The slow march to fiscal dominance

Mario Draghi is known as the ECB President who said that he would do “whatever it takes” to save the euro. Now, his report on European Union competitiveness is designed to save the EU, and it’s caused quite a stir. Draghi identified the issues of EU competitiveness as poor productivity, caused by fragmentation of industrial policy along national lines, and a lack of co-ordination and focus across policy lines, such as fiscal, trade and foreign policies. 

As a solution, Draghi is calling for a re-focus of industrial policy and a minimum annual investment of “€750 to €800 billion…based on the latest Commission estimates, corresponding to 4.4-4.7% of EU GDP in 2023. For comparison, investment under the Marshall Plan between 1948–51 was equivalent to 1–2% of EU GDP”. The investment would have to be financed mainly by euro area debt. If implemented, the Draghi Plan will put the eurozone on the road to fiscal dominance. Currently, euro area debt averages 88.6% of GDP, which is just short of the 90% guideline specified by Reinhart & Rogoff when a sovereign becomes at risk of significant and prolonged reductions in economic growth. By comparison, the U.S. debt to GDP ratio stands at 121%. However, eurozone countries have arguably less fiscal room as member states can’t print their own currency and must rely on the European Central Bank.

This will cement developed economies’ path to fiscal dominance. Investors will need to prepare accordingly.
 The full post can be found here.