The Stability and Growth Pact

main indicators used in the the fiscal CSRs

Roberta TORRE European Commission – DG Economic and Financial Affairs

Fiscal Policy and Surveillance

EP Summer seminar

9-10 July 2018, Brussels

Fiscal Country Specific Recommendations

"Achieve the medium term budgetary objective in 2019".

"Ensure that the nominal growth rate of net primary government expenditure does not exceed x% in 2019, corresponding to an annual structural adjustment of x% of GDP."

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The structural balance

• Concept of structural budget balance (SB) – takes out the impact of the economic cycle (and one-offs)

𝑆𝐵 = 𝐵𝑢𝑑𝑔𝑒𝑡𝐵𝑎𝑙𝑎𝑛𝑐𝑒

𝑌 − ∗ 𝑂𝑢𝑡𝑝𝑢𝑡 𝐺𝑎𝑝 − 𝑜𝑛𝑒𝑜𝑓𝑓𝑠

Cyclically adjusted budget balance

IF ΔSB > 0 => Fiscal position is improving

IF ΔSB < 0 => Fiscal position is deteriorating

• Also used as operational indicator in corrective arm

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The Medium Term Objective (MTO)

• Country-specific anchor for the structural balance

• Set by Member States subject to:

(i) Safety margin with respect to the 3%

(ii) Ensure sustainability or rapid progress towards it

(iii) Euro area and ERMII: -1.0%

• Allows room for budgetary manœuvre since it is expressed in structural terms

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What is the expenditure benchmark?

Growth in total government expenditure excluding:

o Interest expenditure

o Cyclical component of unemployment benefits

o Expenditure matched by EU funds

In addition:

o Investment is smoothed over four years

o Discretionary revenue measures are netted out

The benchmark growth rate against which the former is compared

o For MS at MTO: medium-term potential GDP growth

o For MS not at MTO: a lower, country-specific rate

The expenditure benchmark

The expenditure benchmark

How does the expenditure benchmark work?

Analysis of government expenditure net of discretionary measures

• For countries at their MTO:

Net expenditure must grow at most in line with potential GDP

• For countries not at their MTO:

Net expenditure must grow at rate below medium-term growth rate of potential GDP

• Difference between two growth rates calculated to ensure structural balance improves as required (0.5% as a rule)

• Unless excess is matched by discretionary revenue measures: No cap on expenditure!

Why have an expenditure benchmark?

• Only expenditure trends can be controlled by government over the medium term

• Circumvent uncertainty surrounding the structural budget balance

• Provide operational guidance to MS concerning appropriate adjustment path towards the MTO

• Strengthen automatic stabilisation

• Expenditure on a sustainable path

• Revenues are allowed to fluctuate with the economic cycle

The expenditure benchmark

Why have an expenditure benchmark?

The expenditure benchmark

Expenditure aggregate growth (COM 2007 Spring Forecast)

Nominal potential GDP growth (COM 2007 Spring Forecast)

Structural balance (COM 2007 Spring Forecast)

Structural balance (COM 2014Spring Forecast)

Thank you

E-mail: roberta.torre@ec.europa.eu

Additional slides

If at MTO at the start of the year:

• Remain at MTO, while respecting the Expenditure Benchmark, and do not jeopardize it

If NOT at MTO at the start of the year:

• Adjust towards the MTO, while respecting the Expenditure Benchmark

• Required adjustment: 0.5% of GDP as a benchmark, less in bad times, more in good times + if high debt and/or sustainability concerns

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• Effort modulated according to cyclical conditions, debt level and

sustainability risks

• Structural reform clause

• Investment clause

The requirement of the preventive arm

The matrix of fiscal adjustment

Cyclical conditions

Modulation of the fiscal effort according to the economic cycle

Distance to the MTO: situation in 2017

• Minimum MTOs are computed for each MS:

MTO min= max(MTOMB, MTOILD, -1€/ERM)

• Regular updates: every 3 years or after reforms with major impact on sustainability

Minimum MTO

Minimum Benchmark

BAD TIMES

Implicit Liabilities and Debt

DEBT and FUTURE LIABILITIES (e.g. aging costs)

Limit for EA

and ERMII

•

ε - semi-elasticity of the budget balance to the output gap

ROG - Representative Output Gap

Nms – number of available observations for the MS concerned

Ni – number of years since 1986 (number of EU obs)

P5% - fifth percentile of output gap distribution

Outliers dropped:

EU: percentiles 2.25 and 97.5 MS: min(2009, 2010)

MTOMB: Buffers against bad times

MTOILD: taking debt and future into account

MTOILD= Balance60% stabil.+ Effortdebt red+ α Ageing

The resulting MTO is then rounded to the most favourable quarter of percentage point.

Debt stabilizing component

MTOILD= 60% GDPf (2060) +f(dt)+α x Ageing

Balance60% stabil = 60% γ (2017-2060)

Where γ is the average nominal GDP growth in the period 2017-2060.

MTOILD: Sustainability component

MTOILD= Balance60% stabil.+ Effortdebt red+ α Ageing

f(dt)= 0.024dt-1.24 f(60) = 0.2

f(100) = 1.2

-1.5

-1

-0.5

0

0.5

1

1.5

2

0 10 20 30 40 50 60 70 80 90 100 110 120

f(dt)

dt

MTOILD= Balance60% stabil.+ Effortdebt red+ α Ageing

MTOILD= 60% GDPf (2060)+f(dt)+ α Ageing

This represents the budgetary adjustment that would be necessary now to cover the projected increase in age-related expenditure

1. 1/3 of ageing costs

MTOILD: Sustainability component

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Smoothing of investments

Expenditure matched by EU funds revenue

Discretionary revenue

measures and revenues

mandated by law

Cyclically-adjusted expenditure

Expenditure matched by EU funds

Interest expenditure

The components of the EB

Breakdown of the difference between the SB and the EB

Two potential types of factors can explain differences between the two indicators:

1. Factors that flaw one of the two estimators

Windfalls/shortfalls

2. Factors that are related to the different definitions of the two indicators

Different potential GDP growth rates

Specific treatment of expenditure items

(e.g. interest payments)

• Both pillars taken into account: SB and the EB

• MS that overachieved MTO: only structural balance

• Compare observed/forecast developments with the required ones

• Significant deviation thresholds:

Significant deviation criteria (Articles 6(3) and 10(3) of Regulation 1466/97)

Assessing compliance: HOW?

Year

Indicator

Deviation SB 0.5% 0.25%

Deviation EB 0.5% 0.25%

Year t (Year t + Year t-1 )/2