Chapter 17: Fiscal policy and the Stability Pact I know very well that the Stability Pact is stupid, like all decisions which are rigid. Romano Prodi (EU Commission President), Le Monde, 17 October 2002

Fiscal policy in the monetary union In a monetary union, fiscal policy: the only macroeconomic instrument at national level; government borrows in slowdown and pays back on behalf of citizens; government acts as substitute to inter-country transfers in case of asymmetric shock. Problems of fiscal policy: effectiveness of fiscal policy depends on private expectations; slow implementation.

Fiscal policy in the monetary union Crucial distinction: automatic stabilizers: fiscal policy is spontaneously countercyclical: tax receipts decline when the economy slows down; welfare spending rises when the economy slows down; no decision, so no lag: nicely countercyclical rule of thumb: deficit worsens by 0.5% of GDP when GDP growth declines by 1%.

Fiscal policy in the monetary union discretionary fiscal policy: a voluntary decision to change tax rates or spending. Because of automatic stabilizers, budget figures do not reveal what governments do with fiscal policy. Cyclically adjusted budget shows what the balance would be if the output gap is zero in a given year. Difference between actual and cyclically adjusted budget = footprint of automatic stabilisers.

Fiscal policy in the monetary union Actual and cyclically adjusted budgets in the Netherlands, 1972–2011:

Fiscal policy externalities Should fiscal policy be subjected to some form of coordination? Yes, if national fiscal policies are a source of externalities: cyclical income spillovers via trade, strengthened by monetary union through increased trade. Income spillovers, 1970–2011:

Fiscal policy externalities borrowing cost spillovers, as one country’s deficit would induce higher interest rate for everyone: weak argument since euro area integrated in world financial markets; still, capital inflows can appreciate common currency and affect competitiveness. excessive deficits, which may lead to default: capital outflows and a weak euro; pressure on other governments and Eurosystem to help out. ‘no-bailout’ clause in Maastricht Treaty.

Fiscal policy externalities deficit bias and collective discipline: build-up of debt reflects failure of democratic control over governments.

Principles At which level of government (regional, national, supranational) should policies be conducted? The theory of fiscal federalism deals with this question. Two arguments for sharing responsibilities: externalities; increasing returns to scale. Two arguments for retaining sovereignty: heterogeneity of preferences; information asymmetries. Theory of fiscal federalism does not provide a general answer: case-by-case approach and often we face trade-offs with no compelling answer.

Principles Four arguments for and against centralization at the EU level are unlikely to lead to clear-cut conclusions. Where should the burden of proof lie? The EU has taken the view that the burden of proof lies with those who argue in favour of sharing sovereign tasks: principle of subsidiarity. In other words: unless there is a strong case of increasing returns to scale or of externality, the presumption is that decisions remain at the national level.

Principles What does it all mean for fiscal policy in the Eurozone? In true federal states, there is a powerful federal level of government. In the Eurozone, instead, the Commission budget is far too small to play any macroeconomic role. The case for policy coordination is convincing. A step has been taken in 2011: ‘European semester’. In January of each year, the Commission presents its Annual Growth Survey, including forecasts and evaluation of member countries’ economic situation. This triggers discussions among governments and in the European Parliament. Following recommendations by the Council, every government submits to the Commission their Stability and Convergence Programmes. The Commission then assesses the national programmes and submits its conclusions and recommendations in time for the June Council.

The Stability and Growth Pact (SGP) Adopted in 1997, the SGP was meant to avoid excessive deficits, with fines for countries not respecting it. Enforced by ECOFIN, countries (e.g., France and Germany in 2003) avoided fines. SGP was reformulated in 2005 to avoid its rigidity. The SGP consists of four elements: definition of what constitutes an ‘excessive deficit’; preventive arm, designed to encourage governments to avoid excessive deficits; corrective arm, which prescribes how governments should react to a breach of the deficit limit; sanctions. The SGP applies to all EU countries but only the Eurozone countries are subject to the corrective arm.

The Stability and Growth Pact (SGP) ‘excessive deficit’; deficits are excessive when above 3% of GDP; countries in the monetary union commit themselves to a medium-term budgetary stance ‘close to balance or in surplus’; ‘exceptional circumstances’ when provisions are automatically suspended; preventive arm: in the form of peer pressure. Finance Ministers engage in a collective discussion of one another’s fiscal policy; corrective arm: ‘early warning’ and recommendations when deficit is believed to breach the limit; excessive deficit procedure for excessive deficit: recommendations, to be followed by corrective measures, and ultimately sanctions; sanctions: if a country fails to take corrective action and bring its deficit below 3%, it is sanctioned. The fine starts at 0.2% of GDP and rises by 0.1% for each 1% of excess deficit. SGP does not remove fiscal policy sovereignty: governments are in full control. Also, its intent is clearly pre-emptive.

