1 Marco Buti (European Commission) and André Sapir (Université Libre de Bruxelles, Bruegel and CEPR) Fiscal Policy in Europe : A Long View Second annual Berkeley-Vienna conference: The US and European Economies in Comparative Perspective Berkeley, September

I. A CONCEPTUAL FRAMEWORK

3 EUROPE SINCE WWII: Three sub-periods

4 An interpretation: the Musgravian triangle Golden age Redistribution Stabilisation Allocation No trade offs: setting up of the welfare state allows improvement of allocation (correct market failures in unemployment and social insurance), redistribution (via the same programmes) and stabilisation (tax and welfare systems as automatic stabilisers) Social welfare maximisation increases the chances of re- election: benevolent government = political economy approach + + +

5 Fall from heaven Redistribution Stabilisation Allocation Trade offs emerge: between allocation and redistribution/ stabilisation (work incentives hampered) Social welfare maximisation ≠ politically motivated behaviour Sustainability becomes a problem - -

6 Maastricht consolidation Redistribution Stabilisation Consolidation Allocation Primary focus: discipline/sustainability Maastricht consolidation: higher taxes, lower spending  impact on Musgrave, in the short and longer run Beyond a critical level, reducing taxes may improve allocation and stabilisation /+

7 II. THE PAST 30 YEARS

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16 III. FUTURE PERSPECTIVES: AGEING KICKS IN

17 Demographic changes

18 LONG TERM BUDGETARY PROJECTIONS

19 The “maximum sustainable” level of debt is decreasing s M (a) ↓, y (a) ↓, r ? a = ageing

20 IV. EMU’S FISCAL FRAMEWORK: HELP OR HINDRANCE?

21 SGP spirit The approach chosen by the framers of the SGP was two-pronged: The 3% of GDP reference value should be treated as much as possible a ‘hard ceiling’. Member States should commit themselves to a “medium-term budgetary objective” of “close-to- balance or in surplus”.

22 In the steady state Sustainability ↓ public debt Stabilisation CTB + automatic stabilisers Allocation ↓ public spending … BUT WE NEVER GOT THERE

23 Lessons from the first 5 years of EMU High structural deficits and debts Lack of consolidation in good times Somewhat better stabilisation (but largely in spite of the rules) Political assessment Economic assessment Fading ‘ownership’ Large countries/small countries divide Enlargement of the EU heightens the problems

24 SGP reform: motivation Sustainability↓ public debt plus reforms for ageing StabilisationCTB + automatic stabilisers plus country differentiation Allocation↓ public spending plus expenditure quality

25 The reformed SGP 1.Economic governance Stability programme for the legislature Involvement of national parliaments Reliable forecasts Better statistical governance 2.Preventive arm Diversified MTOs At least 0.5% structural adjustment 3.Corrective arm Exceptional circumstances ‘All ORFs’, but only if d>3% is ‘close and temporary’ Debt and sustainability Repeatability of EDP steps

26 THE OLD AND THE NEW STABILITY PACT: two readings Old SGPNew SGP: collusion New SGP: genuine 1. Public visibilityHigh but fadingLower 2. Clear incentives Less clearEasier to get away with Better rationale 3. Political ownership Small MSHigh deficit MS: D+F+I All MS 4. Constraining calendar CTB in the medium term MTO de facto never MTO in the medium term 5. Collegial culture Acrimony prevailed From collegiality to collusion New collegiality based on trust