Abstract
The fiscal cost of the financial and economic crisis in Europe is huge. The paper provides provisional estimates of this cost and looks at its implications for the sustainability of public finances, taking into account also the impact of aging populations. The historical experience suggests that economic growth is persistently lowered in the aftermath of financial crisis, making fiscal consolidation more difficult yet all the more essential. Meanwhile the timing of the exit from fiscal stimulus and subsequent fiscal consolidation must reconcile sustainability and stabilisation goals—a delicate balancing act. The paper will argue in favour of structural reform to boost the economic growth potential alongside fiscal consolidation. The fiscal coordination framework in the EU, together with the Europe 2020 strategy, is seen to underpin this approach.
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Notes
European Council Conclusions, Brussels, 26 March 2010.
The mnemonics used in these and subsequent figures are: BE = Belgium, BG = Bulgaria, CZ = Czech Republic, DK = Denmark, DE = Germany, IE = Ireland, EE = Estonia, EL = Greece, ES = Spain, FR = France, IT = Italy, CY = Cyprus, LV = Latvia, LT = Lithuania, LU = Luxembourg, HU = Hungary, MT = Malta, NL = Netherlands, AT = Austria, PL = Poland, PT = Portugal, RO = Romania, Sl = Slovenia, SK = Slovak Republic, FI = Finland, SE = Sweden and UK = United Kingdom.
In fact, there is evidence that real estate bubbles and trade deficits are to some extent two sides of one coin, with the former absorbing labour and capital resources that would otherwise be available for export activities, see e.g. Égert and Kierzenkowski (2010).
The fiscal space indicator used in Fig. 7 comprises five elements: the initial public debt, the contingent liabilities vis-à-vis the financial sector, the expected revenue shortfalls stemming from the unwinding of the real estate and construction boom, the current account position and the share of discretionary (as opposed to entitlement) expenditure in the government budget (see for further explanation European Commission 2009b, c). It should be underscored that the indicator is an imperfect gauge of fiscal space and for illustrative purposes only.
Assuming a time-variant r does not change the results fundamentally, but maker the maths a lot more unpleasant. The actual indicator used by the European Commission (2006, 2009a) does assume a time-variant r to reflect variations in the growth rate of the economy g, whereas the interest rate i is held constant.
In fact, the report presents estimates for three scenarios labelled the "Rebound scenario" in which the loss in potential output would be fully recovered after 10 years, the “Lost decade” scenario in which potential output would return to its pre-crisis growth rate after 10 years (but not the level of potential output), and the “Permanent shock” scenario in which also the growth rate of potential output is permanently lower.
The EDP sets out criteria, schedules and deadlines for the Council to reach a decision on the existence of an “excessive deficit” (meaning a deficit above the 3% of GDP threshold or that is inconsistent with convergence of public debt to the 60% of GDP threshold). No EDP procedure will be launched if the excess of the government deficit over the 3% threshold is considered temporary and exceptional and the deficit remains close to the threshold. When the Council decides that a deficit is excessive, it makes recommendations to the Member State concerned and establishes deadlines for effective corrective action to be taken. The Council monitors implementation of its recommendations and abrogates the EDP decision when the excessive deficit is corrected. If the Member State fails to comply, the Council can decide to move to the next step of the EDP, the ultimate possibility being to impose financial sanctions.
In Fig. 14 Greece is not shown because its EDP has been overtaken by the programme for deficit reduction agreed by the euro area Member States, the European Commission, the ECB and the IMF, with the deficit required to reach 3% of GDP by 2014.
The 1937/1938 recession in the United States is often quoted as a warning against premature exits from fiscal stimulus. However, the cutback in fiscal stimulus at the time was not an early but rather a late exit, in the wake of an unduly late and timid entry in the Great Depression in the first half of the early-1930s (Van den Noord 2010). Moreover, while the 1937/1938 recession can be attributed to cut backs in fiscal stimulus to some extent, were predominant. Notably, geopolitical tensions played a major role, along with adverse business confidence effects of Roosevelt's New Deal policies. Concerning the latter, the strengthening of wage bargaining power amid mass unemployment and heightened uncertainty over property rights were prominent.
Buti et al. (2010) suggest, moreover, the electoral impact of reform to be strongly dependent on which types of policies are considered. In particular, reform measures that are more likely to hit large groups of ‘insiders’, such as reform of employment protection legislation or pension reform, seem electorally damaging. In contrast, reform measures targeted at large groups of ‘outsiders’, such as the unemployed, would be electorally beneficial, while lowering taxes on labour would also find a positive reception with the electorate.
In that year eleven EU Member States—Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland—adopted the European Union's single currency, the euro, establishing the second largest single currency area in the world (after the United States). Five other EU Member States have joined the euro area since its inception: Greece in 2001, Slovenia in 2007, Cyprus and Malta in 2008 and Slovakia in 2009. The area is set to expand further as most EU Member States currently outside the euro area are preparing to join at some point in the future. Only Denmark and the United Kingdom have formally opted out of the single currency.
For an early account of the rationales and features of the Stability and Growth Pact, see Brunila et al. (2001).
EU Member States that have not yet adopted the single currency annually submit “Convergence Programmes” which essentially have the same coverage as the Stability Programmes.
Originally the SGP stipulated that as a rule a deficit above 3% is not excessive if real GDP has fallen by 2% or more. The Ecofin Council could also grant a waiver if GDP has fallen if the downturn is abrupt or large relative to past trends, but member states have committed not to invoke this possibility if the drop in GDP is less than ¾ %. These provisions have been modified in 2005.
The excessive deficit should be corrected in the year following its identification by Eurostat unless there are special circumstances. If, in the opinion of the ECOFIN Council, a member state fails to take sufficient measures to correct an excessive deficit, and after giving a further notice it may impose measures, including the obligation of a deposit with the Commission of initially 0.2% of GDP plus one tenth of the difference between the actual deficit and the reference value, with an upper limit of 0.5% of GDP. If the next year shows again an excessive deficit, another deposit according to the same formula for the variable amount can be required. If after 2 years the excessive deficit is still found to exist, the deposit will "as a rule" be converted into a fine, to be distributed among the other member states according to their share in the area wide gross national product.
Other relevant factors may also be taken into account, but only if the general government deficit remains close to the reference value and its excess over the reference value is temporary.
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Acknowledgments
Inputs by Christine Frayne and comments by Martin Larch and Karl Pichelmann are gratefully acknowledged.
Conflict of interest
Developments are unfolding rapidly, and the current text incorporates statistical information available up to 5 May 2010, the date of the release of the Commission’s 2010 Spring Forecast (European Commission 2010a). The author has written this article in his former capacity of Economic Adviser in the European Commission. The views expressed in this paper are the author’s only and do not necessarily reflect the position of the European Commission.
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This paper is an updated and revised version of an address given at the conference “The Aftermath of the Crisis”, on November 5–6, 2009 at the Österreichische Nationalbank.
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van den Noord, P. Turning the page? EU fiscal consolidation in the wake of the crisis. Empirica 38, 19–51 (2011). https://doi.org/10.1007/s10663-010-9144-1
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DOI: https://doi.org/10.1007/s10663-010-9144-1