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Economic Survey of the Euro Area 2005: Putting the fiscal house in order

 

The following OECD assessment and recommendations summarise Chapter 3 of the   Economic Survey of the Euro Area 2005   published on 12 July 2005.

Fiscal policies should focus on the longer term

With ageing related fiscal pressures building up, a repeat of past policy errors – a weakening or reversal of consolidation efforts amid buoyant cyclical conditions – would be very costly. Fiscal consolidation since the early 1990s had been impressive. But most of it was realised in the run up to monetary union as countries needed to comply with the convergence criteria stipulated in the Maastricht Treaty. Since the advent of the euro, the deficit bias has re emerged, though not in all countries. In practice the 3% “reference value” has not been adhered to by a number of euro area countries. The excessive deficit procedure has been invoked (or threatens to be invoked) for half of the euro area countries, but its enforcement ended in a stalemate in November 2003. Since then, the rules have been amended, allowing under certain conditions more time to correct an excessive deficit. Moreover, the amended rules will in future cater for country-specific medium-term budgetary objectives, reflecting sustainability aspects. To achieve sustainable public finances, reaching and maintaining the medium-term objective of keeping budget balances “close to balance or in surplus” over the cycle, as stipulated in the Stability and Growth Pact (SGP), will be essential.

Fiscal consolidation: Moving targets (1)
General government balance in the euro area as a per cent of GDP (2)

1. The various vintages of the Stability Programmes were released over the following periods: 1st 1998/99, 2nd 1999/2000, 3rd 2000/01, 4th 2001/02, 5th 2002/03, 6th 2003/04, 7th 2004/05.
2. Excluding UMTS licence proceeds
Source:  European Commission/Eurostat and OECD, Economic Outlook 77 database.

The fiscal rules suffered from incentive, reporting and enforcement gaps

The fiscal rules embedded in the Maastricht Treaty and SGP have been praised for their simplicity, the flexibility in their implementation, their medium term orientation, the reliance on automatic stabilisers and their explicit enforcement mechanisms. However, a long standing criticism has been that they suffer from biased incentives: there is a “hard” 3% ceiling for the deficit to gross domestic product (GDP) ratio, but there are no legal instruments to enforce the “close to balance or in surplus” rule embedded in the SGP – which is nevertheless essential to provide the necessary room for manoeuvre in downswings. The rules have also suffered from weaknesses in reporting: in some cases the stability programmes which take stock of countries’ fiscal position and outlook have been biased by projections, which have proven too optimistic, by too favourable assessments of the structural fiscal position and by the use of one off measures and creative accounting. Finally, the implementation of the rules has not been such as to ensure a swift correction of excessive deficits in all cases.

One-offs, “creative accounting” operations and reclassifications
affecting the fiscal balance (1)
In per cent of GDP

1. Abstracting from UMTS license receipts, operations amounting to less than 0.1% of GDP and one-offs that temporarily worsen rather than improve the recorded fiscal position.
Source: Koen, V. and P. van den Noord (2005), “Fiscal Gimmickry in Europe: One-off Measures and Creative Accounting”, OECD Economics Department Working Papers, No. 417, OECD, Paris.

A recent rewrite raises countries’ ownership and allows more room for judgement

The Stability and Growth Pact has been reformed. Consequent to a decision of the European Council in March 2005, the interpretation of the “exceptional circumstances” clause – which provides a waiver if the rules have been breached – and the adjustment path towards compliance with the rules after a breach, will both become more flexible. Aspects of the reform that have attracted less attention are the provisions to heighten the surveillance of the fiscal rules by the EU authorities, including during periods of high growth and to reinterpret the close to balance or in surplus rule so as to make it tailor made for individual countries, giving greater weight to the debt (as opposed to the deficit) criterion, long term sustainability and countries’ structural reform efforts. The interpretation and implementation of the SGP is thus increasingly focusing on the longer term, which is welcome. Furthermore, due consideration will be given to relevant factors, such as R&D spending, public investment, or expenditure related to the unification of Europe, when assessing whether an excessive deficit exists. Moreover, these other relevant factors will be important in determining the adjustment path from a deficit above 3% to a deficit below 3% of GDP. Taking into account “relevant factors” in assessing whether an excessive deficit exists is however subject to the overarching principle that the excess of the deficit over the reference value is temporary and that the deficit remains close to the reference value. A rigorous implementation of the amended pact will be key to fostering fiscal sustainability.

Institutional reforms in the pursuit of prudent budgeting is key

Inevitably, mechanisms that will ensure fiscal discipline at the national level have become more important. This requires stronger enforcement mechanisms within each country so as to address deficit bias at source. The decision making rules governing the budget process influence the extent to which the externalities of fiscal policy are internalised so that full account is taken of the costs and benefits of public policy. Deficit bias essentially results from co ordination failure. A strong mandate of the finance minister to set deficit, debt and expenditure targets is a way to internalise the externalities resulting from government spending, which commonly benefits specific groups in society while financed from taxes to which all taxpayers contribute. Without such a strong mandate, the externalities are not taken into account and deficit bias results. The targets must be rooted in realistic short , medium , and long term projections of economic growth, public revenues and social benefit entitlements. The stability programmes should be based upon, if not become the centrepiece, of such multi year budgeting.

Return to the  Economic Survey of the Euro Area 2005  

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A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.

Ein Policy Brief auf deutsch kann als pdf Datei heruntergeladen werden. Es enthält die Gesamtbeurteilung und Empfehlungen der OECD auf den Seiten oben.

To access the full version of the OECD Economic Survey of the Euro Area:

  • Readers at subscribing institutions can go to SourceOECD, our online library.
  • Non-subscribers can purchase the PDF e-book and/or printed book at our Online Bookshop.
  • Government officials can go to  OLISnet's Publication Locator.
  • Accredited journalists can go to their password-protected website .

For further information please contact the Euro Area Desk at the OECD Economics Department at webmaster@oecd.org.  The OECD Secretariat's report was prepared by Paul van den Noord, Boris Cournède, Line Vogt and Alexandra Janovskaia under the supervision of Peter Hoeller.

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