The Euro Zone's Next Big Economic Battle? How to Be Green and Placate the Markets

  • As the euro zone prepares to reinstate fiscal rules, a debate has emerged over how best to ensure they reflect the market environment.
  • While countries want leeway for climate-friendly investments, others are adamant that the bloc needs fiscal consolidation.

The 19 nations that share the euro currency have a new topic to fret over in the coming months, which could ultimately end up being one of the biggest challenges of modern times.



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Broadly, the euro zone wants to spend more on climate policies in the future. But many countries are becoming concerned that this approach would push their debt level to extreme highs.

Consequently, these nations are now suggesting that climate-friendly investments shouldn't count against their total expenditure — an idea that the more fiscally-conservative nations will find hard to accept.

"I would not say 'yes' to that proposal, because debts are debts," Austrian Finance Minister Magnus Brunner told CNBC in Brussels, Belgium, this month when asked whether he would approve a debt break for green investments.

The 19 euro members are meant to follow EU fiscal rules that state they should not have public deficits above 60% of their GDP (gross domestic product). EU law also obliges countries to keep budget deficits below 3% of GDP.

These rules, which aim to keep the region on a sustainable fiscal path, were paused in the wake of the coronavirus pandemic to provide nations with the fiscal leeway to spend more and support their citizens.

Now, as the euro zone prepares to reinstate them next year, a debate has emerged over how best to ensure they reflect the market environment — higher debts, a different labor market and higher inflation.

Speaking to CNBC earlier in January, Spanish Finance Minister Nadia Calvino said: "We need to have an appropriate fiscal framework that is growth-friendly."

Spain, France and Italy — among others — do not want to put an abrupt end to the current loose fiscal policy stance, fearing this would damage the economic recovery.

The euro zone is actually expected to grow faster than the U.S. in 2022, precisely due to the fact that countries in Europe are able to pump a lot of money into their economies.

But other euro nations are adamant that the bloc needs fiscal consolidation to ensure that it can weather any future shocks more easily and avoid worrying financial markets at a time when the European Central Bank is adjusting its policy.

Austrian's Brunner said: "We are very much for stabilization ... sticking to the rules is very important for Austria."

'Clear benefits in acting early' on climate

This debate becomes increasingly difficult with Europe's pledge to reduce greenhouse gas emissions by at least 55% within the next eight years.

Climate Action Network Europe, a group representing over 1,500 NGOs and more than 47 million citizens, has previously called for "fundamental" reform of EU fiscal rules and economic governance "to ensure that any additional fiscal space will translate into targeted and effective climate action by Member States."

This is especially important, CAN Europe said, because "massive public and private investments in climate mitigation and adaptation are urgent to avoid runaway catastrophic climate scenarios."

As noted by the European Central Bank last year, "there are clear benefits in acting early" when it comes to tackling the climate emergency. "The short-term costs of the transition pale in comparison to the costs of unfettered climate change in the medium to long term."

At present, it is not yet clear what stance Germany — the traditional powerhouse of Europe's economy and historically one of the most fiscally-conservative nations — will take on fiscal reform.

"The German finance minister in principle does not like the word flexibility," Guntram Wolff, director at the think tank Bruegel, told CNBC.

However, he added that German Finance Minister Christian Lindner "might accept a very targeted flexibility on green investments" given the topic's domestic importance.

Other experts have suggested that instead of reforming the fiscal rules to support green investments, the EU will likely raise new joint debt.

The bloc surprised markets in 2020 when agreeing to temporarily tap the markets to fund the economic recovery from the Covid-19 pandemic. The same instrument could be used to specifically target the transition to carbon neutrality.

"The legacy of the pandemic is that we really know now that if the crisis is big enough then common European debt might at least be part of the solution and my bet come two, three, four years from now [is] the climate situation will reach that political level," Jacob Kirkegaard, senior fellow at the German Marshall Fund think tank, told CNBC.

Ireland's Finance Minister Paschal Donohoe also told CNBC "this is an important theme" that will follow the euro area throughout 2022.

However, he said that whatever the finance ministers end up deciding upon, one thing is clear: these investments "cannot all be met by public capital."

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