above the 3% deficit limit to reduce deficit spending by a minimum of 0.5% of GDP annually: But this can be counterproductive in reducing debt-to-GDP.
Requirements for growth in net expenditure to be lower than GDP growth: This ignores that a 1% green stimulus, irrespective of the current deficit position, can generate growth and reduce debt-to-GDP in the medium term due to the outsized green multiplier.
Requirement for a reduction in debt-to-GDP within the initial four to seven-year period: We argue that this contradicts scientific conclusions on how we act on climate, which requires us to make early investments to cut emissions rapidly.