The fiscal stance in

the euro area

Servaas DEROOSE

Deputy Director-General
European Commission, DG Economic and Financial Affairs

Public Finance Dialogue

Berlin 14 October 2016
 Introduction
Maastricht assignment

o Monetary policy centralised

o Fiscal policy decentralised, subject to Stability and Growth

Pact (SGP)

Delors Report (1989) stressed the importance of the

fiscal stance in the euro area

"() the task of setting a Community-wide fiscal policy

stance will have to be performed through the coordination of
national budgetary policies."

=> Does the current degree of coordination guarantee

appropriate fiscal stance in the euro area and the
member states?
2
 Outline
1. Rationale: Why is it useful?
2. Concept: How to define it?
3. Fiscal stance in practice: How appropriate?
4. Policy: What are the implications?
5. Alternative avenues: What more can be done?
6. Conclusions

3
 Rationale

Economic underpinning
Normal times
o Monetary policy cum sound fiscal policy + automatic
stabilisers in general successful tools for stabilisation

Severe crisis/protracted stagnation

o Significant economic slack and persistently low inflation
o Monetary policy overburdened: reaching its limits,
diminishing effectiveness, adverse side-effects
o At ZLB, fiscal multipliers likely to be higher than in
normal times
=>Additional discretionary action needed for stabilisation
and to support reaching inflation objective

4
 Rationale

Legal basis
Article 121 of the Treaty: "Member States shall regard
their economic policies as a matter of common concern and
shall coordinate them within the Council"
=> recommendations for countries and for euro area as a whole,
including on euro area fiscal stance

Article 7(4) of the Two Pack (Regulation (EU)

473/2013) requires the Commission to "make an overall
assessment of the budgetary situation and prospects in the
euro area as a whole", based on "the national budgetary
prospects and their interaction across the area" and the
Commission shall also, "as appropriate, outline measures to
reinforce the coordination of budgetary () policy at the
euro-area level".

5
 Rationale

Political support
Long tradition of Commission assessments of euro area
national fiscal policies and implications for the euro area

o E.g. annual mid-year review of budgetary policies for the Eurogroup

o E.g. assessments of draft budgetary plans

More recently, work following mandate of two-pack on

euro area fiscal stance (*) => evolving mood:
o Many Member States supportive, along with the ECB

o Exercise considered useful in committees

(*) See e.g. European Commission, "The 2016 Stability and Convergence Programmes: An
Overview and Implications for the Euro Area Fiscal Stance", Institutional Paper 34,
September 2016.
6
 Concept

What is the appropriate fiscal stance?

No universally accepted definition

Stabilisation versus sustainability objectives

o Stabilisation: structural (primary) balance; discretionary
fiscal effort (DFE)
o Sustainability: S1 indicator, distance to MTO

Measurement issues and uncertainty

o Output gap: (i) measurement in real time; (ii) length and depth
of the cycle; (iii) pace of closing output gap
o Stabilisation impact: (i) fiscal multipliers; (ii) time lags; (iii)
spillovers
o Aggregation: (i) sensitivity to method used; (ii) consistency

7
 Concept

How do we do it in practice?
Ranges for working towards stabilisation
o The change in the output gap projected in the Commission's
forecast (but corrected for the expected impact of fiscal policy)
measures the spontaneous closure of the output gap that would
result from a neutral fiscal stance (all other assumptions
unchanged compared to baseline).
o Range: the structural primary balance in 2017 adjusts to close
the output gap compared to its 2016 level by either 25% or 50%.

Ranges for working towards sustainability

o The S1 indicator measures the cumulative adjustment of the
structural primary balance over the next 5 years needed to
reduce debt to 60% of GDP by 2030 (taking into account ageing
costs).
o Range: the structural primary balance in 2017 adjusts by either
25% or 50% of this cumulative adjustment (i.e. frontloading).
8
 Concept

Spill-overs:
coordination versus no coordination

GDP GDP

Gov't Gov't
Balance Balance
(% GDP) (% GDP)

9
 Practice

Recent fiscal stance: slightly expansionary

Discretionary fiscal effort in 2014-16 (% of GDP)
1

0.5

-0.5

-1

-1.5
2014 2015 2016 2014 2015 2016 2014 2015 2016 2014 2015 2016 2014 2015 2016 2014 2015 2016
(f) (f) (f) (f) (f) (f)
Revenue side - 2014 Expenditure side - 2014 Revenue side - 2015 Expenditure side - 2015
EA-19 DE FR IT ES REA
Revenue side Expenditure side Total DFE

Note: (f) indicates forecasts. Source: DG ECFIN.

