Florian Schuster, Maximilian Krahé, Pola Schneemelcher, Philippa Sigl-Glöckner

The Stability and Growth Pact (SGP) is up for review. It is also in urgent need of reform if rule-based fiscal policy is to be maintained without impeding the recovery from the Covid crisis, without standing in the way of achieving the climate targets, and without undermining European sovereignty in an era of new geopolitical challenges. Yet, legislative reform faces significant challenges, given the position of countries such as Germany. Thus, we argue that a first reform step that is both viable within the current framework and supportive of economic recovery and growth could be a useful start.

In particular, we propose to update the method for estimating potential output to better reflect actual economic potential, instead of largely extrapolating from a past trend. This would not require legislative change, build on past efforts of the EU-COM to refine the potential output calculations and could yield fiscal space for the recovery from Covid as well as for climate, energy, and security investments. Finally, it would also help better to align the fiscal rules with European core values, in particular gender equality.

In what follows, we

• identify three problems with the current method for calculating potential output,
• put forward a concrete proposal for improving the method, and
• show the impact of this proposal for seven selected European economies.

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