SGP and countercyclical fiscal policies Does the Pact impose procyclical fiscal policies?: budgets deteriorate during economic slowdowns; reducing the deficit in a slowdown may further deepen the slowdown; a fine both worsens the deficit and has a procyclical effect. Solution: a budget close to balance or in surplus in normal years.

SGP and countercyclical fiscal policies If budget in balance in normal years, plenty of room for automatic stabilisers and some limited room left for discretion action.

SGP and countercyclical fiscal policies SGP is designed to provide a strong incentive for each government to bring its budget to a position of balance (or surplus) in good years. Budget balances since 1999 (% of GDP):

SIX PACK On 13th December 2011, the reinforced Stability and Growth Pact (SGP) enters into force with a new set of rules for economic and fiscal surveillance. These new measures, the so-called "Six-Pack", are made of five regulations and one directive proposed by the European Commission and approved by all the Member States and the European Parliament last October.

SIX PACK Preventive arm (European Parliament and Council 2011c): modification of the Stability and Growth Pact in order to better guarantee that the member states achieve the medium-term budgetary objective and stick to it; Corrective arm (Council of the European Union 2011b): modification of the legislative basis of the corrective arm of the Stability and Growth Pact; Sanctions (European Parliament and Council 2011a): this regulation establishes a system of graduated sanctions aimed at enforcing respect for the preventive and corrective arms of the Stability and Growth Pact in the Eurozone;

SIX PACK Budgetary frameworks of the member states (Council of the European Union 2011a): definition of the requirements pertaining to the budgetary frameworks of the member states; Macroeconomic imbalances (European Parliament and Council 2011d): establishment of procedures for the detection, prevention and correction of macroeconomic imbalances.

TWO PACK This reform package, the so-called 'Two-Pack', enters into force on 30th May 2013 in all euro area Member States. The new measures mean increased transparency on their budgetary decisions, stronger coordination in the euro area starting with the 2014 budgetary cycle, and the recognition of the special needs of euro area Member States under severe financial pressure.

Euro Plus Pact Limits of SGP became obvious with debt crisis. A reform informally adopted in 2011: Euro Plus Pact It aims at strengthen and expand the Pact (reversing the 2005 reform). and makes no reference to the no-bailout clause: deficit target: cyclically adjusted primary budgets must be balanced; debt target: evolution of the debt will be one criterion used to evaluate policies (by end 2011, the debt average is close to 90% and the old target is beyond reach for many years to come); sanctions: decision procedure much more certain and automatic. If the pact is put into place, the Commission recommendations will be automatically accepted unless a qualified majority (two-thirds of the vote) decides to the contrary; implicit liabilities: member governments should start planning for the ageing phenomenon.