10
 Practice

Limited overall GDP effects

Impact of discretionary fiscal policy on GDP in 2014-16 (% of GDP)

Note: Cumulative difference in the real GDP level between actual developments and a counterfactual
where the fiscal stance would have been neutral from 2014 onwards. The simulations focus on short-
run macroeconomic effects and assume that there are no sustainability risks.

Source: DG ECFIN, QUEST simulations.

11
 Practice

Composition of adjustment has been sub-optimal

Euro area, 2011-2016 (% GDP)

3.0
Total Mainly tax-based
2.5
Expenditure with standard
Revenues
methodology (SB),
2.0
and even more so
1.5 with refined
1.0
methodology (DFE)
+ Expenditure cuts
0.5
often at the
0.0 expense of
Discretionary Fiscal Effort Structural Balance investment
-0.5

-1.0

Source: DG ECFIN.

12
 Practice: 2017

Aggregated government plans

Government plans Broadly

(stability programmes) +0.1
neutral
0 fiscal
Commission spring stance
forecast 2016 -0.2
(no policy change)

Change in the structural primary balance

Note: % of GDP. Source: DG ECFIN.
13
 Practice: 2017

Plans vs. sustainability and stabilisation needs

+ 0.6

Sustainability needs

+ 0.3

Government plans Broadly

(stability programmes) +0.1
neutral
0 fiscal
-0.0
Stabilisation needs stance
-0.2

Change in the structural primary balance

Note: % of GDP. Source: DG ECFIN.
14
 Practice by MS:
2017

Stabilisation and sustainability

3
Good economic times

LV LT Note:
IE Horizontal
SI
1 axis: S1
MT indicator.
Vertical
CY NL SK axis:
Fiscal Consolidation output gap
0
scope needed in 2017
ES
EE BE assuming a
AT EA IT PT neutral
-1 DE fiscal
FR stance.
LU FI

-2

Bad economic times

-3
-7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7

Source: DG ECFIN.
15
 Practice by MS:
2017

Sustainability: Alternative indicators confirm high risks

6
Rank correlation
S1, distance to MTO 0.67
4 S1, primary gap 0.79
Distance to MTO, primary gap 0.58

-2

-4

-6
EA LU EE LV CY DE NL AT LT SK MT ES SI IE FI IT BE FR PT
S1 (DSA pointing to low risk) S1 (DSA pointing to medium risk)
S1 (DSA pointing to high risk) S1 (no DSA)
Distance to the MTO at the beginning of 2017 Primary gap

Source: DG ECFIN
16
 Practice by MS:
2017

Stabilisation: Output gap dynamics and length of cycle

OG in 2017 (assuming Upturn
no change in the SPB)
2

Note: 2017
1.5
LV assuming a neutral
LT
SI IE Narrowing fiscal stance.
after few Shaded areas:
1 years of levels at which the
MT good times output gap is
0.5
considered to be
Closing after several NL broadly closed.
years of bad times CY Size of the
0 SK bubbles: number
ES PT BE
EE of consecutive
years with an
-0.5 output gap of the
EA AT
Narrowing but still IT same sign, as
DE
not closed after -1 FR measured in 2016
several years of bad (pale blue: 1-4
FI
times LU years, dark blue:
-1.5 5-8 years).

OG in 2016 Source: DG ECFIN.

-2
-2 -1.5 -1 -0.5 0 0.5 1 1.5 2
Still not closed after several Closed
years of bad times, and Downturn
widening again

17
 Practice by MS:
2017

Government plans
3.0
Euro Member States with a
Member States with a negative OG in 2016
area positive OG in 2016
2.5

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0 broadly
neutral fiscal
-1.5 stance

-2.0

-2.5
EA-19 LU EE CY DE NL AT SK ES FI IT BE FR PT LV LT MT SI IE

Change in the SPB in the 2016 stability programmes

Source: DG ECFIN.
18
 Practice by MS:
2017

Plans vs. sustainability and stabilisation needs

3.0 3.0
Euro Member States with a
Member States with a negative OG in 2016
area positive OG in 2016
2.5 2.5

