The European fiscal compact. Implications for …The European fiscal compact. Implications for...
Transcript of The European fiscal compact. Implications for …The European fiscal compact. Implications for...
The European fiscal compact.
Implications for Romania
Ionut Dumitru Chairman of the Fiscal Council*
February 8, 2012
* The opinions expressed in this presentation are those of the author and do not necessarily represent the views of the Fiscal Council
1. What does the European fiscal compact comprises?
• Part of the Treaty on Stability, Coordination and Governance in the Economic and
Monetary Union - new treaty to be signed by all EU countries except the United
Kingdom and the Czech Republic.
• The treaty aims to strengthen fiscal discipline by introducing automatic penalties
and better enforcement.
• The new treaty includes the requirement that national budgets are balanced or in
surplus. This requirement will be met if annual structural deficit will not exceed
0.5% of GDP.
• Member States will be obliged to introduce the "target for a balanced budget" in
their national legal systems, preferably at the constitutional level. The deadline
for fulfilling this obligation is one year after the entry into force of the Treaty.
• If the public debt is significantly below 60% of GDP and risks in terms of long-
term sustainability of public finances are low, the structural deficit may reach up
to 1% of GDP.
2. Is the fiscal compact enough for the proper functioning
of the Monetary Union? (1)
• The 3% of GDP budget deficit ceiling and the 60% of GDP ceiling for public
debt have always existed, as established by the Maastricht Treaty in 1992.
• The Stability and Growth Pact (1997) - the position of medium-term structural
budget balance to be ‘close to balance or in surplus’.
• The new fiscal pact sets automatic correction rules and penalties when a • The new fiscal pact sets automatic correction rules and penalties when a
country exceeds these limits.
• The Eurozone is an unprecedented currency union in history, sharing only the
monetary policy, without having a fiscal union.
• Successful monetary unions in history are those that have combined the
monetary union with the fiscal one (U.S., Canada, Germany and Switzerland).
• Bordo, Markiewicz and Jonung (2011) – required characteristics for a successful
monetary union:
– an independent central bank that aims price stability
– free trade and movement of production factors and capital
– a common fiscal policy, with strong fiscal rules, member states having a certain fiscal
independence, but fiscal discipline imposed by the financial markets and strengthened
by the rule of “no bail-out” of member states by the federal government
– the existence of strong mechanisms to deal with asymmetric shocks (automatic
stabilizers such as unemployment benefits and progressive income taxation, as well as
transfers from the states less affected by shocks to those most affected).
2. Is the fiscal compact enough for the proper functioning
of the Monetary Union? (2)
transfers from the states less affected by shocks to those most affected).
• The EU budget accounts for slightly above 1% of GDP, a low value, and it is not
used as a stabilization mechanism.
• There are no fiscal transfers between member states when asymmetric shocks
occur, while labor mobility and flexibility in Europe is much lower than in U.S. or
Canada.
• EU member states are quite heterogeneous in terms of economic development
and competitiveness.
3. The fiscal compact impact for Romania
The cyclical and structural deficit
• Actual budget deficit = Cyclical deficit (automatic stabilizers) + structural deficit (discretionary policies)
• Both public revenues and expenditurse have components influenced by the economic cycle. Through its cyclical fluctuations, the budget balance automatically contributes to the “smoothing” of fluctuations in aggregate demand and economic cycle.
• The revenues and expenditure components influenced by the economic cycle act as “automatic stabilizers” smoothing the economic cycle and reducing GDP volatility. “automatic stabilizers” smoothing the economic cycle and reducing GDP volatility. The more progressive the tax system is, the better the action of this mechanism.
• The structural balance represents the fiscal stance when the production factors are at their “normal” level, i.e. when the economy is midway between an economic boom and a recession.
• The economic cycle impact on the cyclical balance is determined by the output-gap and the revenue and expenditure elasticity to changes in the economic activity.
