Will Fiscal Stimulus Packages Be Effective in Turning Around the European Economies? Presented by: Howard Archer Chief European & U.K. Economist IHS Global Insight
European Fiscal Stimulus Limited? Europeans argue that measuring size of fiscal stimulus resulting from the extra packages that have been announced do not take into consideration the automatic stabilizers or safety nets built into fiscal policy Europeans tend to have more generous welfare systems, which will provide some extra support European Union argues that current stimulus measures amount to at least 3.3% of GDP (400 billion euro) cumulatively and perhaps as much as 4% of GDP. This includes increased welfare spending on unemployment benefits & social benefits There is underlying concern that if budget deficits are allowed to get too large could put serious pressure on a country s membership of the Eurozone Also argued that if budget deficits soar now it will undermine businesses and consumers confidence as they will anticipate future major tax hikes European Commission has allowed flexibility under Stability & Growth Pact, but has set deadlines for countries to bring budget deficits back under 3% of GDP: France (2012), Spain (2012), Ireland (2013), UK (2013/14)
Fiscal Stimulus Packages (Percent of GDP) 2008 2009 2010 Total U.S. 1.1 2.0 1.8 4.8 Canada 0.0 1.5 1.3 2.7 Japan 0.4 1.4 0.4 2.2 Germany 0.0 1.5 2.0 3.4 France 0.0 0.7 0.7 1.3 Italy 0.0 0.2 0.1 0.3 United Kingdom 0.2 1.4-0.1 1.5 Source: IMF Staff Estimates, February 2009
GDP Deficits (Percent of GDP) 2008 2009 2010 Eurozone -1.9-4.7-5.0 Germany -0.1-3.3-4.5 France -3.4-6.4-5.7 Italy -2.7-4.6-4.5 Spain -3.8-6.8-6.7 Ireland -7.1-12.1-10.0 United Kingdom -5.5-12.4-11.9
Differing Approaches to Fiscal Measures General recommendation is that fiscal measures should be Temporary, Timely, and Targeted Income tax cuts and supports, particularly for low paid Spain, Italy, Germany, France Centre-piece of U.K. package was cutting of Value-Added Tax from 17.5% to 15.0% from December 1, 2008 to end-2009 Increased and/or accelerated infrastructure spending Germany, France, Spain, U.K. Tax and other supportive measures to encourage companies to employ or maintain jobs Spain, Germany Measures targeted at specific industries cars (Germany, France), textiles (Portugal), construction (Spain)
Fiscal Stimulus in Germany: The Facts Two fiscal packages (October 2008 and January 2009) plus constitutional court ruling forcing government to return to full commuter tax relief, are worth roughly 90 billion euro for 2009 10 combined, or 1.5% of GDP in 2009 and 2.0% in 2010 Additional indirect stimulus Government guarantees for (non-financial) businesses borrowing: 100 billion euro total Allowing automatic stabilizers to run by not compensating for worsening public sector budgets triggered by the recession in the form of tax revenue shortfalls and necessary additional spending on unemployment or social purposes Measures include infrastructure investment (roughly 17 billion euro over 2009 10), sector-specific subsidies (notably 5.0 billion euro for car scrappage premium), additional funds to limit labour market damage, modest income tax relief, one-off child bonus in April 2009, additional subsidy for public health insurance that reduces deductions from gross wages Speed of impact varies greatly, from almost immediate (car subsidy; tax reimbursement for commuters) to not before 2010 (most infrastructure projects). Support from announcement effect should not be underestimated
Fiscal Stimulus in Germany: Assessment and Outlook Important for boosting consumer and business morale in extremely pessimistic economic environment characterized by vicious circles Main support for domestic demand next to relatively resilient consumer spending Unable to jump-start economy of its own accord as long as global growth and thus German exports remain depressed thus stimulus serves primarily as bridge until new recovery develops, smoothing adjustment needs over time and limiting long-run damage to growth potential Public sector deficit to spike from near zero in 2008 to 3.3% of GDP in 2009 and peak of 4.5% in 2010, before subsiding gradually thereafter, deficit improvement to less than 3% not before 2012/13
France: Several Limited Measures Implemented Despite its large fiscal deficit, the French government implemented several measures aimed to limit the impact of the crisis on the real economy 26 billion euro stimulus package unveiled in December 2008: Focused on investment, but also included measures aimed to support small and medium businesses, the housing market, and the struggling automotive sector Some of the investment expenditure outlined in the plan is actually expenditure that had already been planned for the coming years brought forward 75% of the extra-spending is planned to be executed in 2009 The government estimated that these funds will add 0.6 percentage point to GDP in 2009 we believe this is too optimistic Additional measures: 6.5 billion euro car industry bail-out Tax cuts including slashing income tax for low earners, and increased social security benefits totaling approximately 3.7 billion euro New scheme, costing 1.1 billion euro, to fight unemployment among the young The total amount of these measures accounts for ~1.9% of French GDP
France: Fiscal Measures Will Help But Not Cure The measures will help in moderating the recession somewhat; however, they will not avoid a sharp fall in GDP in 2009, currently forecasted at 3.2% The impact of these measures on the fiscal accounts will be exacerbated by the marked contraction in activity We currently expect the fiscal deficit, as a percentage of GDP, to stand at 6.4% in 2009 and 5.7% in 2010, up from 3.4% in 2008 Meanwhile, the stock of government debt is expected to stand at 75.1% and 79.3% of GDP in 2009 and 2010 respectively, up from 68.0% of GDP in 2008 The European Commission has given France until 2012 to bring the fiscal shortfall below 3% of GDP For this to happen, fiscal policy will have to be tightened once the effects of the crisis dissipate we currently expect the deficit to stand below 3% only in 2014
