EU budget rules Macroeconomic Workshop Eurasian Economic Commission Moscow, 22 November 2018

1. EU budget rules • Macroeconomic Workshop • Eurasian Economic Commission • Moscow, 22 November 2018 Edouard Turkisch (European Commission and University of Paris Nanterre) The opinions expressed and arguments employed herein do not necessarily reflect the official views of the European Commission

2. Outline • The EU fiscal rules: a living framework References in the attached document: • EU structural budget deficit calculation approach • Establishment of structural budget balance target levels • Reality check: the effects of EU fiscal rules (sustainability, pro-cyclicality) References in the attached document: • The impact of EU budget rules on macroeconomic stability • Recommendations of the EU to its Member States • Implementation of the recommendations • Budget rules at the national level • Further prospects References in the attached document: • EU budget rules: prospects

3. I. The EU fiscal rules: a living framework

4. The EU economicgovernance: rather new and evolving 'Fiscal compact' agreed Communication Flexibilitywithin existing rules Preventive arm enters into force First European Semester 2011 2013 2005 1997 € 1999 2012 2010 1998 2015 2008 Two-pack enters into force Stability and Growth Pact agreed Corrective arm enters into force Structural Balance takes central stage Communication Steps towards completing the EMU Six-pack enters into force

5. The EU fiscal rules: rather new and evolving Fiscal rules (SGP): focus on sustainability, but tensions between goal of fiscal stability and need to support economic growth(short-term economic stabilisation & long-run impact on potential growth) SGP: wide developments, extending scope to make rules 'smarter' & more encompassing • 1997: focus on the 3% deficit threshold • little regard to cyclical conditions => problems due to inability to prevent excessive loosening in boom times, followed by reluctance to tighten policy in the 2002-03 downturn. • 2005: more emphasis to structural balances: both the objective of the preventive arm & the required fiscal effort in both the preventive arm and the EDP • But this did not prevent fiscal vulnerabilities building up in some countries in the favourable mid-2000s • Great Recession of the late 2000s: • agreement to temporarily relax fiscal policies (deep crisis), but • consolidate stability provisions in SGP: Six-pack reform (2011), Two-pack & Fiscal Compact (2013): failures to build buffers in good times can be penalized, focus on expenditures developments, debt reduction benchmarks, sanctions more automatic (reverse majority), national fiscal councils • Then, interpretations to cater better for growth dimension • allow some countries to lengthen convergence towards fiscal targets (flexibility) • The multiplication of indicators (sometimes diverging) and the sedimentation of provisions/interpretations have also led to a (too) complex system

6. The EU fiscal rules: the current state The Stability and Growth Pact • Framework within which Member States make their budgetary decisions • Member States are responsible for fiscal policy • But must be compatible with common fiscal rules • Two arms • Corrective Arm (a.k.a. Excessive deficit procedure (EDP)) corrects gross policy errors, in nominal terms • Preventive Arm aims to ensure strong underlying public finances, in structural terms

7. The EU fiscal rules: the current state The Corrective Arm of the SGP • Corrective Arm corrects for gross policy errors (nominal terms) • Both deficit and debt criteria are operationalised • Deficit: 3% of GDP • Debt: 60% of GDP or sufficiently diminishing and approaching 60% at satisfactory pace • An EDP can be opened for breach of deficit or/and debt criterion (but not automatic); can only be closed if deficit below 3% and debt benchmark met

8. Only very few countries left in the corrective arm Reduced number of Member States with excessive deficits, supported by improving economic conditions

9. The EU fiscal rules: the current state Overall picture of all Member States Overall picture of all Member States EURO AREA NON-EURO AREA Countries under the corrective arm (EDP) 2017 2018 2016-17 ES UK FR Countries under the preventive arm AT* EE LT MT BG HU* SE BE* FI* LU NL CZ PL HR DE* IT* LV SK DK RO PT IE* SI* CY* EL*,** * Member States subject to the debt rule. ** Member States under an economic adjustment programme.

