The coordination of fiscal policy in the EU

Bucharest, 10 April 2008

Elena Flores, European Commission

2

INDEX OF PRESENTATION

1. Multilateral fiscal policy surveillance: overview of the architecture

2. Fiscal policy-making in the EU: evolving rules

3. How did it work? Challenges ahead

3

1. Multilateral fiscal policy surveillance: overview of the architecture

• The rationale for sound public finances in EMU

• Why EMU-specific fiscal rules?

• The Maastricht fiscal rules

• The Stability and Growth Pact

4

The rationale for sound public finances in EMU

1. PRICE STABILITY

Support ECB monetary policyLower interest rates - Low interest paymentsLonger time-horizon: more private investment

2. SMOOTHING THE CYCLE

No national monetary policy need for room to let automatic stabilizers play freely

3. STRUCTURAL REFORM & SUSTAINABILITY

Need for room to implement reform that have a short term cost for public finances; Cope with the impact of ageing.

5

Why EMU-specific fiscal rules?

EMU unprecedented historical experiment

- monetary policy is centralised whilst fiscal policy is decentralised (MS)

-EMU-specific fiscal rules are best seen as device to ‘protect’ an independent stability-oriented common monetary policy against (possibly) destabilising opportunistic national fiscal policies

6

The Maastricht fiscal rules: Treaty

• “Member States shall avoid excessive government deficits” (Treaty Article 104)

– deficit below the reference value of 3% of GDP, unless it has declined substantially and continuously and reached a level close to the reference value or the excess is limited, exceptional and temporary

– debt should not exceed the reference value of 60% of GDP, or should be on a decreasing trend and approach the reference value at a satisfactory pace

7

The SGP (2): preventive arm

• Euro area Member States are obliged to annually submit stability programmes to the Commission, non-euro area Member States have to submit convergence programmes

• The medium-term budgetary position must ensure a safety margin against breaching the 3% limit

• The Council gives an early warning in case of significant divergences of budgetary positions from the medium-term budgetary objectives (MTO’s) or the adjustment path towards them

8

The SGP (3): corrective arm

• Tight timetable for the Excessive Deficit Procedure so as to arrive at a speedy decision on the existence of an excessive deficit

• First steps on the decision on the existence of an ED • Following steps on the correction of an excessive deficit

-Art 104.7: recommendation to correct the ED

-Art 104.9: strengthened surveillance• Sanctions if the EDP does not lead to a deficit correction

9

2. Fiscal policy-making in the EU: evolving rules

• Overview

• Positive aspects

• Difficulties

• Changing circumstances

• Reform of the Pact

10

Overview

1. Positive aspects

1. Anchoring budget deficits

2. Putting sustainability of public finances on top of the policy agenda

2. Difficulties

1. Medium-term budgetary objectives turned into moving targets(overly optimistic forecasts; insufficient control of public spending)

2. SGP worked asymmetrically over the cycle (pro-cyclicality)

3. Short-sightedness in the conduct of budgetary policy (one-offs)

4. Lack of political will (Early warnings not effective; events of Nov 2003)

5. Rising concerns about equal treatment among MS

3. Changing circumstances

1. Relation deficit and debt criterion weakened (stock-flow adjustment)

2. Increased economic heterogeneity in enlarged EU-25 made more difficult “one-size-fits-all”

3. Ageing populations

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Positive aspects: anchoring budget deficits

35

40

45

50

55

19701972

19741976

19781980

19821984

19861988

19901992

19941996

19982000

20022004

2006

% o

f G

DP

-2

-1

0

1

2

3

4

5

6

GD

P g

row

th r

ate

Deficit

Expenditure

Growth rate

Revenues

12

Positive aspects: increase in debt levels stopped

20

30

40

50

60

70

80

1970 1975 1980 1985 1990 1995 2000 2005

debt

rat

io, a

s a

% o

f GD

P

EUR-12

EUR-15

13

Difficulties: MTO’s became moving targets

-7

-6

-5

-4

-3

-2

-1

0

1

1990 1992 1994 1996 1998 2000 2002 2004 2006

ActualProjections

3rd

4th

1st vintage

2th

5th

6th

14

Difficulties: lack of consolidation in good times

98

3 3

1 1

3 3

5 5

-5

-4

-3

-2

-1

0

1

2

3

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

-15

-12

-9

-6

-3

0

3

6

9

Output Gap (lhs)

Cyclically-adjusted balance (lhs)

Number of MS with a deficit >3% (rhs)

Fiscal consolidation in bad times

No consolidation in good times

Bad times, timid consolidation

15

Difficulties: short-sightedness in the conduct of fiscal policy

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

1999 2000 2001 2002 2003 2004 2005

as %

of

GD

P

One-off measures

General government balance

Cyclically-adjusted balance

Cyclically-adjusted balance net of one-offs measures

16

Changing circumstances

– Relation deficit and debt criterion weakened (stock-flow adjustment)

– Enlargement - EU-25

– Ageing populations

=> Enriched common framework with stronger rationale and more focus on sustainability and debt

17

Changing circumstances:Heterogeneity

BE FIN

AT1

FR

EUR-12

IT

UE-25

CZNL

UK

SW

EE

LV HUN

GE

DK

SP

IE

LUX

SK

LT

POL PTMT

SI

ELCY

0%

2%

4%

6%

8%

10%

12%

14%

0 50 100 150 200 250

Gross domestic product at current market prices per head of population (% EU average)