Italy: Large Debt Burden Limits Fiscal Response Government has pledged very limited fiscal stimulus, with greater corrective action ruled out by the poor state of the public finances Italy's public debt stood at 105.8 percent of GDP at end-2008 General government budget deficit was 2.7 percent of GDP in 2008 Fiscal stimulus plan amounts to 7.0 billion euros (US$10 billion), which amounts to just 0.4 percent of GDP Most measures rolled out at the start of 2009 The main action is 2.4 billion euros worth of tax breaks for 8 million low-income families There are modest tax breaks for companies, and fiscal incentives to encourage households to buy high value consumer durables The modest fiscal stimulus plan will fail to prevent Italy from suffering a deep and prolonged recession
Italy: Deep Recession Points to Substantial Deficits Public finances will deteriorate alarmingly in the next few years General government budget deficit is projected to widen to 4.6 and 4.5 percent of GDP in 2009 and 2010, respectively This is primarily due to falling tax receipts and operation of automatic stabilizers rather than the cost of the limited fiscal stimulus plan However, budget deficit is expected to narrow again from 2012 as Italy enjoys stronger economic growth Government is also likely to target serious spending cuts to ensure fiscal deficit slips below 3 percent of GDP by 2012 Nevertheless, Italy will still face escalating public debt levels during the next few years, which is now expected to soar to over 110 percent GDP by early 2011 Continuous fiscal correction action will be required to reduce public debt to a more sustainable level
Spain: Massive Fiscal Stimulus Fails to Save Spain enacts largest fiscal stimulus plan in Western Europe The overall cost of the fiscal stimulus measures announced since April 2008 is around 50 billion euro, or just under 5.0 percent of GDP There have been several packages announced, containing more than 80 initiatives Household support measures include 400 euro income tax rebate for workers and pensioners, paid in 2008, and tax cuts for 3.5 million low-income families Support to companies include credit guarantees and state loans and tax credits for firms hiring unemployed with dependents Key spending initiative is to allocate 8 billion euro to municipal public works projects The troubled construction and autos industries will receive some direct financial assistance, although they are still expected to endure deep and prolonged slumps More fiscal stimulus measures likely after the Prime Minister removed Economy Minister Solbes who advised against new stimulus from office
Spain: Public Finances Spiralling Out of Control Despite major government fiscal stimulus action, the economy is in deep recession, which could last until late 2010. Hit by a steep downturn in the housing and labour markets, excessive levels of private debt, and weaker demand from key export markets The cost of the fiscal stimulus measures, falling tax receipts, and automatic stabilizers will put significant pressure on public finances General government budget deficit is set to widen from 3.8 percent of GDP in 2008 to 6.8 percent in 2009 and 6.7 percent in 2010 Deficit is unlikely to fall below 3 percent of GDP any time soon as Spain is set to endure a prolonged period of below trend growth and very high unemployment Debt servicing costs will become an increasing burden on public finances The government will need to undertake serious fiscal consolidation measures to place public finances on a more sustainable path Public debt is projected to accumulate in the next few years, rising from around 40 percent of GDP in 2008 to 57 percent by 2012
U.K. Hamstrung by Large Budget Deficits Sharp deterioration in U.K. public finances has effectively precluded further major fiscal stimulus, despite apparent original enthusiasm of Gordon Brown for more, tensions reported between Gordon Brown and Alistair Darling Budget deficit forecast at 12.4% of GDP in 2009/10 & 11.9% of GDP in 2010/11 Bank of England Governor Mervyn King openly warned government against further fiscal stimulus in April budget fearing such a move would undermine confidence in public finances and the wider economy The CBI also argued further significant U.K. fiscal stimulus would lead to businesses and consumers retrenching in fear of higher tax bills in the future Concerns highlighted by failure of a March gilts auction first failure since 1995 Brown now highlighting the three-pronged approach to fighting the recession extremely low interest rates, quantitative easing of 75 billion and last November s 20 billion fiscal stimulus package
U.K. Fiscal Stimulus Measures 20 billion fiscal stimulus package announced in November 2008. No major new initiatives contained in April budget for 2009/10 Centre piece was cutting of Value-Added Tax from 17.5% to 15.0% from December 2008 to end of 2009 Very modest tax measures to help the lowest paid, rise in lowest income tax personal allowance Firms allowed to spread their business tax payments 3 billion of capital spending brought forward from 2010/11 Automatic Stabilizers are particularly effective in the U.K. IMF believes the effect of the stabilizers will amount to an additional fiscal stimulus of 2% of GDP in 2009 alone IMF calculates the U.K. s tax and benefit system to be among the most automatically responsive in the world Concern government could suffer a funding crisis, so major pressure on it to set out credible strategy to sustainable public finances over the long term Fiscal policy to be tightened by 0.8% of GDP a year from 2010/11 to 2013/14
Bottom Line May well be further fiscal stimulus by Western European countries, but will vary significantly across the region Will be heavily influenced by the state of public finances Indeed some countries are having to actually tighten fiscal policy to try to stop their credit rating being further downgraded Ireland announced major fiscal tightening in April emergency budget Fiscal stimulus will not be sufficient in itself to turn around Eurozone economies, part of package of measures including interest rate cuts, non-conventional monetary policy and financial sector support Will also need upturn in global growth. Particularly true for the most export orientated countries most notably, Germany Fiscal support to certain sectors may help at expense of others e.g., German car subsidy scheme may limit other consumer spending
Thank you! Howard Archer Chief European & U.K. Economist howard.archer@ihsglobalinsight.com