Assessing the fiscal stance in the euro area : The Commission's methodology

10th meeting of the Network of public finance economists in public administration

2 March 2016

Eloïse Orseau ECFIN C1 - Fiscal policy and surveillance

Copyright rests with the author. All rights reserved.

• Motivation: institutional and macroeconomic context

• Methodology: measurement and assessment criteria

• Analysis and findings based on the 2015 autumn forecast in the PFR

• Issues and envisaged methodological improvements

Outline

Two Pack (Regulation (EU) 473/2013 Art. 7(4))

– 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"

– The Commission shall also, "as appropriate, outline measures to reinforce the coordination of budgetary (…) policy at the euro-area level"

Five Presidents' Report

– Reinforce the foundations of EMU, including by moving "towards a Fiscal Union that delivers both fiscal sustainability and fiscal stabilisation"

Current focus on the fiscal stance due to constraints on monetary policy

– Monetary policy currently constrained at the zero lower bound

– Fiscal policy in a better position to stabilise the economy than in normal times, given the amplification of the expansionary impact of fiscal stimulus by low real interest rates

– Coordination would help taking better into account the fiscal spillovers across euro area countries

Motivation: why assess the fiscal stance?

• What was missing:

- a consistent definition of the fiscal stance and indicators to measure it

- transparent, quantified criteria to assess it

• Analysis conducted within the rules of the SGP; analytical, descriptive approach, not normative

• Timeline:

- October 2015: presentation by the Commission of a tentative methodology and discussion in committees (EWG-A and EWG)

- December 2015: analysis of the fiscal stance according to the revised methodology in the PFR

- 2016: Further work on the methodology

Methodology: starting point and timeline

Measurement: what indicators and why?

• Indicators used in the PFR: ΔSPB, ΔSB and DFE

• Different focuses:

– comparability with SGP requirements (SB),

– comparability with S1 (SPB),

– calculations using the fiscal multiplier (SPB),

– assessment of fiscal effort (DFE)

Assessment: defining transparent, simple criteria

• Two separate criteria: long-term sustainability of public finances and short-term economic stabilisation

• The illustrative calculations are a basis for discussion

• Comparisons:

– Sustainability needs vs. stabilisation needs

– Needs vs. projections

Methodology in the 2015 PFR

Estimating sustainability needs

• Principle: Structural fiscal adjustment required to put or maintain debt on a

sustainable path

• Indicator: Measured by the S1 indicator, i.e. the improvement in the structural primary balance in 2016-2020 to bring the debt ratio to 60% in 2030.

(Advantages of S1: existing indicator, includes the costs of ageing populations)

• Illustrative quantification: 25% of the total effort assumed to be achieved in the first year

Estimating stabilisation needs

• Principle: Ensuring that the output gap is closed at a sufficiently rapid pace

• Indicator: Fiscal stimulus (or consolidation) necessary to achieve the envisaged reduction of the output gap

• Illustrative quantification: Reduction of the output gap by 25% to 50% in one year (range)

Methodology in the 2015 PFR

Analysis in the 2015 PFR: sustainability needs

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

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

Change in the SPB implied by sustainability needs

Member States with a negative OG in 2015 Member States with a positive OG in 2015

Euro area

broadly neutral fiscal

stance

Analysis in the 2015 PFR: sustainability vs stabilisation needs

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

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

Change in the SPB consistent with a reduction of the OG by 25% Change in the SPB consistent with a reduction of the OG by 50%

Change in the SPB implied by sustainability needs

Member States with a negative OG in 2015 Member States with a positive OG in 2015

Euro area

broadly neutral fiscal

stance

(-3.1)

Analysis in the 2015 PFR: needs vs. forecasts

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

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

Change in the SPB consistent with a reduction of the OG by 25% Change in the SPB consistent with a reduction of the OG by 50%

Change in the SPB in the Commission forecast Change in the SPB implied by sustainability needs

Member States with a negative OG in 2015 Member States with a positive OG in 2015

Euro area

broadly neutral fiscal

stance

(-3.1)

• Broad compatibility of sustainability and stabilisation objectives in normal times

• Tensions rising if stronger sustainability needs or more ambitious stabilisation targets

• Differences across Member States in terms of:

- needs

- budgetary room for manœuvre to address both needs

- priorities (more or less tilted towards stabilisation)

• Implications:

- Possibility of tensions between stabilisation needs for the euro area and national stabilisation needs

- Stimulus tends to be feasible in countries that do not need it and needed in countries that do not have the fiscal scope to implement it

Main findings in the 2015 PFR

Indicators of fiscal effort, cycle and sustainability

• Uncertainties related to estimates of the output gap and the structural balance in real time, also affecting S1

Putting needs together

• The balance between the two objectives varies with time and economic conditions: difficulty to get a composite indicator

Aggregation of countries

• The analysis assumes the same multipliers (large uncertainty)

• The meaningfulness of compounding fiscal adjustments by different governments is not clear (no central decision + countries have different fiscal room for manoeuvre, therefore a certain fiscal stance does not have the same meaning in all MS)

• No spillovers included currently in the analysis, only a mechanical aggregation of national fiscal stances

Conceptual and methodological issues

Improving indicators • For symmetry: range (25%-50%) for the sustainability needs

• Complement the OG by the number of consecutive years with a positive or negative OG?

