Fiscal policy

• The recent shift towards balanced budget rules in the euro area is an important achievement in this direction, and has contributed to better average underlying budgetary positions.
• Still, the fiscal rule framework needs to be rendered more effective in reducing high levels of government debt and their dispersion across the euro area.
• This in turn would help to contain the procyclicality of fiscal rules at the country level.

1 Introduction

• Among other things, the measures introduced placed a stronger focus on reducing government debt ratios to sound levels.
• They also included a fiscal compact, which contains a close-to-balance provision for countries medium-term budgetary objectives (MTOs).
• While work to further improve the functioning of EMU continues, progress towards more fiscal integration has so far been limited.

2 Fiscal rules in the euro area

• [6] Fiscal policies in the euro area countries are governed by supranational as well as national fiscal rules.
• Whereas at the beginning of the century there were only around 20 national fiscal rules altogether in the euro area countries, the number has now increased to 62, according to the European Commissions fiscal rules database (see Chart 1).
• Chart 1 National fiscal rules in the euro area (number of rules)
• In many countries the fiscal rules that were in place in the earlier years of EMU have been exchanged for more sophisticated fiscal rules.
• Fourth, the monitoring of compliance with fiscal targets has been strengthened considerably, with independent fiscal authorities, equipped with a relatively broad mandate for surveillance, now established in all euro area countries.
• Additionally, independent fiscal institutions at the national level (fiscal councils) assess compliance with national fiscal provisions (see Table A, left-hand column).

3 Fiscal developments in the euro area

• From its peak in 2009 at 4.5% of GDP, the euro area aggregate structural deficit declined to 0.7% of GDP in 2018 (see Chart 2).
• The euro area as a whole has thus moved to an underlying budgetary deficit that comes very close to the floor of 0.5% of GDP set by the fiscal compact.
• These favourable trends for the euro area as a whole mask very heterogeneous fiscal developments at the country level.
• [31] On the other hand, as shown in Chart 2, a number of euro area countries continue to record large structural budget deficits.
• Consequently, these countries were not building the buffers that would allow them to avoid fiscal tightening in the next downturn.
• This can have an impact on the resilience of the euro area as a whole.
• Heterogeneity in euro area countries fiscal positions is also visible in the dispersion of government debt-to-GDP ratios.
• In fact, since 2009 an increasing number of euro area countries have posted government debt-to-GDP ratios of above the Maastricht Treatys 60% reference value.

4 Fiscal frameworks in other monetary unions

• Comparing the public finances and fiscal frameworks of the euro area, the United States and Switzerland reveals some similarities but also important differences.
• This includes the stabilisation function of the central budget, which can limit the procyclicality of fiscal rules at the lower level.


Chart 7 Decomposition of general government debt in Switzerland, 1990-2017 (left-hand scale: CHF billions; right-hand scale: percentages of GDP)

• First, differences relate to fiscal federalism, its main purpose and how strongly it is established in the respective monetary unions.
• [32] In the United States, fiscal federalism mainly takes the form of countercyclical stabilisation policies, from the centre to the state level.
• The differences in the fiscal rule frameworks of the euro area, the United States and Switzerland can be captured by a rule stringency index.
• As shown in Chart 9, this is a simple composite index based on publicly available indices for the three monetary unions.
• Overall, countries fiscal rules in the euro area seem to be more stringent than the sub-federal rules in the other two monetary unions.
• At first sight, the above finding that fiscal rules in the euro area are more stringent than those in other monetary unions might be surprising.
• During a recession, rules may provide insufficient fiscal room for manoeuvre to stabilise the economy.
• One possibility for smoothing the impact of the business cycle on fiscal positions is to create a rainy day fund.
• As indicated in Table A, all rainy day funds are subject to specific conditions regarding the build-up and withdrawal of funds.
• Table A Rainy day funds in US states main characteristics (number of US states)

5 Lessons for the reform of fiscal rules in the euro area

• The increased reliance in the euro area countries on balanced budget rules will eventually help to bring government debt ratios to lower and less divergent levels.
• Though the reflection of the fiscal compact in national rules is still recent, it is thus a major achievement that should ultimately help to increase the resilience of the euro area.
• First, the fiscal framework needs to be rendered more effective in ensuring sound fiscal positions and reducing high levels and dispersion of government debt ratios across the euro area.

6 Conclusions