Ave

rage

pot

ent

ial g

row

th,

in n

omin

al t

erm

s 20

00-2

005

18

Reform of the Pact

• Reform of the Pact: preventive arm

• Reform of the Pact: corrective arm

• Reform of the Pact: evaluation

19

Reform of the Pact: preventive arm

In November 2003, conflict Council/Commission about the SGP: a reform process was launched in 2004, agreement in March 2005, enacted in Council regulations in July 2005

New Council Regulation: 1055/2005 amending Regulation (EC) No 1466/97

• Differentiated medium-term budgetary objectives according to MS specificities (debt, potential growth, implicit liabilities)

• Annual structural adjustment of 0.5% GDP as a benchmark

• Larger efforts required in ‘good times’

• New incentives for structural reforms (deviation permitted)

• Direct “early policy advice” by Commission

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Reform of the Pact: preventive arm

• SGP complemented by national budgetary rules and institutions

• Need to base budgetary projections on realistic macroeconomic forecast

• SCP for the legislature

• National Parliaments increased role (discuss SCP and Council opinions, follow up recommendations to EW and EDP)

21

Reform of the Pact: corrective arm New Council Regulation: 1056/2005 amending Regulation (EC) No 1467/97

• Always a report Art 104(3) when deficit exceeds 3%,

• No expenditure item excluded, as demanded by some MS

• Clarification of nature and role of ‘Other Relevant Factors’ (which are taken into account only if the deficit close to the reference value and if the excess is temporary)

• Minimum fiscal effort required for MS under EDP of ½ % of GDP irrespective of other relevant factors

• Possibility of extended deadline for correction of excessive deficit to better reflect economic situation

• Modifications of exceptional circumstance (“severe economic downturn”) when growth is negative

• Possibility to repeat steps in the EDP in case of unexpected adverse events

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Reform of the Pact: evaluation

1. A rules-based system was preserved1. 3% and 60 % remain the nominal anchors2. No re-definition of the budget deficit3. Exceptions granted from 3 % ceiling only if the deficit remains close to

the reference value and excess is temporary

2. Removed incentives for time-inconsitent policies and short-sightedness of fiscal policy

1. One-off and temporary measures not included in fiscal effort

3. Stronger economic underpinnings1. Allowing for country-specific elements in setting MTOs and in

adjustment path to MTO2. Incentives for fiscal consolidation in good times3. Linking structural reforms with fiscal policy4. Economic elements taken into account in deciding on existence of

excessive deficits and in setting deadlines for their correction5. Obligation of fiscal efforts in the EDP

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3. How did it work? Challenges ahead

Data taken into account by the Council when deciding on the existence of an excessive deficit

2004 2005 2006 Conclusions

IT 3.1% of GDP

(observed)

3.6% of GDP

(COM spring-05 forecast)

4.6% of GDP

(COM spring-05 forecast) Close, not temporary

PT 2.9% of GDP

(observed)

6.2% of GDP

(Plans of the Portuguese authorities)

4.8% of GDP

(Plans of the Portuguese authorities) Not close, not temporary

UK 3.2% of GDP

(observed)

Just below 3½% of GDP

(COM autumn-05 forecast)

Around 3.1% of GDP

(COM autumn-05 forecast) Close, not temporary

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3. How did it work? Challenges ahead

Indentification (= year t)

Deadline for the

correctionEffort in t Effort in t+1 Effort in t+2 Effort in t+3

Yearly average

GE 2003 2004 (t+1) - - 0.5% of GDP

FR 2003 2004 (t+1) > 0% of GDPat least 0.5% of

GDP- - 0.3% of GDP

NL 2004 2005 (t+1) 0.6 % of GDPat least 0.5% of

GDP- - 0.5% of GDP

GR 2004 2005 (t+1) - 0.5% of GDP

IT 2005 2007 (t+2) > 0% of GDP - 0.6% of GDP

PT-II 2005 2008 (t+3)Package of

0.6% of GDP1.5% structural 0.75% structural 0.75% structural 0.9% of GDP

UK2006 (fiscal

year)2006 (t) 0,5% structural - - - 0,5% of GDP

104(7) rec. under the original

SGP to EU-15 Member

States

104(7) rec. under the

revised SGP

1.0% of GDP of structural measures

Structural measures of at least 1% of GDP over the 2 years

Change in the structural balance of at least 1.6% of GDP cumulated

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3. How did it work? Challenges ahead

• Still a long way to go to reach the MTO

• Not sufficient consolidation in good times

• Better integrate medium and long tem fiscal challenges

• Improve efficiency of national fiscal rules

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3. How did it work? Challenges ahead

0

0,5

1

1,5

2

2,5

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Very low coverage by fiscal

rules

Low coverage by fiscal

rules

High coverage by fiscal

rules

Very high coverage

by fiscal rules

Share of government finances covered by numerical fiscal rules and primary cyclically-adjusted primary balance

27

Reference material

• Economic and Monetary Union: Legal and Political Texts -edited jointly by the Commission and by the General Secretariat of the

Council of the EU (2007) -Link:

http://bookshop.europa.eu/eubookshop/FileCache/PUBPDF/QC7606262ENC/QC7606262ENC_002.pdf

Public Finance in EMU, link:http://ec.europa.eu/economy_finance/publications/publicfinance_en.htm

• Fiscal Policy Surveillance in Europe -edited by Peter Wierts, Servaas Deroose, Elena Flores and Alessandro

Turrini (2006)