Ten years of the Stability and Growth Pact

Labour market

France (metropolitan) Population geo\time 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 EU (28 countries) 496436597 498300775 500297033 502090235 503170618 504494374 504060345 505127210 506880616 508191116 Belgium 10511382 10584534 10666866 10753080 10839905 11000638 11094850 11161642 11203992 11258434 Bulgaria 7629371 7572673 7518002 7467119 7421766 7369431 7327224 7284552 7245677 7202198 Czech Republic 10223577 10254233 10343422 10425783 10462088 10486731 10505445 10516125 10512419 10538275 Denmark 5427459 5447084 5475791 5511451 5534738 5560628 5580516 5602628 5617345 5659715 Germany 82437995 82314906 82217837 82002356 81802257 81751602 80327900 80523746 80767463 81174000 Estonia 1350700 1342920 1338440 1335740 1333290 1329660 1325217 1320174 1315819 1313271 Ireland 4208156 4340118 4457765 4521322 4549428 4570881 4582707 4591087 4605501 4625885 Greece 11004716 11036008 11060937 11094745 11119289 11123392 11086406 11003615 10926807 10812467 Spain 44009971 44784666 45668939 46239273 46486619 46667174 46818219 46727890 46512199 46439864 France 63229635 63645065 64007193 64350226 64658856 64978721 65276983 65560721 65835579 66352469 France (metropolitan) 61399733 61795238 62134866 62465709 62765235 63070344 63375971 63652034 : Croatia 4312487 4313530 4311967 4309796 4302847 4289857 4275984 4262140 4246809 4225316 Italy 58064214 58223744 58652875 59000586 59190143 59364690 59394207 59685227 60782668 60795612 Cyprus 744013 757916 776333 796930 819140 839751 862011 865878 858000 847008 Latvia 2227874 2208840 2191810 2162834 2120504 2074605 2044813 2023825 2001468 1986096 Lithuania 3289835 3249983 3212605 3183856 3141976 3052588 3003641 2971905 2943472 2921262 Luxembourg 469086 476187 483799 493500 502066 511840 524853 537039 549680 562958 Hungary 10076581 10066158 10045401 10030975 10014324 9985722 9931925 9908798 9877365 9849000 Malta 404999 405616 407832 410926 414027 414989 417546 421364 425384 429344 Netherlands 16334210 16357992 16405399 16485787 16574989 16655799 16730348 16779575 16829289 16900726 Austria 8254298 8282984 8307989 8335003 8351643 8375164 8408121 8451860 8506889 8584926 Poland 38157055 38125479 38115641 38135876 38022869 38062718 38063792 38062535 38017856 38005614 Portugal 10511988 10532588 10553339 10563014 10573479 10572721 10542398 10487289 10427301 10374822 Romania 21257016 21130503 20635460 20440290 20294683 20199059 20095996 20020074 19947311 19861408 Slovenia 2003358 2010377 2010269 2032362 2046976 2050189 2055496 2058821 2061085 2062874 Slovakia 5372928 5373180 5376064 5382401 5390410 5392446 5404322 5410836 5415949 5421349 Finland 5255580 5276955 5300484 5326314 5351427 5375276 5401267 5426674 5451270 5471753 Sweden 9047752 9113257 9182927 9256347 9340682 9415570 9482855 9555893 9644864 9747355 United Kingdom 60620361 61073279 61571647 62042343 62510197 63022532 63495303 63905297 64351155 64767115 Iceland 299891 307672 315459 319368 317630 318452 319575 321857 325671 329100

Unemployment rate in EU GEO/TIME 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 European Union (28 countries) 8,2 7,2 7,0 9,0 9,6 9,7 10,5 10,9 10,2 : Belgium 8,3 7,5 7,9 7,6 8,4 8,5 Bulgaria 6,9 5,6 6,8 10,3 11,3 12,3 13,0 11,4 Czech Republic 7,1 5,3 4,4 6,7 7,3 6,1 Denmark 3,9 3,8 3,4 6,0 6,6 Germany (until 1990 former territory of the FRG) 10,1 7,4 5,8 5,4 5,2 5,0 Estonia 5,9 4,6 5,5 13,5 16,7 10,0 8,6 Ireland 4,5 4,7 6,4 12,0 13,9 14,7 13,1 9,4 Greece 7,8 12,7 17,9 24,5 27,5 26,5 Spain 19,9 21,4 24,8 26,1 France 8,8 8,0 9,1 9,3 9,2 9,8 Croatia 11,6 9,9 11,7 13,7 16,0 17,3 Italy 7,7 10,7 12,1 Cyprus 3,7 6,3 11,9 15,9 16,1 Latvia 17,5 19,5 16,2 15,0 10,8 Lithuania 4,3 13,8 17,8 15,4 13,4 11,8 Luxembourg 4,2 4,9 5,1 4,8 Hungary 11,2 11,0 Malta 6,5 Netherlands Austria 4,1 Poland 8,1 Portugal 8,9 12,9 15,8 16,4 14,1 Romania Slovenia Slovakia 14,5 14,0 14,2 13,2 Finland 8,7 Sweden 6,2 United Kingdom Iceland 2,9 2,3 3,0 Source: EUROSTAT

