Current developments and prospects
B. Change in general government cyclically-adjusted primary balance
3.3. Overall assessment and risks
The Council found in its opinions on the programmes that with the exception of the UK (1), Member States’
medium-term budgetary targets satisfy ‘the requirements of the Stability and Growth Pact’. Most countries were found to fulfil this requirement in 2001 with the exception of Germany and Portugal. The Council also asked two high-debt countries (Belgium, Italy), and countries that still project deficits in 2003 (Germany, France, Portugal), to use additional room for manoeuvre to improve budget balances further and/or speed up consolidation in order to
(1) In the UK, the deficit is projected to increase as a result of a cautious
trend growth assumption and of an expansion in planned govern- ment investment.
P a r t I
C u r r e n t d e v e l o p m e n t s a n d p r o s p e c t s
Table 11
Budget balance targets, expenditures and revenue ratios over the 2001–04 period according to the SCP
(% of GDP)
Total expenditures Total revenues 2001 2004 2001 2004 B 48.9 46.8 49.1 47.4 D 46.5 44.0 45.0 44.0 EL 45.2 42.2 45.7 44.2 E 40.6 40.0 40.6 40.3 F 52.1 49.8 51.1 50.1 IRL 30.8 29.2 (*) 35.1 33.8 (*) I 47.2 44.3 46.4 44.7 L 39.8 38.8 (*) 42.4 41.2 (*) NL 45.2 44.4 45.9 46.3 A 50.9 49.4 50.2 49.4 P 46.8 46.0 45.7 46.0 FI 46.2 43.9 50.9 48.8 EUR-12 47.1 45.1 46.5 45.6 DK 53.5 52.0 56.4 54.7 S 53.7 52.9 (*) 57.2 54.9 (*) UK 39.7 40.7 40.3 39.6 EU-15 46.1 44.7 45.9 45.0
increase safety margins. The importance of expenditure control was emphasised in the Council opinions of virtu- ally all Member States. Countries with potential infla- tionary problems were urged to keep a tight fiscal stance and/or to stand ready to use fiscal policy to reduce infla- tion pressures should the situation call for it (Spain, Greece, Ireland, the Netherlands, Luxembourg, Portugal and Finland).
Overall, the programmes point to a slow but continued improvement of actual budget balances over the medium term. Nonetheless, two questions remain about the degree of ambition of programmes and the realism of targets. Firstly, it is evident that the pace of fiscal consolidation has slowed down considerably and that the necessary adjustment efforts are postponed towards the end of the period. In addition, it could be argued that a greater degree of budgetary ambition is needed in a number of countries, not least to prepare for the budgetary impact of ageing populations (see Part IV). Member States should exploit the window of opportunity available in coming years to accelerate the pace of debt reduction and/or build
reserve funds years, i.e. before the budgetary impact of demographic changes fully emerge.
Second, there are some risks that may lead to the targets of the programmes not being fully attained. While the budgetary projections were often made using prudent macroeconomic assumptions in earlier programmes (and were sometimes criticised as being overly cautious), in this round of updates the opposite seems to be the case for some Member States. In addition, a large part of the improvement of budget balances in the last few years has come about through strong increases in tax revenues. As this increase is considered to be structural, it has been included in the projections. However, this involves a risk that the structural element of this revenue growth has been overestimated which may lead in future years to lower revenue growth than expected. Also, as public debt levels are still relatively high, the impact of interest rate shocks on budget balance and other budgetary shocks has to be taken into account when setting medium-term budgetary targets (see Part II).
– 1.5 0 1.5
– 1.5 0 1.5
Change in cyclically-adjusted revenue
Changes in cyclically-adjusted primary expenditure
Revenue-based deterioration 1999 (0.4) Consolidation
1997 (1.1) 2004 (0.2) 2003 (0.2) 2002 (0.2) 1998 (– 0.1) 2000 (0) 2001 (– 0.3) Revenue-based consolidation ‘Tax rises cum
deterioration'
‘Tax cuts cum consolidation' Expenditure-based deterioration
Expenditure-based consolidation Deterioration Graph 9: Composition of fiscal adjustment in the euro area, 1997–2004 (1)
(1) In brackets, changes in CAPB excluding UMTS proceeds (in 2000 and 2001).
