The strong deterioration in the public finances, with the EU average general government budget deficit forecast to reach more than 7% of GDP in 2010 and the debt ratio rising correspondingly, is due to both the automatic effect of economic performance and the discretionary support measures introduced by EU governments, the EU commission writes in its 2010 report on public finances.
“Cold-shower consolidation can be the only viable solution in the high debt countries.”
“Events in Spring 2010 have exposed the urgency of addressing the fiscal challenge in the euro area and the EU. Sovereign risk premiums increased to unprecedented levels in Member States with perceived high budgetary and macro-financial risks,” the EU commission says.
The 2010 Report on Public Finances in EMU presents recent budgetary developments, reports developments in budgetary surveillance and draws lessons for debt reduction strategies.
It also investigates the link between macro-financial and budgetary risks.
This year’s edition of the Report on Public Finances reviews how Member States’ fiscal policies have evolved in the wake of the financial and economic crisis.
It assesses the prospects for public finances and policy needs ahead. The strong deterioration in the public finances, with the EU average general government budget deficit forecast to reach more than 7% of GDP in 2010 and the debt ratio rising correspondingly, is due to both the automatic effect of economic performance and the discretionary support measures introduced by EU governments.
With real economic growth having fallen to –4.2% in 2009, there has been an automatic decrease in revenues and increase in spending as a share of GDP.
The credit and asset price led boom that preceded the crisis in many Member States has increased the impact of the recession on the public finances as related previously substantial revenues have dried up.
Discretionary support measures introduced to support both aggregate demand and the financial sector specifically have also added to the burden on the public finances.
Already in autumn 2009, the EU agreed on a fiscal exit strategy that should be co-ordinated and differentiated across countries in the framework of a consistent implementation of the Stability and Growth Pact (SGP), taking account of fiscal risks and macro-financial imbalances.
The second part of the report examines developments in fiscal surveillance and focuses on:
(1) The implementation of the Stability and Growth Pact throughout the crisis.
(2) Ways to improve the measure of the cyclically-adjusted budget balance, and;
(3) The role that Member States’ fiscal frameworks can play in promoting sound budgetary policies and consolidation.
The third part of the report, analyze debt developments and prospects.
A significant part of the budgetary deterioration in the downturn will not be automatically re-absorbed by the recovery under way. High levels of public debt impact the interest rates, and increase the debt service burden.
The higher taxes made necessary by higher debt weigh negatively on growth. A credible commitment to a sustainable path for public finances is instrumental to achieving durable output and employment growth.
The increasing budgetary costs of aging populations emphasizes the need for addressing the budgetary challenges head on.
In this context, the 2010 Report on Public Finances in EMU presents lessons from successful and unsuccessful fiscal consolidations based on historical experiences and simulations.
Although there is no one-size-fits-all solution and starting conditions play an important role in defining the right strategy, gradual and expenditure-based consolidations are generally preferable to “cold-shower” or revenue-based ones.
Nevertheless, revenue-based consolidations can also be effective, notably those focusing on VAT and property taxes, and in particular in countries with low revenue ratios.
“Cold-shower” consolidation can also be the only viable solution in the high debt countries.
Finally, in its fourth part the report also analyze the link between macroeconomic imbalances and fiscal risks.
The crisis has shown that the divergent growth patterns in EMU and growing macroeconomic imbalances implied contingent budgetary risks.
In particular, the countries that suffered the greatest deterioration in their public finances during the crisis had typically experienced weak competitiveness, increasing external imbalances and booming credit and domestic demand in the years running up to the crisis, while the countries that suffered the smallest deterioration generally had displayed stable or falling macro-financial risks.
Credit market and asset price evolutions have played a key role in this context by feeding persistently buoyant tax revenues and hence allowing excessive public expenditure growth during the booms, followed by large tax revenue shortfalls, the EU commission concludes.
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