High Debt, Low Rates and Tail Events:
Rules-Based Fiscal Frameworks under Stress


Good afternoon and thank you to the European Fiscal Board and Professor Thygesen for hosting this timely and thought-provoking conference.

In will deal with three key issues. How do we manage the transition to recovery? What does the new normal look like? And are our rules fit for it?


First, how do we manage the transition to recovery?

Any discussion on when and how we should scale back public support measures should start from three basic premises.

First, in 2020 the EU economy went through the worst recession in its history, and will not return to pre-pandemic levels before mid-2022. The crisis has also been more severe than in the US, which is now bouncing back more strongly than the EU.

Second, uncertainty and risks to the forecast remain extraordinarily large. On the downside, new variants of the virus and the risks associated with them. On the upside, vaccination rollout could move more quickly than expected, or effectively hamper virus transmission, which is something we do not yet know.

Third, with the previous crisis we saw how costly it was to turn off the taps too soon. And while the cases are not exactly comparable, I think it is instructive to see the approach being taken by the new US administration, an approach discussed as we all know, but very clear. I’ve just come from a two-hour meeting of the G20 and it’s incredible how unanimous was the message: no premature withdrawal of supportive messages.

So given the context of a very deep, uneven recession and high uncertainty, I’m even more convinced after this meeting of the G20 that it would be wiser to err on the side of doing more, not less.

If we want to avoid repeating past mistakes and a sharp rise in insolvencies, we will need to manage the withdrawal of public support measures very carefully. This means moving gradually from a blanket approach to more targeted actions. We will need to step-up employment incentives for workers to support transition and reduce risk of long-term unemployment. And we also will need to distinguish between companies that are viable and those that are non-viable, but this famous distinction will not be easy in these times, given the divergence between sectors and the fact that some are still not seeing the light at the end of the tunnel.  

When it comes to the Stability and Growth Pact and the general escape clause, we have made clear our stance for this year. The question now is what about 2022?   

Next week, we will provide guidance for the period ahead and the criteria that we will look at to decide on the general escape clause. This will form the basis for discussions in the Eurogroup and ECOFIN, and decisions. Once again, we should be clear that when it comes to fiscal support at the current juncture, the risks of doing too little outweigh the risks of doing too much.


Second, what does the new normal look like?

Today’s afternoon session focused on the issue of high public debt levels, and this will definitely be a legacy of this pandemic, with average debt in the euro area probably above 100% of GDP.

We have seen significant increases in debt-to-GDP ratios all over world in the last year as countries grappled with Covid-19. These reflected a mix of increases in spending, falling revenues and lower GDP.

The debt burden has been eased by exceptionally low interest rates. Economic analysis and market indicators point to interest rates remaining low for the foreseeable future, driven by a chronic excess of saving over investment. Monetary policy has also provided an effective backstop against belief-driven surges in yields for the most exposed countries. As Isabel Schnabel indicated this morning, the current era of low inflation and low interest rates is unlikely to change in the near term. In this environment, a supportive fiscal stance is needed to achieve a balanced policy mix and support monetary policy in achieving price stability. 

Some economists may question the sustainability of these high debt levels. In my view, the answer lies in what we use this debt for.

  • If it’s to finance research, education, infrastructure, hospitals – we can see this as “good debt”, to coin Mario Draghi’s phrase, before he became prime minister.
  • If it’s to finance current expenditures and measures with no impact on productive capacity, then it’s “bad debt” and its sustainability will come into question.

Against this background, I think Member States should seek to take advantage of the current low interest rate environment to “grow out of debt” through investments and reforms. These are front and centre of our Recovery and Resilience Facility.

Once the health situation is fully under control and the economic situation has solidly improved, Member States will need to achieve a gradual and realistic reduction of high public debt ratios, especially countries with higher debt. That will imply building back adequate levels of primary surplus.

