Dilemmas for the EU in deficit-financing of defence expenditure and maintenance of fiscal discipline

The European Union is grappling with the challenge of increasing defence expenditure while maintaining fiscal discipline under the Stability and Growth Pact (SGP). The European Commission has proposed activating the national escape clause available under the SGP to accommodate defence spending without triggering the excessive deficit procedure (EDP). However, the scope and enforcement of this measure remain uncertain. A proposed 1.5 percent of GDP cap on extra fiscal flexibility is legally questionable and unlikely to be enforced. While low-debt countries do not require the clause due to existing flexibility, highly indebted nations may find it insufficient in the face of rising debt costs. The escape clause may also serve as a backdoor for European Central Bank interventions under the Transmission Protection Instrument, which requires compliance with EU fiscal rules. The Commission has also proposed the Security Action for Europe (SAFE) funding mechanism, a €150 billion loan programme to finance national defence investments. SAFE relies on national borrowing and follows the model of the SURE (Support to mitigate Unemployment Risks in an Emergency) facility, put in place during the COVID-19 pandemic. However, SAFE's limited scale and dependence on national fiscal capacities mean it falls short of the collective security funding approach advocated by economists. Meanwhile, Germany's decision to reform its constitutional debt brake marks a major departure from its traditional fiscal policies. The reform establishes a permanent 'defence golden rule', exempting military spending from borrowing limits, alongside a €10 trillion infrastructure fund. Although this move does not endanger Germany's fiscal sustainability, it undermines EU-wide fiscal coordination and conflicts with the SGP. This could weaken the European Central Bank's position in future market interventions. Given these challenges, discussions on a new EU fiscal framework are necessary to ensure fiscal flexibility while maintaining debt sustainability.