10. The EU fiscal rules: the current state The preventive arm of the SGP • Preventive Arm aims to ensure strong underlying public finances • Must be at their Medium Term budgetary Objective (MTO) or on the adjustment path towards it • What is the MTO? A country-specific level for structural balance that has built-in buffers against bad economic times, high debt levels and future liabilities • Need to show compliance with two pillars: • Structural balance • Compliance with expenditure benchmark. What is the expenditure benchmark? A rule that limits the growth rate of net expenditure

11. What is a prudent fiscal policy?

12. The EU fiscal rules: the current state From corrective to preventive arm of the Pact • From "getting headline deficit below the 3%"… • … to "respecting the Medium Term Objective (MTO) in structural terms"... (i.e. without cyclical effects and one-off) • … or converging to it at a pace of around 0.5% GDP per year (with modulation)

13. From corrective arm to preventive arm Slowdown in fiscal adjustment, especially in the corrective arm … due to the nominal strategy in better times Note: For this graph only, “preventive arm countries” in 201x comprises the countries that were in the preventive arm in 201x but not yet at their MTO at the start of 201x.

14. Not all countries achieved the MTO in 2017 Source: European Commission Spring 2008 Forecast

15. The EU fiscal rules: some developments in fiscal surveillance A stronger focus on the expenditure benchmark in the Preventive Arm The path toward the MTO: A two-pillar approach • Change in structural balance • Expenditure benchmark: A stronger focus when examining compliance Why have an expenditure benchmark?

16. The EU fiscal rules: some developments in fiscal surveillance Expenditure Benchmark: analysing government expenditure net of discretionary measures • For countries at their MTO: • Net expenditure must grow at most in line with potential GDP • For countries not at their MTO: • Net expenditure must grow at rate below medium-term growth rate of potential GDP • Difference between two growth rates calculated to ensure structural balance improves as required (0.5% as a rule) • Unless excess is matched by discretionary revenue measures: No cap on expenditure! • "More communicable", but stillrelying on structural balances and MTO • Issue:when Structural Balance and ExpenditureBenchmark point to differentassessments!

17. Fiscal governance: state of play Rules EU National SGP: both preventive and corrective Fiscal Compact Directive Fiscal frameworks Institutions EU National Enforcement EU (Markets) Fiscal Councils Commission and Council Graduated system of EU sanctions Peer pressure

18. II. Reality check: the effects of EU fiscal rules1. on fiscal sustainability 2. on pro-cyclicality of fiscal policy

19. The effects of EU fiscal rules on fiscal sustainability Public debt ratios have increased much less in EU than in US and Japan since 1985

20. The effects of EU fiscal rules on fiscal sustainability For the last 2 decades only, fiscal policy has limited public debt increase more in the EU as a whole than in US and Japan. This isconsistent with an influence of the EU fiscal framework on fiscal outcomes.

21. Headline balances in EU Member States (% of GDP) The effects of EU fiscal rules on fiscal sustainability Over long run, indicators key for fiscal surveillance better managed for "bad performers" … but difficult to distinguish effects of fiscal rules from other effects (which counterfactual?)

22. Cyclically adjusted balances (structural aspects) The effects of EU fiscal rules on fiscal sustainability

23. The effects of EU fiscal rules on fiscal sustainability Expenditures developments (compared to growth potential) Pre-crisis Post-crisis

24. The effects of EU fiscal rules on fiscal sustainability Fulfilment of the debt benchmark criteria For debt rations > 60% of GDP, convergence of debt in nominal terms towards 60% of GDP, for Member States in the Preventive Arm, after a transition period of 3 years where fiscal effort is expressed in structural terms

25. The effects of EU fiscal rules on fiscal sustainability Despite improvements shown above: • public debt still close to historical peaks; • diverging patterns among Member States since crisis Development in debt ratios between 2008 and 2017 in selectedMember States debt Source: European Commission Spring 2018 forecast

