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The reform of the European union’s fiscal governance framework in a new macroeconomic environment

The main proposals for the reform of the European Union’s fiscal policy framework affect three blocks of issues: (i) simplifying the rules to make them more transparent and flexible; (ii) incorporating new supranational risk-sharing instruments into the Economic and Monetary Union, in particular to facilitate the absorption of severe shocks; and (iii) the fiscal aspects necessarily being accompanied by reforms at the national (structural reforms) and supranational (e.g. pressing forward with the capital markets union) levels. Irrespective of their political feasibility, these proposals do not easily fit the current macroeconomic environment, which is far removed from that of the 1990s: structural trends, such as digitalisation, globalisation, the climate transition and population ageing, affecting the natural rates of interest and potential growth are emerging or taking hold. Also, after the Great Moderation, we have entered a period of severe global shocks. In this paper we argue that this setting calls for a paradigm shift in how the fiscal policy framework is designed, as opposed to the incremental reform approach of recent decades. We provide quantitative elements to illustrate several challenges with a bearing on any reform process in the current setting: (i) medium-term debt anchors should be adapted to the medium and long-term interest rate and potential growth expectations; (ii) economies may remain subject to very severe shocks, meaning that fiscal space must be recovered in the medium term; and (iii) realistic mechanisms for absorbing existing fiscal imbalances must be implemented.