A fiscal framework that targets full employment

A fiscal framework that judges budgets by their effect on employment and prices rather than by deficit and debt ratios. Public debt is sustainable when the economy has full employment and price stability; the deficit becomes a countercyclical policy variable instead of a fixed ceiling.

The euro needs two things fixed, not replaced. One is the ECB's role as dealer of last resort. The other is the fiscal framework, which is too tight and aimed at the wrong target: hitting a deficit ratio does not deliver full employment or price stability. When a member state is hit by a shock, its tax revenues fall and its deficit rises just as its economy needs support. Finland after the collapse of its largest company is the pattern: rising unemployment, falling revenues, a higher deficit, then spending cuts that deepen the downturn. Without its own exchange rate, a country in that position can only hope its neighbours' demand pulls it out.

The alternative is to treat the deficit limit as a policy instrument that moves with the cycle, and to measure fiscal sustainability by its real outcomes. An independent fiscal council could advise governments on the employment and price effects of a budget and on the resources it would use, in place of policing ratios.

The pandemic shows this can work. With the general escape clause active and the ECB buying member-state bonds, eurozone governments spent to protect jobs and incomes, and unemployment rose far less than in the United States. The eurozone is capable of an institutional framework that supports employment and price stability.

Wouldn't some countries then spend more than others? Yes, and that is the point: a country with idle workers and factories needs more demand than one at full capacity. Common rules can still govern how fiscal space is shared, but they should target the outcomes people care about.