Assessment of the prospective fiscal stance appropriate for the euro area

On 20 June 2017, the European Fiscal Board (EFB) shared with the European Commission its first advice on the overall direction of fiscal policy in the single currency area. The Board is of the view that in 2018 a neutral fiscal stance is appropriate for the euro area as a whole and that such a stance could be implemented through differentiated national fiscal policies within the parameters of the Stability and Growth Pact (SGP). In addition, the Board considers that governments should target a re-composition of government expenditure to increase investment spending, which has borne the brunt of successive fiscal consolidation efforts in the aftermath of the crisis.

The report is an assessment of the prospective fiscal stance appropriate for the euro area as a whole.  The timing of the publication reflects the sequencing of policy decisions in the annual surveillance cycle of the European Semester: advice on fiscal policy for 2018 has to be offered before Member States start preparing their budgets. The EFB will publish its first Annual Report in the autumn focusing on how the framework for national fiscal policies - the rules of the Stability and Growth Pact – has been applied and how it might be reformed.

The EFB's assessment highlights that although economic slack in the euro area as a whole is expected to recede in 2018 the recovery remains comparatively slow and scarred by the impact of the exceptionally deep post-2007 crises. Taking into account available evidence about the economic situation and outlook as well as public finances in the euro area Member States, the EFB concludes that in 2018 there is neither a case for a discretionary fiscal impulse nor for a fiscal contraction. A neutral fiscal stance is considered to be appropriate combined with a re-composition of government expenditure towards higher investment spending. Government investment is the expenditure category which in per cent of GDP suffered particularly large cuts during the last phase of fiscal consolidations. The EFB notes that a neutral fiscal stance for the euro area as a whole could be achieved through differentiated national fiscal policies within the parameters of the Stability and Growth Pact (SGP): Countries with fiscal space – in the sense of having done better than their Medium-Term Objective for public finances – make use of it, while consolidation continues in other countries especially those with high government debt-to-GDP ratios.

The EFB acknowledges differences between the euro-area and the country-by-country perspective. From a purely national perspective, cyclical conditions in Member States with fiscal space are not necessarily perceived as warranting a fiscal expansion, while a fiscal expansion is taken to be justified in Member States with no fiscal space and where SGP rules require consolidation. Such differences in perspective are bound to arise in the current governance framework which combines centralised monetary policy with decentralised, rules-based fiscal policy. Individual countries do not factor in cross-country effects of national fiscal policy and, more generally, do not plan policies aimed at a smooth functioning of the euro area as a whole. Such tensions can only be overcome through enhanced forms of cross-country coordination or further fiscal integration.

Background

Until recently, the euro area aggregate was a virtual entity as regards fiscal policy making; it was the result of a simple mechanical aggregation. The assessment of fiscal policy both ex ante and ex post was centred on national developments. The profound dislocations produced by the post-2007 global financial and economic crises made clear that there can be cases where centralised monetary policy can be overburdened with stabilising the euro area economy while national fiscal policies are caught between limited fiscal space in some countries and the preference for tight budgets in others. In line with its mandate, the EFB will look at the euro area as a single and distinct entity. The underlying motivation is not to fine-tune discretionary fiscal policy interventions, something that in normal times proved to be impractical. Rather, assessing developments from the aggregate perspective adds value to the policy debate in the euro area.