Employment rate by sex, age group 20-64 Total   geo\time 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 EU (28 countries) 67,9 68,9 69,8 70,3 69 68,6 68,4 69,2 Belgium 66,5 67,7 68 67,1 67,6 67,3 67,2 Bulgaria 61,9 65,1 70,7 68,8 65,4 62,9 63 63,5 Czech Republic 71,2 72 72,4 70,9 70,4 71,5 72,5 73,5 Denmark 78 79,4 79 79,7 77,5 75,8 75,7 75,4 75,6 75,9 Germany 69,4 71,1 72,9 74 74,2 74,9 76,5 76,9 77,3 77,7 Estonia 77,1 70 66,8 70,6 72,2 73,3 74,3 Ireland 72,6 73,4 73,8 66,9 64,6 63,8 63,7 65,5 67 Greece 64,4 65,6 65,8 66,3 59,6 55 52,9 53,3 Spain 67,5 69,7 68,5 64 62,8 62 58,6 59,9 France 69,9 70,5 69,5 69,3 Croatia 60 60,6 63,9 64,9 64,2 62,1 59,8 58,1 57,2 59,2 Italy 61,5 62,4 62,7 61,6 61 60,9 59,7 Cyprus 74,4 76,8 75,3 75 70,2 Latvia 69,1 73,2 75,2 66,6 64,3 68,1 Lithuania 71,3 72,7 71,8 Luxembourg 69,6 70,1 71,4 72,1 Hungary 62,2 62,6 62,3 60,1 60,4 66,7 Malta 57,4 57,9 59 63,1 64,8 Netherlands 75,1 76,3 77,8 78,9 78,8 76,4 76,6 Austria 71,6 72,8 73,9 74,6 Poland 58,3 65 64,5 64,7 Portugal 73,1 Romania 63,6 65,7 Slovenia 73 71,9 68,3 67,8 Slovakia 66 66,4 65,9 Finland 74,8 Sweden 78,1 80,1 80,4 78,3 79,8 80 United Kingdom 74,1 76,2 Iceland 85,5 86,3 86,7 85,3 80,6 81,8 82,8 83,5

Labour cost index by NACE Rev. 2 geo\time 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 EU (28 countries) 2 2,3 1,2 0,9 1,6 1,4 1,5 1,9 1,8 EU (27 countries) 2,2 Belgium 2,7 2,6 2,1 0,8 0,7 0,6 0,2 0,1 Bulgaria 5,5 4,7 5,2 6,1 6 5 6,8 7 7,4 Czech Republic 1 1,7 -2,5 0,4 3,6 3,5 3 Denmark 1,1 Germany 3,7 3,9 2,4 Estonia 8,1 7,6 7,2 7,5 6,2 6,4 5,1 5,7 Ireland 0,5 -1,4 -0,6 -0,9 0,3 Greece -5,4 -8,6 -9,6 -2,9 -4,7 -3,3 -0,7 8,6 : Spain -3,5 -0,4 France Croatia 3,1 -0,2 -1,3 Italy -0,3 Cyprus -1,9 -4,5 -4,6 -2,7 -1,8 -1,6 -0,5 Latvia 6,5 5,3 5,9 7,3 Lithuania 4,4 6,3 5,8 4,3 Luxembourg 4,6 3,3 4 Hungary 5,4 4,1 2,5 3,2 3,4 Malta 3,8 Netherlands Austria 4,5 2,8 Poland Portugal -6,5 -2,4 -9,4 -2,8 Romania 8,3 Slovenia -2,1 -3,8 -5,8 -0,8 -1,5 Slovakia 2,9 Finland Sweden United Kingdom

Immigration geo\time 2007 2008 2009 2010 2011 2012 2013 Belgium 146409 164152 : 135281 144698 147387 118256 Bulgaria 1561 1236 14103 18570 Czech Republic 104445 108267 75620 48317 27114 34337 30124 Denmark 64656 57357 51800 52236 52833 54409 60312 Germany 680766 682146 346216 404055 489422 592175 692713 Estonia 3741 3671 3884 2810 3709 2639 4109 Ireland 122415 82592 50604 52339 53224 54439 59294 Greece 66529 58613 60462 60089 58200 57946 Spain 958266 599075 392962 360705 371331 304053 280772 France 293980 296608 296970 307111 319816 327431 332640 Croatia 14622 14541 8534 8959 10378 Italy 558019 534712 442940 458856 385793 350772 307454 Cyprus 19017 14095 11675 20206 23037 17476 13149 Latvia 7517 4678 3731 4011 10234 13303 8299 Lithuania 8609 9297 6487 5213 15685 19843 22011 Luxembourg 16675 17758 15751 16962 20268 20478 21098 Hungary 24361 37652 27894 25519 28018 33702 38968 Malta 6730 6043 6161 4275 5465 7111 8428 Netherlands 116819 143516 122917 126776 130118 124566 129428 Austria 72862 73772 69295 70978 82230 91557 101866 Poland 14995 47880 189166 155131 157059 217546 220311 Portugal 46300 29718 32307 27575 19667 14606 17554 Romania 138929 135844 149885 147685 167266 153646 Slovenia 29193 30693 30296 15416 14083 15022 13871 Slovakia 16265 17820 15643 13770 4829 5419 5149 Finland 26029 29114 26699 25636 29481 31278 31941 Sweden 99485 101171 102280 98801 96467 103059 115845 United Kingdom 526714 590242 566514 590950 566044 498040 526046 Iceland 12546 10288 3921 3948 4073 4960 6406

