THE STATE OF THE EURO AREA AND FISCAL EXPANSION
The autumn package of the 2017 European Semester was published, and sets out economic and social priorities for the EU, the euro area and the Member States' levels.
It includes:
- a Recommendation for a Council Recommendation on the economic policy of the euro area
- the assessment of euro area Member States' Draft Budgetary Plans for 2017: a Chapeau Communication and individual Opinions for 18 euro area Member States (all except Greece) including the Assessment of action taken by Portugal and Spain, as well as analytical Staff Working Documents
The case for a coordinated fiscal expansion?
The Commission called for a euro area coordinated fiscal expansion of 0.5pp of GDP in 2017 (Citi), which still needs to be endorsed by the Council. The full delivery of the fiscal requirements agreed for each country would imply, on aggregate, a moderately restrictive fiscal stance for the euro area in 2017 and 2018, which the EC judges as “not appropriate”. As noted by Citi, this is the first time the EC calls for a coordinated fiscal stance, to support the single monetary policy of the ECB. The European Commission strikes a new balance in its recommendations with a call for fiscal expansion, as noted by Charles Wyplosz, in a TelosEU column.
The EC proposes that member states which are “over-achieving their fiscal objectives” should use their fiscal space, countries that are under the preventive arm of the Stability Pact (i.e. a with a fiscal deficit smaller than 3% of GDP) should remain “broadly compliant” with the rules and countries still under the Excessive Deficit Procedure should “ensure a timely correction of their excessive deficits” to provide fiscal buffers against unforeseen circumstances.
Marco Buti and Nicolas Carnot, in VoxEU, argue that the case is strong for spending now on investment and other targeted programs supporting growth and employment. But some countries are able to exploit a clear margin, while others need to pursue a more prudent approach of gradual debt unwinding.
Olivier Blanchard (hat-tip EuroIntelligence) reminds us that the argument for a large increase in the deficit is usually based on a comparison of the return on investment for infrastructure spending, which is surely positive, and the real interest rate, which is negative. However, close to capacity limits, the case becomes less clear: to avoid overheating the economy, any increase in public sector spending would have to be offset by equivalent falls in private spending. The relevant opportunity cost of public investment becomes the marginal product of the private capital that would be crowded out. This may apply to Germany, but not France, or Italy or Spain—all constrained by deficit rules. The consequence is that the only economically viable way of raising fiscal spending would be at the eurozone level. EuroIntelligence concludes that a fiscal union is needed for the eurozone to function economically.
Germany’s resistance. In practice, the EC proposal effectively means that Germany and the Netherlands (and a few other small countries) should be the only ones having to adopt a significantly more expansionary fiscal stance, as all the other major euro area members (France, Italy, Spain, Belgium) are either under the corrective or the preventive arm of the Stability Pact. Germany, through FM Schauble, rejected the call for more spending, as reported by EuroIntelligence, and noted that Germany increased investment more than the euro zone average in the last decade. One argument is that more investment spending would not bring additional benefits as earmarked resources are already under-utilised because investment capacity is hitting its limits.
The Eurogroup’s rejection. However, the Eurogroup did not endorse the specific target (see the Statement and opening remarks)—saying it was “important to strike an appropriate balance” – recommending a neutral rather than positive fiscal stance for next year. The joint statement says Germany, the Netherlands and Luxembourg have fiscal scope to boost growth but acknowledges that it is a matter for national governments.
In practice, a slightly accommodative stance to be expected. Goldman Sachs updated their assumptions for the Euro area fiscal stance—somewhat easier than previously, at a stimulus of around ½% of GDP in 2017, slightly higher than in 2016, driven by increased fiscal space (owing to low interest payments and improving growth) and upcoming elections in large Euro area economies. They estimate the impact on growth, up to ¼% in 2016 and ½% in 2017, thanks to relatively high multipliers.