• Complement S1 with Debt Sustainability Analysis and distance to the MTO?

• When do needs become more pressing? Introduce non-linearities?

Aggregation • Integrate spillovers and contagion effects in the analysis

Way forward with the methodology

• Analysis of the fiscal stance in the euro area, in line with the Two Pack, and in a context of impaired monetary policy

• Assessment of the projected fiscal stance against two transparent and separate criteria: sustainability and stabilisation needs

• Main findings:

- In many cases, fiscal policy can address both needs at the same time at least partially, but tensions can exist

- There can also be tensions between individual country needs and euro area needs

- The EA fiscal stance is currently slightly tilted towards stabilisation

• Still work in progress, and methodology to be refined

Conclusion: main messages

Thank you

Background slides

Total fiscal adjustment needed in 2016-2020 according to the S1 indicator (as % of GDP)

Gap to the

debt-

stabilizing

primary

balance

Cost of

delaying

adjustment

BE 3.4 -0.5 0.4 3.2 0.2

DE -1.3 -2.6 -0.2 0.7 0.8

EE -3.6 -0.4 -0.4 -3.3 0.5

IE 3.9 -0.9 0.5 2.7 1.6

EL 8.8 0.0 1.3 8.4 -0.9

ES 1.6 -0.1 0.2 2.6 -1.1

FR 3.8 0.8 0.5 2.4 0.0

IT 2.4 -2.1 0.3 4.6 -0.3

CY 0.1 -2.0 0.0 2.8 -0.7

LV -1.4 0.6 -0.2 -1.4 -0.4

LT 0.3 -0.1 0.0 -1.0 1.3

LU -3.2 -1.4 -0.4 -2.8 1.4

MT 0.4 -1.0 0.0 0.4 0.9

NL -0.7 -0.5 -0.1 0.6 -0.7

AT 0.2 -2.0 0.0 1.8 0.4

PT 3.5 -1.7 0.5 4.2 0.5

SI 2.6 0.1 0.4 1.5 0.6

SK -0.5 0.0 -0.1 -0.5 0.1

FI 2.7 0.5 0.4 0.2 1.7

EA 1.4 -1.1 0.2 2.2 0.1

S1

("2015

scenario")

Due to

Initial budgetary position

Debt

requirement

Ageing

costs

Source: Commission services.

Change in the SPB implied by stabilisation and sustainability needs and in the Commission forecast (as % of GDP)

Source: Commission services.

SUSTAINABILITY NEEDS

EA 0.2 -0.4 0.3 -0.2 -1.8 0.7 0.6

LU 0.3 -0.2 -0.8 0.2 -1.5 0.4 0.6

DE -0.4 -0.5 -0.3 -0.3 -0.4 0.1 -0.2

NL 0.4 -0.1 -0.2 -0.4 -1.6 1.0 0.7

SK 0.0 -0.3 -0.1 0.0 -1.2 0.3 0.3

CY 1.4 0.3 0.0 -0.4 -3.6 2.4 2.1

AT -0.2 -0.6 0.1 -0.5 -1.2 0.5 0.1

ES 1.2 0.0 0.4 -0.3 -3.9 2.2 1.9

IT 0.2 -0.7 0.6 -0.7 -2.9 1.4 0.9

SI 1.3 1.1 0.6 0.2 -0.5 1.1 1.2

FI 0.0 -0.7 0.7 0.2 -2.5 0.5 0.7

BE 0.0 -0.2 0.8 0.3 -0.9 0.1 0.3

PT -0.3 -1.0 0.9 -0.9 -2.3 1.1 0.4

FR 0.2 -0.3 0.9 0.4 -1.8 0.3 0.6

EL -0.6 -3.1 2.2 0.6 -7.9 1.0 1.5

EE -0.1 0.0 -0.9 -0.1 0.5 -0.1 -0.2

LV 1.0 1.5 -0.3 0.2 1.7 0.2 0.4

LT 0.3 0.4 0.1 -0.3 0.4 0.3 0.1

MT 0.7 0.9 0.1 0.2 0.6 0.2 0.4

IE 1.1 1.5 1.0 0.6 1.2 0.1 0.6

STABILISATION NEEDS

Change in the

SPB consistent

with a

reduction of

the OG by 25%

Change in the

SPB consistent

with a

reduction of

the OG by 50%

Change in the SPB

implied by the

sustainability needs

COMMISSION FORECAST

Change in

the SPB in

2016

(ΔSPB baseline )

OG in 2015ΔOG in 2016

(ΔOG baseline )

Recalculated

ΔOG in 2016

with ΔSPB=0

(ΔOG° )