26. The effects of EU fiscal rules on fiscal sustainability even if "bad performers" for fiscal outcomes perform better than before, they still often lag behind, also with high interest payments and weak growth The fiscal and non-fiscal drivers of public debt developments since the crisis (over 2008-2017, % of GDP)

27. The effects of EU fiscal rules on fiscal sustainability A mixed picture, with large divergence in public debt levels… Source: European Commission Spring 2018 Forecast Size of bubbles proportional to country shares in total EU-28 GDP; EL not shown in the chart

28. The effects of EU fiscal rules on procyclicality of fiscal policy % of GDP Note: 2018 is based on the no-policy change scenario of the Commission forecast. EA fiscal stance measured as: ΔSPB – structural primary balance; DFE – Discretionary fiscal effort; ΔSB structural balance; ΔCAPB - cyclically-adjusted primary balance; ΔCAB - cyclically-adjusted balance. Source: European Commission spring 2017 forecast.

29. Reality check: the effects of EU fiscal rules Fiscal rules have worked well for some Member States, less for others… … leading to questions about fiscal rules: • Issue of enforcement? Are the rules sufficiently applied? • Issue of design? are the fiscal rules sufficiently tight? Or should the framework include broader considerations, incl. macro interactions? There is no fiscal rule that is a panacea • Structural balances "good concept", but technical difficulties (IMF's mixed view) and well accepted only "when convenient" (ie in bad times, not in good times) Peer pressure and ownership are also key for Member States • National fiscal rules following EU fiscal rules (but too many?) • Independent Fiscal Institutions

30. III. Further prospects

31. Which next developments for the fiscal rules? But focus on debt? SB? EB? "stupid but better working" rule?

32. Which next developments for the fiscal rules? Conventional view on fiscal policies in EMU – pre crisis "Put own house in order…" Revising the role of fiscal policy in EMU – post crisis "…and strengthen the joint foundation" Interactions is needed with other pillars: • Monetary "coordination" in a single market • Economic surveillance (macroeconomic imbalances main cause of the crisis, not fiscal policy!) A larger common Fund? (beyond the rescue fund with a total lending capacity of 500 bn euro, a stabilisation mechanism? + Capital Market Union?) • Tighter fiscal rules possible, with top-up • DE proposal: no (ex-ante) transfers but force savings in good times

33. Thanks! Contact: Edouard.TURKISCH@ec.europa.eu

34. Background slides

35. The effects of EU fiscal rules on fiscal sustainability

36. Fiscal policy in EMU: an evolving view Conventional view on fiscal policies in EMU – pre crisis C • Rules to tame deficit bias in absence of national exchange rate policy • Automatic stabilisers: let them play • Risk of debt monetisation dominates monetary-fiscal relations • Low spillovers because of offsetting monetary policy reaction • Negative coordination suffices "Put own house in order…" • Discretionary fiscal policy needed in case of large shocks • High multipliers and spillovers when monetary policy is constrained • Aggregate fiscal stance and differentiated fiscal space matter • Sovereign-banks nexus • Institutions vs. rules • Links fiscal policies/ structural reforms • Difficult to sanction sovereign states Revising the role of fiscal policy in EMU – post crisis "…and strengthen the joint foundation"

37. E(M)U fiscal rules: a living framework Crisis innovations Specific applications • Expenditure rule • Debt benchmark + Stronger national fiscal frameworks • Interlocking requirements on: • Nominal balance • Structural balance • Expenditure growth • Debt ratio development • Escape clause in case of EU/EA downturn • Debt/output gap 'Matrix of adjustment requirements • Investment and flexibility clauses • Modulation of country-specific adjustment on the basis of an increasing number of factors; but… • No tool to address large asymmetric shocks and to manage the aggregate fiscal stance • Reinforced EA dimension • European Stability Mechanism (ESM) • Surveillance of Draft Budgetary Plans • Attention to EA aggregate stance • Rescue fund with a total lending capacity of 500 bn euro • Closer supervision of national budgets • Sanctions, more articulated system Basis from the past Treaty and legacy of original SGP and 2005 reform