When the time does come for a gradual fiscal consolidation, and I repeat, we are not yet there, Member States should avoid another mistake from the last crisis, which was to allow the burden of cuts to fall to a great extent on public investment. Several EU Member States experienced a sharp drop in public investment in the wake of the financial crisis. This was also reflected in net investment – i.e. gross fixed capital formation less consumption of fixed capital – which fell to 0.1% in the period 2010-2018. Fiscal policy should ensure a composition of public finances that is both growth-friendly and sustainable. The RRF will play a key role here. The EFB and others have put forward useful proposals on how to incentivise a better composition of public finances.


And third, are our rules fit for the new normal?

As you well know, we launched the Economic Governance Review one year ago, drawing the lessons from the financial crisis on the application of the EU fiscal rules.  It will be important when we relaunch this review, in the second part of this year, that we factor into our ongoing reflection the lessons we have learned from the deep crisis that this pandemic was.  

Let me offer a few thoughts, including on some of the topics that have been discussed today and in the European Fiscal Board’s annual report.


First, we need to reflect on how our fiscal rules can support sustainable growth even as they keep spending under control. Both dimensions are essential. We should not forget that public finances should serve our public policy priorities. And the European priorities boil down to the three dimensions of sustainability: climate, environment and social. Big challenges, if we look at the needs for public expenditure. In this context, a special treatment for growth-enhancing expenditure is in my view needed. Or to put it another way, our fiscal rules should be adapted to improve the composition of public finances and make sure that any new debt is good debt.


Second, we must reflect on the role that a ‘debt rule’ should play in our fiscal framework. While a strict debt rule could lead to a drastic, pro-cyclical and self-defeating and improbable adjustment, a credible mechanism to steer debt onto a gradual and steady downward trajectory remains warranted. The requirements here must be realistic: this is key to ensuring enforceability and reducing the risk of divergence in our Union and our Single Market.

It is clear that the current rules lack a sufficient medium-term focus. Yet the main goal of fiscal rules should be to prevent unsustainable public finance trajectories, which can only be achieved by focussing on the medium term. The Commission made this point a year ago, when we launched the economic governance review; the EFB has highlighted it; and it emerged from today’s discussions as well. 


Third, we need to ensure that fiscal policy acts in a counter-cyclical manner and contributes to macroeconomic stabilisation. This crisis has shown us that discretionary fiscal policy can be both timely and forceful. And as long as monetary policy is constrained, I believe that fiscal policy will continue to play a greater role in macroeconomic stabilisation.

So better coordination is needed to achieve the right policy mix in the euro area, in particular in terms of determining the euro area fiscal stance. This is also why the Economic Governance Review should be looked at jointly and in parallel with the ECB Strategy Review so that the two reviews result in a coherent outcome.

We should have a reflection on whether there is a need to turn to the general escape clause more often in economic downturns, in order to account for the effective lower bound on monetary policy. A single, more readily usable escape clause could be balanced by eliminating the multitude of exceptions that currently apply to the normal provisions of the Stability and Growth Pact. The inclusion of such a single escape clause, by the way proposed by the EFB and others, would preserve the ability to cater for unforeseeable occurrences, while reducing the complexity of the framework. 

Of course, the first best way of strengthening the role of fiscal policy against shocks remains the introduction of a permanent fiscal capacity in the euro area. And here let me recall that, while our recovery plan is a specific and extraordinary response to an unprecedented crisis, we should not underestimate the novelty represented by Next Generation EU. For the first time, the European Union will be issuing common debt for a common purpose, and for the benefit of all of our citizens. And this is a real game-changer.



Ladies and Gentlemen,


Before I wrap up, let me take this occasion to thank the EFB and the network of independent fiscal institutions for the essential work that they do and the key role they play in underpinning the credibility of our fiscal framework.

Today’s conference has given us plenty of food for thought. In the coming months we will reflect on how to move forward.

There is room to bring in change through interpretative changes to our rules. But if we want to be more ambitious – and if not now, when? – we should not rule out legislative changes too.

Thank you very much.