2.0 2.0

1.5 1.5

1.0 1.0

0.5 0.5

0.0 0.0

-0.5 -0.5

-1.0 broadly -1.0

neutral fiscal
-1.5 stance -1.5

-2.0 -2.0

-2.5 -2.5
EA-19 LU EE CY DE NL AT SK ES FI IT BE FR PT LV LT MT SI IE
Change in the SPB consistent with a closure of the OG by 50% compared to 2016
Change in the SPB consistent with a reduction of the OG by 25% on top of the neutral fiscal stance scenario
Change in the SPB implied by 25% of S1
Change in the SPB in the 2016 stability programmes
Change in the SPB implied by 50% of S1

Source: DG ECFIN.
19
 Policy implications

Policy implications

What aggregate fiscal stance is needed?

o Requires consensus on the objectives in terms of
stabilisation and sustainability, and on their relative weights
How can, in theory, a given aggregate fiscal stance be
broken down into national fiscal policies?
o Consistency with needs in individual Member States
o Internalisation of spillovers and contagion risks
o Efficiency and political economy considerations
How to deal with inadequate geographical composition?

20
 What more?

What more can be done?

Limited scope for an accommodative fiscal stance in the

euro area
o Economically
o Institutionally
o Flexibility within SGP exhausted

Other avenues for fiscal policy to play its role in

supporting the economy, in the short and medium term:
o Enhance automatic stabilisers
o Make budget composition more growth-friendly
o Central fiscal capacity?

o The new European Fiscal Board

21
 What more?
Automatic stabilisers

Enhance automatic stabilisers

How?
o Acknowledge trade-off (risk of allocative distortion) and political
economy risk of perpetuating temporary measures
o Add safeguards to minimise these risks

Example: time profile of unemployment benefits

o More generous in the first 6 months, with a rapid decrease
thereafter => help stabilisation and reduce unemployment trap

Additional measures to mitigate adverse effects of

automatic stabilisers
o E.g. cyclical investment tax credits or property taxation

22
 What more?
Composition

Improve the composition of the budget

A more growth-friendly composition of budgets could
help support growth in the short and long term
o Ex-ante budgetary neutral => no tensions with fiscal rules
o Possibly ex-post expansionary impact
Expenditure
o Raise importance of productive spending, such as public
investment, R&D, education, active labour market policies (by
reviewing public wage bill, subsidies)
o Increase efficiency / better targeting => better outcomes at an
unchanged level of expenditure or lower expenditure for same
outcome
Revenue
o Shift tax away from labour to consumption, property and
environmental taxes
o Broaden tax bases and eliminate inefficient tax expenditures
23
 What more?
Composition

Improving the quality of public finances

540.00

fi
fi
ee
520.00

ie nl pl High
iede performance
High performance- be Low efficiency
500.00

High efficiency
PISA mean score

cz
at uk
cz fr dk
si lv
es lu it
hu pt
480.00

hr lt
se
sk
el Low performance-
460.00

Low Low efficiency

performance-
High efficiency
440.00

bg ro cy

3 4 5 6 7
Total expenditure on primary and secondary education (average 2002-2011)

The example of expenditure in education (Pisa score)

24
 What more?
Central capacity

A central fiscal capacity?

Strengthen stabilisation via central capacity, whilst

ensuring compliance with SGP at national level
Different modalities
o Unemployment (re-)insurance mechanism
o Macroeconomic stabilisation fund
o Investment facility
Unresolved issues
o No permanent transfers
o Avoid moral hazard
o Degree of automaticity
o Financing

25
 What more?
European Fiscal Board

The new European Fiscal Board

Mandate: advise the Commission in its fiscal surveillance
tasks concerning the euro area, e.g.
o Evaluate horizontal consistency of fiscal surveillance decisions
o Evaluate the appropriateness of the actual fiscal stance at euro
area and national level
o Advise on the appropriateness of the prospective fiscal stance for
the euro area and possibly on the appropriate national fiscal
stances consistent with it
Composition:
o Chair + 4 members (international experts, appointed for 3 years)
o Independent and transparent (annual report)

26
 Conclusions
Since the 2013 two-pack reforms
o More attention for the euro area fiscal stance
o More political support
o New player: European Fiscal Board
But not easy to implement in practice
o Different objectives (sustainability / stabilisation); weights?
o Measurement issues and uncertainty
o Consistency between appropriate fiscal stance for the euro area as
a whole and the sum of the national fiscal stances?
What can fiscal policy do in the current circumstances of
sub-par growth and limits to monetary policy?
o Asymmetry of SGP => only moral suasion, no obligation for
countries with fiscal space to use it
o Enhance automatic stabilisers
o Improve composition of budgets
o Central fiscal capacity?
27