Estimation of potential GDP and GDP deviation from the
potential level – a key element
2.9%
2.6%2.4%
2.6%2.8%
2.0% 2.1%
3.4%
3.8%
4.2%
4.7%
5.3%5.1%
2.7%
2.0%1.9% 2.0%
2.2%
0%
1%
2%
3%
4%
5%
6%
200
220
240
260
280
300
320
340
360
Potentia l GDP growth (rhs) Potentia l GDP (RON bn in 2005 prices) Real GDP (RON bn in 2005 prices)
Note: European Commission estimates, November 2011
-10
-5
0
5
10
15
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
F
20
12
F
20
13
FOutput gap (in %)
Cyclical and structural component of public
revenues and expenditure
-5
0
5
10
15
-10
0
10
20
30
40
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
F2
01
2F
20
13
F
Cyclically adjusted total revenue (% of GDP)
� The cyclical component of revenues is higher than
the cyclical component of expenditure
Note: European Commission estimates, November 2011
-10
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
F
20
12
F
20
13
F
Output gap (%)
Cyclical component of revenue (% of GDP)
Cyclical component of expenditure (% of GDP)
Cyclically adjusted total revenue (% of GDP)
Cyclical component of revenue (% of GDP)
Total revenues (% of GDP)
-10
0
10
20
30
40
50
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
F2
01
2F
20
13
F
Cyclically adjusted total expenditure (% of GDP)
Cyclical component of expenditure (% of GDP)
Total expenditure (% of GDP)
Actual deficit, structural deficit and the cyclical deficit
-10
-8
-6
-4
-2
0
2
4
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
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08
20
09
20
10
20
11
F2
01
2F
20
13
F
-10
-5
0
5
10
15
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
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05
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07
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20
10
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11
F
20
12
F
20
13
F
Note: green hatched areas designate periods when output gap is positive (economy is growing above potential)
European Commission estimates, November 2011
� When the economy grows above potential (positive output gap), a cyclical budget surplus is recorded
and the actual deficit is lower than the structural deficit ���� the risk that policy makers implement
expansionary policies by increasing public expenditure based on temporary income (of cyclical nature)
� Pro-cyclical discretionary fiscal policy has abolished the economic cycle stabilization role of automatic
stabilizers.
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
F2
01
2F
20
13
F
Cyclically adjusted net lending (% of GDP)
Cyclical component of expenditure (% of GDP)
Effective budget deficit (% of GDP)
Cyclical component of net lending (% of GDP)
Output gap (%)
Cyclically adjusted net lending (% of GDP)
The new rule imposes a very strict control over public
finances, with advantages and disadvantages
Advantage: very low risk of pro-cyclical fiscal
policies.
� For example, if the rule would have been applied in the past,
in 2008 when the economy was growing above potential, a
budget surplus of 2.5% would have been required instead of
an actual deficit of 5.7%
Disadvantage: reduced fiscal space during
recessions.
-2.9
-5.7
1.92.5
-0.4
-8
-6
-4
-2
0
2
4
recessions.
� In Romania, the structural deficit limit of 0.5% of GDP will
likely be reached before the actual government deficit equals
3% of GDP (Romania may have budget deficits of 3% of GDP
only in times of extreme crisis - negative output gap of about
8.3%)
Note: deficit recalculated by the relation: -0.5% + cyclical deficit (% of GDP)
Source: own calculations based on European Commission estimates, November 2011
-9.0-10
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
F
2012
F
2013
F
Effective budget deficit (% of GDP)
Deficit recalculated based on the fiscal rule (% of GDP)
The size of automatic stabilizers in the European economies
Change in percentage points due to an increase in output gap of 1 p.p.*
0.60
0.49
0.47
0.30
-0.30
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
* For the budget balance, the graph presents the impact as % of GDP
Source: AMECO, author’s estimates
� Compared with other European countries, the government’s ability to contribute to the smoothing of
fluctuations in the business cycle through automatic stabilizers is relatively low for Romania.
Romania would need stronger discretionary fiscal stimulus (structural deficit) during recessions.
-0.30
Danemarca
Olanda
Suedia
Finlanda
Belgia
Germ
ania
Franta
Italia
Zona Euro
Luxemburg
UE27
Slovenia
Austria
Ungaria
Irlanda
Spania
Marea Britanie
Grecia
Polonia
Cipru
Rep. C
eha
Bulgaria
Portugalia
Malta
Estonia
Romania
Slovacia
Letonia
Lituania
Revenue Expenditure (-) Budget balance
The size of automatic stabilizers is closely related to the tax
system and public sector as share of GDP
DK
NE
SW
FI
BE
DE
FR
IT
LU
EU27
SE
AU
HU
UKEL
PL
CY
CZPT
MT42
47
52
Structural component of
expenditure
(% of potential GDP, average 2001-
2011)
Source: AMECO, author’s estimates.
