European Union between austerity and stagnation

The reaction to the pandemic shock led the European Union (EU) countries to use the suspension of the old Stability and Growth Pact (2020-2023) for a strong expansion of public spending. Together with the launch of Next Generation-EU and unconventional monetary policies, this fostered the economic rebound but also caused significant imbalances in public budgets.

Today it is therefore inevitable to put the high national public debts and deficits on downward trajectories through the application of the new fiscal rules, approved in April 2024. The necessary budgetary adjustments affect the majority of EU countries; although gradual and - taken one by one - growth-compatible, taken together they risk having recessionary effects.

Last June, the European Commission provided net spending trajectories to member states with unbalanced budgets; these days, all EU countries are releasing their structural fiscal plans and draft budget laws for 2025 for the Commission's scrutiny expected by the end of November. Although the picture is not complete, two macro-trends emerge clearly. Firstly, Member States with fiscal imbalances are reluctant to resort to justified deviations from the Commission's reference trajectories in order to make their adjustments more gradual. Second, almost all countries with fiscal space are inclined not to expand their net public spending or to do so only marginally. As a result, overall budgetary adjustments in the EU will have restrictive impacts as of 2025. According to our calculations on provisional data, structural primary balances will improve on average by more than half a point next year. France's adjustment will be about one point of GDP and those of Italy and Spain - respectively - 0.6 and 0.4; moreover, despite low public debt and economic recession, Germany will increase its structural balance by ¾ of a point.

The recessionary tone of national budgetary policies will take place at a time when the European economy is essentially stagnant in economic terms and requires profound changes to its obsolete production model in structural terms. Such policies will, therefore, be pro-cyclical in nature and will hinder the realisation of those innovative investments and reforms that the Draghi Report considers necessary to avoid the EU's economic and social agony. Attempts to circumvent this obstacle will force monetary policy to perform substitute tasks.

The European Central Bank (ECB) has embarked on a path of lowering policy interest rates. The danger of an upturn in inflation rates above the 2% threshold has receded into the background in the face of the high probability of a prolonged period of stagnation aggravated by the described budgetary policies. Even if in a context that appears - at least in the short term - less dramatic, the risk is to re-propose a policy mix analogous to that which characterised the periods 2011-2014 and - above all - 2014-2019: the ECB will be the only expansive policy actor, even if it will not have to bow to the sui generis "fiscal dominance" that led to curbing the effects of fiscal restrictions by means of unprecedented negative interest rates.