The Coordination of Fiscal Policies in Europe

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1 Gian Paolo Ruggiero Ministry of the Economy and Finance Department of the Treasury The Coordination of Fiscal Policies in Europe Warsaw 21 November /12/2003 1

2 1. A European monetary policy and 12 national budgetary policies 2. Why national budget policies? 3. The rationale for coordination 4. The institutional mechanisms (rules and/or discretion) 5. How does it work in practice? 04/12/2003 2

3 1. A monetary policy and 12 budgetary policies A single monetary policy run by the Eurosystem (ECB + NCB) with a European objective (price stability in the euro area) Budgetary Policies under national competence with national objectives but need for coordination Other policies remain national (income policy; supervision of banks; international finance ) 04/12/2003 3

4 2. Why national budgetary policies? 2.1 Political reasons 2.2 Economic reasons 04/12/2003 4

5 2.1 Political reasons A single budgetary policy in Europe requires a single tax policy and expenditure. This requires a much stronger political integration of what is realistically speaking possible today. Monetary union (and the single monetary policy) don t require the same degree of political integration (price stability is the agreed open objective) 04/12/2003 5

6 2.2 Economic reasons Criterion: Principle of subsidiary The competencies which are not treated in a (more) efficient manner at a lower level are transferred to the higher level of the Government (example of monetary policy). Distinction of the budget policy objectives : a. macroeconomic stabilisation b. income distribution c. efficiency of resource allocation 04/12/2003 6

7 A. Stabilisation policies Asymmetric shock Single budget: stabilisation takes place in an automatic way between the regions of the Union (distributive effects) National budgets: stabilisation takes place through national budgetary policies (through an increase in deficits) Which one is more efficient? 04/12/2003 7

8 A. Stabilisation politics Symmetric shock Single Union budget: stabilisation by means of a single tool, but several mechanisms National budgets: stabilisation at the national level; coordination problem (free rider ) Which one is more efficient? 04/12/2003 8

9 B. Distribution policies The budget of the Community already involves a sizeable income redistribution towards certain countries in some specific sectors (Structural Funds, Cohesion Fund, agricultural policy ) In other sectors (education; health ) the Principle of Subsidiary doesn t justify centralized decisionmaking 04/12/2003 9

10 C. Efficiency of resource allocation Instances of market failure; local versus global public goods Merit goods and national preferences State aid and the single market 04/12/

11 3. Need for coordination on stabilisation policies 3.1 Spill-over effects 3.2 Disciplinary effect 3.3 Coordination failure 04/12/

12 3.1 Spill-over effects Two kinds of spill-over: - deficit A deficit increase in one country increases demand (more in the home country?) and the interest rate of the entire area -debt The increase in debt in one country increases the risk premium in all countries, with effects on long-term interest rates 04/12/

13 3.1 Spill-over effects Spillover effects are larger in a monetary union than in a flexible exchange system (Fleming-Mundell) Spillover effects can be strongly negative (given the single interest rate of the Union) Built-in incentives for expansionary budgetary policies 04/12/

14 3.2 Disciplinary effect The disincentive to expansionary policies are stronger in a flexible exchange system than in a monetary union: - interest rates (short, long term) - exchange rate The Maastricht Treaty contains some disciplinary mechanism which are not sufficient: - Independence of the ECB - Prohibition of monetary financing - No bail out 04/12/

15 3.3 Coordination: satisfying versus optimal Optimal coordination requires detailed information about: - sign and size of spill-over effects; - the reaction of the other members in case of a shock (symmetric or asymmetric); - the management of the other policies (above all, the single monetary policy). 04/12/

16 4. Mechanisms of Coordination in Monetary Union 4. 1 Broad Economic Policy Guidelines (BEPGs) 4.2 Stability and Growth Pact (SGP) 4.3 Eurogroup 04/12/

17 4.1 BEPGs Once per year (in June) Objectives of budgetary policy for the current year and for short term (for example budget adjustment until 2004); Recommendations about structural reforms; Verification of the accomplishment of the recommendations in March of the following year; New procedures from this year. 04/12/

18 4.2 The SGP Two objectives: avoid deficits higher than 3% of the GDP reach balances close to stability or in surplus in the medium run. 04/12/

19 4.2 The SGP Instruments Every year (until mid-december) the countries submit a Stability Program containing the budget objectives for the following 4 years. The ECOFIN (following a proposal of the Commission) expresses an opinion on the adequacy of the Program and make recommendations. 04/12/

20 4.2 The SGP Sanctions Procedure of violation of the Treaty in case of breaking the 3% limit (excessive deficit procedure) Early warning in case of risk of breaking the 3% limit (Germany and Portugal in 2002, France in 2003) 04/12/

21 4.3 The Eurogroup Composition: Ministers of Economy of the 12 countries + ECB and Commission Format: informal; no decisions are taken; common positions and orientations are developed and communicated externally Content: exchange of opinions on economic developments, budgetary and monetary policies, operation of the SPG, euro exchange rates, ERM II 04/12/

