After years of dormant peripheral risk, the recent resurgence of fragmentation issues in Europe, amid rising stagflationary risks at a time of Central Banks committing to tame inflation, puts the delicate fiscal and monetary equilibrium under the spotlight. When facing a higher inflationary regime, we call for a new set of fiscal rules designed to overcome the limits of the old overly rigid one size-fits-all framework.
- The implementation of some rules seems realistic: the focus on a spending rule rather than on structural deficits, together with a larger use of stochastic debt sustainability analysis.
- Others can also probably be agreed: a stronger role for Independent Fiscal Institutions, positive incentives in terms of access to EU funds, more distinction between current and investment spending, and a closer interaction of fiscal and macroeconomic surveillance.
- There are rules that will be more challenging to achieve: an orderly sovereign default process and a blue debt / red debt system would involve very complex transformations, with many issues needing to be resolved in terms of governance, the treatment of legacy debt and interaction with other EU fiscal and monetary instruments.
Nonetheless, even limited reforms to EU fiscal rules could help reduce the specific “institutional fragility and complexity” risk premium that European assets (public, yet also private sector ones) carry in comparison to their equivalents in other regions.