Readiness 2030 and the New Fiscal Framework
Why Europe’s defence build-up need not derail debt sustainability — and why accounting rules will shape its fiscal impact. A working paper by Daniel Gros, and Silvan Hofer
Introduction
Europe faces the necessity to provide for its own security, which implies large increases in defense spending. In the long run, these expenditures will have to be financed through a combination of tax increases and expenditure cuts elsewhere. This is also implicit in the EU’s fiscal framework.
The new version of the fiscal rules emphasizes the tool of (stochastic) debt sustainability analysis (DSA) to ascertain fiscal sustainability.
But given the need to urgently ramp up defense expenditure without forcing member states to make large cuts elsewhere, the European Commission invited member states in early 2025 to activate the NEC.
This mechanism allows states to temporarily deviate from the existing consolidation paths mandated under the DSA by excluding defense expenditures up to 1.5% of GDP from the fiscal rules for four years.
A country that uses the fiscal space in the NEC will have, at the end of the adjustment period of four years, a deficit that is up to 1.5% higher than under the baseline plan.
The Commission (2025) therefore assumes that in this case the country will need a second adjustment plan during which it has to bring down the deficit by 1.5% (or whatever was the increase in military expenditure).
Whatever the time path of the increase in military expenditure and subsequent reduction in the deficit, the NEC would leave a legacy of higher public debt of around 6% in the case of a gradual ramp-up of higher expenditure and a gradual winding down of the higher deficit.
The key questions are then: What does a higher debt level of this order of magnitude mean for the eventual adjustment necessary by the end of a second adjustment period?
And, given only 16 countries have requested activation of the NEC, not among them larger debtors like Italy or Spain, is this eventual adjustment prohibitive for high debt countries?
We develop a simple and transparent framework for showing how activation of the NEC impacts the required adjustment of the primary balance.
Under the relevant scenario of a buffer to cushion r-g shocks, we find that a country which fully exploits the NEC will have to increase the primary balance by only 0.12% of GDP at the end of the adjustment period.
Applying the framework to Italy, we show that its predictions closely match those from a full-scale model, lending credibility to the rule-of-thumb we propose. We note that under the previous debt adjustment rule, an increase in the debt ratio of 6 percentage points would have required an additional adjustment of 0.30 (6/20) points of GDP, more than double the value under the new rules.
We first give a short overview of the state of the NEC. Then, we derive the simplified DSA framework and use it to show how the NEC would increase the buffers required.
This gives an order of magnitude of the adjustment required, even for the countries that have not chosen to ask for the NEC (Part I). We also briefly explain how increases in defense spending are recorded, and the timing issues stemming from it (Part II).
IEP Bocconi does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