22 5. The experience: how did the coordination function? 5.1 BEPGs 5.2 The SGP 5.3 The Eurogroup 04/12/

23 BROAD ECONOMIC POLICY GUIDELINES 5.1 The Experience with BEPGs Discussion because Economic Policy is a matter of common concern Monetary Committee was established in 1958, now Economic and Financial Committee -- (see also Economic Policy Committee) Voting rights on - opinions -sanctions 04/12/

24 5.1 The Experience with BEPGs Broad indications on economic policies with growing emphasis on the structural reforms (three key areas in 2003) Effective instrument. Commitment of the Governments. Sanctions (the case of Ireland) Rigid Instrument. Only once per year. Difficult to adapt to changes in the economic environment (e.g. dates for the objective of the balanced budget) 04/12/

25 5.2 The experience with the SGP Most countries had reached the medium-term objective of a budget balanced or in surplus, but certainly no reason for complacency Country Portugal -4,2-2,7-2,9-3,3 Germany -2,8-3,5-4,2-3,9 France -1,5-3,1-4,2-3,8 Italy -2,6-2,3-2,6-2,8 Netherlands 0-1,6-2,6-2,7 Autumn 2003 Commission forecasts 04/12/

26 5.2 Is the Stability Pact too rigid? Critics: the 3% constraint to cope with Response: if the budget is close to balance or in surplus there is the ample margin limits the scope for stabilization policies in order to face a cyclical slowdown. With an elasticity of approx. 0,5 between cyclical trend and budget balance, a margin of 3% allows to cope with an output gap of 6 percent of GDP The countries with problems started the slowdown with a deficit 04/12/

27 budget balance structural Maastricht limits nominal 04/12/

28 5.2 Replace the PSG with the Golden Rule? Proposal: exclude public investment from the calculation of the deficit Objective: create more room for stabilization policy and incentive to investment Justification: public investment is productive; it increases economic growth and is therefore selffinancing Problems: measurement, efficiency 04/12/

29 5.2 Substitute the SGP with a Debt Pact? Proposal: differentiate budgetary objectives according to the debt level. For countries with low debt levels less stringent a constraint on deficits. Agree on objectives in terms of debt instead of deficit. Reason: With a balance close to zero, public debt tends to disappear. The key aspect of economic policies is the sustainability of the public debit. Problems: misuse of flexibility; sustainability must be forward looking; spill-overs from deficit are high 04/12/

30 5.3 Stability Pact too weak? 4 countries (Portugal, Germany, France and Italy) have not reached a budget position which is close to balance Initially the date fixed to reach the balance was 2001, afterwards it has been postponed to 2004; now to 2006 The expansion was not exploited to put the budgetary house in order. Improvements were mostly due to the cycle. In cyclically-adjusted terms deteriorations were recorded. 04/12/

31 5.2 Commission Proposal to re-interpret the Pact 1. Adjustments for the effect of the economic cycle 2. Adjustments of 0,5% per year 3. No pro-cyclical budgetary policy 4. Flexibility for countries close to balance with low debt 5. Emphasis on sustainability 04/12/

32 5.2 Correction for the cycle The budget objective close to balance or in surplus has to be calculated in cyclicallyadjusted terms rather than in nominal terms The countries that are close to balance must accomplish at least a correction of 0,5% of the GDP per year, from 2003 onwards At the Eurogroup of 7 October all agreed except France who intends to begin from /12/

33 5.2 Flexibility for countries close to balance Countries close to balance and with a debt lower than 60% of the GDP can record temporary deviations from the balance, close to balance or in surplus Room for manoeuvre to stimulate public investment or to accomplish reforms structural reforms 04/12/

34 5.2 Emphasis on the debt sustainability Commitment to reduce the debit Satisfactory pace of debt reduction provided by the Treaty for the countries with a debt level above 60% Methodology to assess sustainability 04/12/

35 5.3 Experience with the Eurogroup Positive - informal exchange of opinions between ministers, Commission and ECB (monetary politics; budget, euro exchange rate) - management of the critical moments ( early warning to Germany and Portugal in February 2002; reinterpretation of the PSG in October 2002) Criticisms - poor functioning in normal times (absence of information exchange on budgets ) - structural reforms are not discussed 04/12/

36 5.3 Proposals to strengthen the Eurogroup Institutionalisation: transform it into a restricted Ecofin in the area of the Euro (Ecofin will include from 2004 on 25 countries); weaker proposal tabled at the IGC Implications: - could take formal decisions on. - which subjects (European DPEF? Sanctions ERM II)? - but according to the rules of the Community (proposal of the EU Commission ) 04/12/

37 Conclusion We are only in the fourth year of the Union The Monetary Union is Political Union (more than we thought) Progress is needed in the coordination of the policies and in the functioning of the institutions (IGC, EU at 25) 04/12/

The Stability and Growth Pact Status in 2001

4 The Stability and Growth Pact Status in 200 Tina Winther Frandsen, International Relations INTRODUCTION The EU member states' public finances showed remarkable development during the 990s. In 993, the