Blog Post

Eurozone countries must not be forced to meet deficit targets

Last year thirteen eurozone countries surpassed the deficit to gross domestic product ratio of three per cent. The latest forecasts by the European Commission suggest the region is slipping into a mild recession this year. As a consequence, in the absence of further policy measures, most of these countries risk missing their budgetary targets. This […]

By: and Date: February 27, 2012 Topic: Macroeconomic policy

Last year thirteen eurozone countries surpassed the deficit to gross domestic product ratio of three per cent. The latest forecasts by the European Commission suggest the region is slipping into a mild recession this year. As a consequence, in the absence of further policy measures, most of these countries risk missing their budgetary targets. This especially applies to Spain, where last year’s deficit was eight per cent of GDP. The Commission expects its output to decline by one per cent this year (not a particularly pessimistic forecast) yet the country is still supposed to reach the three per cent deficit threshold by next year. Many other countries are in the same boat.

The dilemma for the EU – especially for the Commission whose surveillance role is being enhanced – is how to respond to this situation. Should Olli Rehn, the Commission’s vice president, push countries to take further immediate actions? Or should he recognise that these targets are out of reach and put emphasis on efforts rather than outcomes? From a structural point of view, the preferred option is clearly the latter. However, the European fiscal framework has lost a lot of credibility. He may wish to use the opportunity to demonstrate his ability to enforce discipline.

Economic history teaches us that financial crises have long lasting, if not permanent, negative effects . Most European countries have already lost several percentage points of GDP and it seems wise to expect the second recession to do the same. Mr Rehn has good reasons to require action. However, demanding adherence to the 2013 targets has two major drawbacks.

First, immediate austerity measures would aggravate the recession. Recent research suggests that the short-run negative effects of austerity measures tend to be higher than we previously thought. Though most European governments have structural problems with their budgets, that does not call for impairing automatic stabilisers in a recession year.

A second drawback of imposing immediate action is the form that this would almost certainly take. Closing a gap on short notice is not compatible with smart consolidation. The most effective way to achieve a dramatic result by next year would be to just raise existing taxes – with all the adverse consequences on potential output and no effects on the effectiveness of public spending.

A better path to sustainable public finances is to launch credible reforms today that ensure rebalancing of the government budget tomorrow. A typical example is the raising of the retirement age or reform of social benefits. However, it is hard for financial markets to monitor the implementation of such measures. The Commission is right to ask for them and it should have an important role in the surveillance of policy actions and the evaluation of their effects.

Mr Rehn’s involvement in the budgetary policies of individual member states is motivated by their effects on other members. Attention has recently been focused on the negative effects of excess borrowing. However, in this era of major private deleveraging, the positives should also be considered.

This asks for minimum additional austerity over and above what is already planned in countries under direct financial stress and for no additional austerity at all in countries that do not face an immediate threat of losing access to the financial markets. Provided credible structural measures are implemented, this stance would be consistent with the EU treaty and budgetary sustainability. And it would certainly be better for the economy of the eurozone.

A version of this article was also published in the FT A-List


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Filippo di Mauro, Wolfhard Kaus, Steffen Müller, Gianluca Santoni, Verena Plümpe, Andrea Roventini, Valerie Smeets, Nicola Viegi, Markus Zimmermann and Javier Miranda Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Load more posts