via Mike Shedlock
EU fiscal rules, on hiatus since the Covid recession, are about to restart. Recession is unavoidable. France and Germany take a leading role the action.
Eurozone Fiscal Rules
Eurozone fiscal rules have been suspended since 2020 but have been reinstated for 2024.
The rules limited budget deficits to 3% of gross domestic product and public debt to 60% of GDP.
The New Eurozone Rules keep intact the above limits but set a revised process to achieve them.
On December 20, 2023, the Council of the European Union finally reached an agreement on fiscal rules, to be discussed with the European Parliament in the first quarter of 2024 and enforced months later. Ultimately, the new EU fiscal rules represent a compromise between the fiscal hawks of central and northern Europe, led by Germany, and the southern countries, led by France, which insisted on the need to avoid a return to austerity in the European Union (that could cause a recession) and on the need to allow fiscal space to invest in climate transition, defense, and industrial policy.
The new rules maintain the Excessive Deficit Procedure (EDP) from the previous rules, although some aspects have been clarified. The EDP will be triggered by both an excessive deficit and excessive debt, and in assessing it the commission and the council will consider, among other elements, “government debt challenges,” the size of the deviation, progress in the implementation of reforms and investments and, “where appropriate, increases in government defense spending.”
Q1: What do the new rules say?
A1: The new fiscal rules are based on an a prior assessment of the sustainability of each country’s fiscal strategy based on a debt sustainability analysis. This classifies countries by risk levels through a transparent and jointly agreed methodology.
If either of the two targets (deficit or debt) is not met, the European Commission intervenes. It creates a fiscal adjustment plan to bring the member state back towards compliance. This is known as the “technical path,” which will take the form of “national medium-term structural fiscal plans” with a duration of four years, extendable to seven years if certain reforms or investments are carried out.
Q2: What are the new rules and safeguards?
A2: To ensure fiscal adjustment, the EU Council has established the application of several safeguards or conditions applicable to any structural fiscal plan. First, a minimum annual structural deficit reduction rate of 0.4 percent, which may be limited to 0.25 percent if the country is undertaking reforms and investments within a seven-year plan. This minimum reduction will be more demanding, 0.5 percent, if the member state is subject to an EDP. Second, the so-called deficit resilience safeguard forces all countries to reduce their structural deficit even after the 3 percent rule is met, down to a structural deficit of 1.5 percent, to create a fiscal cushion for times of difficulty. Third, the “debt sustainability safeguard,” which concerns the pace of public debt reduction requires that debt at the end of the adjustment period should represent, as a percentage of GDP, an average annual reduction of 0.5 percent for countries with debt between 60 percent and 90 percent of GDP and 1 percent for countries with debt above 90 percent, although it will only apply when the deficit has fallen below 3 percent.
The EU is Two Downgrades of French Debt from Another Debt Crisis
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We want to help Ukraine fight the Russians; become less dependent on China; re-industrialize; invest in climate policy; and cope with the demographic shock. We have not done the math.
What’s happening in Germany right now should serve as an early warning indicator of what happens when you are trying to do too much at the same time. It is the first country to hit the hard budget constraint. This is because Germany has tighter fiscal rules than others. A ruling by the German constitutional court in November enforced those rules in the strictest possible manner. Elsewhere, the EU’s own fiscal rules are also kicking back in this year. So far, governments have not taken them very seriously. But that will change for next year’s budget.
The French government ran a fiscal deficit of 4.9% in 2024, with no real fiscal consolidation in sight. We could be a couple of downgrades of French government debt away from another sovereign debt crisis in the eurozone. With Giorgia Meloni, Italy has a prime minister who succeeded avoiding the radar screens of the bond market vigilantes. But her government is also not addressing the fundamental problem of the Italian economy – the lack of productivity growth. Austerity now beckons everywhere.
You can wrap yourself in a Ukrainian flag. But you cannot help. On top of that, there is a consensus among the European NATO members that they need to spend more on defense. Germany has been struggling to meet the NATO defense spending target of 2 percent of GDP – prompting Donald Trump to make the threat that he would not protect Europe from an attack by Russia.
The west is confronted with more or less foreseeable fiscal shocks – on defense spending, on ageing populations, global trade and subsidies wars – and on climate change.
Germany’s opposition, the CDU/CSU, has already started breaking out of the Green policy consensus in the EU by opposing key planks of the EU and the German Green policy agenda, including the EU’s nature restoration law and Germany’s own domestic heating bill.
Until a few years ago, Germany basked in the delusion that it would become a global leader in green technologies. We now know that this is not so. China is the champion of the car battery and solar technology. The US Inflation Reduction Act is also luring green producers away from Europe.
Germany is the canary in the coalmine – the country where the various fiscal collisions kicked in early. But Germany is not unique.
European countries may choose different responses. Some may try to raise taxes. Some may try to get away with less defense spending than others. Most will reduce Green investments. One way or the other, austerity is coming to a country near you.
Eurozone Fiscal Brakes Are About to Kick In
The French government ran a fiscal deficit of 4.9% in 2024. The rule is 3.0%.
This is why France argued loudly to not return to the old rules.
On a Debt-to GDP basis, France is in even worse shape. “France Government debt accounted for 111.7% of the country’s Nominal GDP in Sep 2023, compared with the ratio of 111.8% in the previous quarter.”
On a debt-to-GDP basis, Germany is 66.1%, Greece 173%, Italy 142%, and Belgium 104% according to Trading Economics.
The target is 60%. Good luck with that.
Congrats to Estonia at 18.5% and Ireland at 44.4%.
Zero Chance to Hit Targets
I see no realistic chance for France, Greece, Italy, or Belgium to hit fiscal targets within four years, or even 10.
Those countries will likely make a token effort. The first thing headed into the ash heap of history will be green policies. That will have the EU greens and Biden hopping mad.
The EU’s 2% of GDP spending for NATO will also go on the ash heap. And that will have Trump hopping mad.
Forget about EU funding for Ukraine. The US will be on its own.
Those are the low-hanging fruit items. Then what? Tax hikes?
Even baby steps towards the fiscal targets will kick off a severe recession.
Germany’s Industrial Superpower Days are Over
Meanwhile, please note Germany’s Industrial Superpower Days are Over
German industrial production started its decline in 2017. An energy crisis and Green madness put on the finishing touches.
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