P a r t I
C u r r e n t d e v e l o p m e n t s a n d p r o s p e c t s
The fiscal stance referred to in this chapter captures the discretionary effort of the government. However, it does not measure the effect of fiscal policy on the economy. The latter is measured by what can be labelled the discre- tionary fiscal impulse. As budgetary components have dif- ferent effects on aggregate demand and supply, one needs an econometric model in which the interrelationships of various policy measures and economic behaviour are spe- cified to measure the effect of fiscal policy on GDP. As pointed out by Buiter (1985), there is no objective, model- free measurement of the impact of fiscal policy. There- fore, the quantitative and qualitative results depend on the specification and parameterisation of the model as well as on the assumptions on the interplay between fiscal and monetary authorities.
Under normal circumstances, the fiscal stance and the fiscal impulse can be expected to go in the same direction (i.e. a loosening of the fiscal stance corresponds to an expan- sionary fiscal impulse). However, when small changes in the fiscal stance are associated with large restructuring of the budget, composition effects may dominate leading to a more-than-proportional impact or to a reversal of the sign. The first-round impact of envisaged discretionary tax and expenditure changes on economic activity can be captured by a ‘fiscal impulse’ indicator that takes the composition of discretionary policy changes in taxation and expenditures explicitly into account. To incorporate the various channels through which changes in fiscal policy can affect economic activity, the short-term impact of fiscal policy changes has been derived from simulations using the Commission’s QUEST model (see Chapter 1 in Part VI for a review on
the main features of QUEST). The approach of the simu- lations is similar to that used in Part III. The implied mul- tipliers of spending and revenue changes are presented in Table 21. It must be kept in mind that the effects produced by simulations, depend inter alia, on the structure of the model, the type of fiscal action, the accompanying monetary and exchange rate policies and modelling of expectations. The simulations assume that the ECB is targeting inflation under a floating exchange rate regime. The supply-side effects of taxation and government expenditures are taken into account although their impact is more long-term than short-term in nature.
As a very broad characterisation, the results indicate that the impact in the first year is more important on the expen- diture side (feeding more directly into demand) than on the tax side (where a large part is saved). However, in the medium term the impact from the expenditure side fades out (due to crowding out), while on the tax side the impact increases over time as supply-side effects become more important. This suggests that the composition and the tim- ing of discretionary budgetary measures are important to consider when analysing the impact of fiscal policy on the demand conditions during a specific year.
Table 12below reports the estimates of the euro-area fiscal impulse resulting from the fiscal stance implied by the pro- grammes. Keeping in mind all the uncertainties related to the estimation of the short-term fiscal policy impact on economic activity and the fact that the changes in the fis- cal stance and the size of the impulses are relatively small, it is interesting to note that the fiscal impulse in 2001 is moderately restrictive despite a slight loosening of the Box 3:The impact of fiscal policy on the economy: a tentative measure of fiscal impulse
Table 12
Euro area fiscal stance and fiscal impulse, 2001 onwards
2001 2002 2003 2004
Fiscal stance (change CAPB) – 0.3 + 0.2 + 0.2 + 0.2
Due to: change CA revenues – 1.1 – 0.5 – 0.4 – 0.1 change CA primary expenditure + 0.8 + 0.7 + 0.6 + 0.4
Fiscal impulse – 0.2 – 0.2 0 0
Due to: revenues side + 0.2 + 0.3 + 0.6 + 0.3 expenditure side – 0.4 – 0.5 – 0.5 – 0.3
fiscal stance. In subsequent years, the negative effects of expenditure cuts on demand are partially compensated by the increasing positive impact of earlier tax cuts.
The difference between the two indicators (fiscal stance and fiscal impulse) reflects several factors. Firstly, the strat- egy of tax cuts cum expenditure reductions leads to a restrictive impulse since the expansionary short-term effect
from tax cuts is much smaller than the restrictive impact from expenditure cuts. Secondly, the short-term expan- sionary impact from tax cuts is relatively small during the first two years, because the positive supply-side effects gain momentum only in the medium term, whereas the economic impact stemming from expenditure changes is largest in first years and fades away rather rapidly there- after. Hence, changes in expenditures tend to dominate in the short term.