Emmigration geo\time 2006 2007 2008 2009 2010 2011 2012 2013 EU (28 countries) : Belgium 88163 91052 100275 66013 67475 74720 90800 Bulgaria 2958 2112 16615 19678 Czech Republic 33463 20500 51478 61782 61069 55910 46106 25894 Denmark 46786 41566 38356 39899 41456 41593 43663 43310 Germany 639064 636854 737889 286582 252456 249045 240001 259328 Estonia 5527 4384 4406 4658 5294 6214 6321 6740 Ireland 44409 48040 65934 69672 78099 87053 89436 83791 Greece 43044 43686 62041 92404 124694 117094 Spain 142296 227065 288432 380121 403377 409034 446606 532303 France 189403 220354 239796 264631 269531 291594 295551 300760 Croatia 7692 9002 7488 12699 12877 15262 Italy 75230 65196 80947 80597 78771 82461 106216 125735 Cyprus 6874 11389 10500 9829 4293 4895 18105 25227 Latvia 17019 15463 27045 38208 39651 30311 25163 22561 Lithuania 32390 30383 25750 38500 83157 53863 41100 38818 Luxembourg 9001 10674 10058 9168 9302 9264 10442 10750 Hungary 4314 4500 9591 10483 13365 15100 22880 34691 Malta 1908 5029 3719 3868 4201 3806 4005 5204 Netherlands 91028 91287 90067 92825 95970 104201 110431 112625 Austria 74432 49898 51563 53244 51651 51197 51812 54071 Poland 46936 35480 74338 229320 218126 265798 275603 276446 Portugal 12700 26800 20357 16899 23760 43998 51958 53786 Romania 302796 246626 197985 195551 170186 161755 Slovenia 13749 14943 12109 18788 15937 12024 14378 13384 Slovakia 3084 3570 4857 4753 4447 1863 2003 2770 Finland 12107 12443 13657 12151 11905 12660 13845 13893 Sweden 44908 45418 45294 39240 48853 51179 51747 50715 United Kingdom 369470 317587 427207 368177 339306 350703 321217 316934 Iceland 4577 7414 9144 5459 4812 4758 4372

Job vacancies in number and % - NACE Rev. 2, B-S, quarterly data geo\time 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 European Union (changing composition) 1,4 1,5 1,6 1,7 EU (28 countries) Belgium 2 2,2 2,5 2,4 1,9 2,1 2,7 Bulgaria 0,6 0,7 0,9 Czech Republic 1 1,2 2,3 Denmark : Germany 2,6 2,8 2,9 3,2 Estonia 1,3 Ireland 0,8 Greece 0,4 Spain France Croatia 0,5 1,1 Italy Cyprus 0,2 0,3 Latvia Lithuania Luxembourg Hungary Malta Netherlands Austria 1,8 Poland Portugal Romania Slovenia Slovakia Finland Sweden United Kingdom Iceland

Average gross annual earnings in industry and services, by sex geo\time 2008 2009 2010 2011 Belgium : Bulgaria 3584 4076 4361 4599 Czech Republic Denmark 52509 53543 55707 56299 Germany 40700 40500 41495 42900 Estonia Ireland 46168 46102 46602 Greece 26661 28241 Spain 25435 26568 27438 27447 France 34329 34854 Croatia Italy Cyprus Latvia 8567 8351 8027 8376 Lithuania Luxembourg Hungary 10055 9234 9496 9868 Malta 18902 18850 19339 Netherlands 42629 43931 44784 45793 Austria Poland Portugal 16735 16776 17741 Romania 5483 5689 5869 Slovenia Slovakia 9349 10031 10407 10788 Finland 38626 38520 42351 Sweden 35802 33163 38023 41026 United Kingdom 40171 36386 38122 38284 Iceland