IRESCY
BGEE
RO
SKLV
LT
32
37
0.20 0.30 0.40 0.50 0.60
Structural component of
expenditure
(% of potential GDP, average 2001
2011)
Automatic stabilizers (pp)
In the medium and long term, the actual deficit is equal
to the structural deficit
Last economic cycle
(1999-2011)
Last two economic
cycles (1995-2013)
Average of the budget deficit
(% of GDP) -3.8 -3.7
Average of the cyclical
component (% of GDP) 0.0 0.0
Average of the structural
Source: Calculations based on estimates of the European Commission, November 2011
� On average over an economic cycle (and the long-term average), the effective budget deficit
should to 0.5% of GDP
Average of the structural
deficit (% of GDP) -3.8 -3.7
Public debt: what is the optimal level?
0
20
40
60
80
100
120
140
160
Esto
nia
Bulg
aria
Rom
ania
Sued
ia
Litu
ania
Ceh
ia
Slov
acia
Slov
enia
Leto
nia
Finl
anda
Polo
nia
Ola
nda
Span
ia
Aus
tria
Ger
man
ia
Fran
ta UK
Belg
ia
Irla
nda
Port
ugal
ia
Italia
Gre
cia
Public debta (% of GDP, Q3 2011)
EEBG
RO
SE
LT
CZSK SILV FI DKPLNL
ESCYMT ATDE
EU27HU FRUKEA BE
IEPT
ITGR
0
20
40
60
80
100
120
140
40 60 80 100 120 140
Publ
ic d
ebt
(% o
f G
DP,
Q3
20
11
)
GDP per capita in 2010 (% of EU27 average)
Source: calculations based on Eurostat data
In the medium and long term, the 0.5% of GDP ceiling for the structural deficit leads to lower public debt (as %
of GDP). In about 20 years, assuming an average GDP nominal growth rate of 5%, public debt will reach 20% of
GDP.
Long-term dynamics of public debt (% of GDP)
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
2032
2034
2036
2038
2040
2042
2044
2046
2048
2050
2052
2054
2056
2058
2060
0.5% of GDP structural def icit
0.7% of GDP structural def icit
1% of GDP structural def icit
Improving EU funds absorption is a must
European Commission payments to member states under the Cohesion
Policy 2007-2013 ( the situation from October 2011)
Source: EUROPE’S SOURCES OF GROWTH - Presentation of J.M. Barroso to the European Council of October 23, 2011
Note: total payments from the EU budget as% of total allocations for 2007-2013.. The figures include the prepayments that are between 7.5%
and 11% for a Member State
EU funds absorption is an enormous stimulus for the economy (for 1 leu own
resources – budgetary deficit – public expenditure amounting 20 lei can be
made), which is crucial in the context of discretionary fiscal policy
constraints imposed by the new fiscal pact and the small size of automatic
stabilizers!!!!!!!
The necessity to increase the efficiency in public spending
0
1
2
3
4
5
Rom
ania
Esto
nia
Ceh
ia
Luxe
mbu
rg
Bulg
aria
Polo
nia
Irla
nda
Litu
ania
Span
ia
Slov
enia
Fran
ta
Ger
man
ia
Aus
tria
Investment expenditure (% of GDP, 2001-2010 average)
World Economic Forum, The Global Competitiveness
Report 2011-2012
� Important financial resources allocated for public
investment expenditure, but:
� there is a strong sentiment that the infrastructure
progress was very small
� poor infrastructure remains a critical problem for
Romania
Source: computations based on Eurostat data Source: computations based on Eurostat data
0
1
2
3
4
5
6
7
Rom
ania
Bulg
aria
Polo
nia
Slov
acia
Ung
aria
Cehi
a
Aus
tria
Fran
ta
Ger
man
ia
Infrastructure quality index (GCI 2011-2012)
2001-2010 average)
4. Concluding remarks
• The new fiscal pact includes as a major advantage for Romania the introduction of a strict fiscal discipline, thus avoiding the pro-cyclicality of discretionary fiscal policy.
• Disadvantage - the use of discretionary fiscal policy, especially in times of recession, is limited, while the automatic stabilizers are relatively too low to be enough in stabilizing the economy.
• The 0.5% of GDP structural deficit ceiling is more restrictive for Romania than the 3% of GDP ceiling for actual deficit.
• Possible solutions:• Top priority - urgent and substantial increase of EU funds absorption
• increase efficiency of public expenditure
• increasing the magnitude of automatic stabilizers
• In the medium and long term, the 0.5% of GDP ceiling for the structural deficit leads to a substantial reduction of the public debt (as % of GDP). Is this desirable for an economy like Romania’s economy?