1. FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY: THEORETICAL BACKGROUND Andreea Stoian, PhD Postdoc Fellow Bucharest Academy of Economic Studies

2. FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY: THEORETICAL BACKGROUND Acknowledgments This work was cofinaced from the European Social Fund through Sectoral Operational Programme Human Resources Development 2007-2013, project number POSDRU/89/1.5/S/59184 „Performance and excellence in postdoctoral research in Romanian economic science domain”.

3. FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY: THEORETICAL BACKGROUND Abstract. The aim of this study is to present the theoretical background for the concepts of fiscal vulnerability and fiscal sustainability. The distinction between them is very thin and accounts for the time horizon. For assessing the state (vulnerable/sustainable) of fiscal policy, it can be used few indicators. Applying them for the case of European Union members, it was shown that Belgium and Italy confronts with a vulnerable fiscal policy. In such situation, it is imperative for the governments to take fiscal adjustment measures to avoid an unsustainable fiscal policy in the long run.

4. FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY: THEORETICAL BACKGROUND Introduction Theoretical background of fiscal sustainability and fiscal vulnerability Interrelations between fiscal sustainability and fiscal vulnerability Assessing the state of fiscal vulnerability/sustainability within EU Concluding remarks

5. 1.Introduction Fatas and Mihov, 2009; Afonso, Agnello, Furceri and Sousa, 2009  over the period 1970-2007, fiscal policy in the euro area has been mildly pro- cyclical, and the adoption of the common currency and the constraints imposed by the SGP have not had a large impact on the cyclical behavior of the structural balance Afonso (2000), Afonso and Rault, 2008  fiscal sustainability issues for EU Corsetti and Roubini, 1996; Alesina, 2000; Kotlikoff and Hagist, 2005  current fiscal policies of most EU countries based on growing social spending will become unsustainable in the future Balassone et al (2009)  countries currently recording high fiscal surpluses (Finland) or have undertaken more important structural reforms to their pensions systems (Germany, Austria and Italy) tend to experience lower sustainability risks

6. 1.Introduction Recent financial crisis  Fiscal policy is vulnerable  Fiscal policy could become unsustainable in the long run

7. 2. Theoretical background of fiscal sustainability and fiscal vulnerability Fiscal sustainability – ‘good management’ of financial resources from public budget  Blanchard (1990), and Blanchard, Chouraqui, Hageman, and Sartor (1990) i) public debt does not explode, nor governments are forced to increase taxes, decrease spending, monetize fiscal deficit or repudiate public debt, or (ii) public debt, as ratio of GDP, converges to its initial level  Zee (1987), Horne (1991), Buiter (1995), Chalk and Hemming (2000), de Castro Fernandez and Hernandez de Cos (2000) solvability criterion  Artis, 2000; Croce and Juan-Ramon, 2003 a solvent government implies public debt reimbursement in the long run by not changing the current fiscal policy  Hamilton and Flavin (1986), Chouraqui, Hagemann and Sartor (1990), Blanchard (1990), Gramlich (1990), Horne (1991), Buiter (1995) public debt as ratio to GDP does not increase faster than the gap between real interest rate and real growth rate

8. 2. Theoretical background of fiscal sustainability and fiscal vulnerability Fiscal vulnerability  Furman and Stiglitz (1999) define a vulnerable economy based on the increased probability that the economic system is not able to absorb all the shocks (speculative attacks on national currency) and to transform them into systemic risk  Allen et al (2002), Rial and Vicente (2004) the economy is vulnerable when there is a liquidity or solvency risk  Brixi et al (2000) fiscal risk related with the government’s ability to meet all its payments  Hemming and Petrie (2000), and Hemming et al (2003) (i) avoiding excessive fiscal deficits and publics debt stocks that can threaten macroeconomic stability in the short run and fiscal sustainability in the long run; (ii) designing a flexible fiscal policy that assures the immediate reaction to domestic and external disequilibrium; (iii) assuring stable and proper taxation rate that allows for collecting sufficient fiscal revenues for the public budget.

9. 3.Interrelations between fiscal sustainability and fiscal vulnerability government’s ability o generate primary surpluses as to meet its financial needs the difference between fiscal sustainability and fiscal vulnerability is very thin

10. 3.Interrelations between fiscal sustainability and fiscal vulnerability Fiscal sustainability – forward-looking concept Fiscal vulnerability – backward-looking concept

11. 3.Interrelations between fiscal sustainability and fiscal vulnerability governments ability to generate primary surpluses as to meet its financial needs the distinction is made by the time horizon considered

12. 4.Assessing the state of fiscal vulnerability/sustainability within EU budgetary balance as ratio to GDP (d), public debt as ratio to GDP (b), primary balance as ratio to GDP (p), the gap between the real interest rate and the real growth rate (gap)  Database EU-27 Annual data from AMECO End year 2008

13. 4.Assessing the state of fiscal vulnerability/sustainability within EU Budgetary balance as ratio to GDP

14. 4.Assessing the state of fiscal vulnerability/sustainability within EU Public debt as ratio to GDP

15. 4.Assessing the state of fiscal vulnerability/sustainability within EU Balassone and Franco (2000)  3% of GDP  60% of GDP

16. 4.Assessing the state of fiscal vulnerability/sustainability within EU Primary balance as ratio to GDP

17. 4.Assessing the state of fiscal vulnerability/sustainability within EU The gap between the real interest rate and the real growth rate (gap)

18. 4.Assessing the state of fiscal vulnerability/sustainability within EU Tabel 1 European states with a vulnerable fiscal policy Indicator/Countr yBEGRITHU d-5,2-7,2-7,1-6,3 b97,362,485,963,6 p1,70,30,7-0,6 gap0,8-2,50,2-5,9

19. Concluding remarks