Brussels, 23 June 2009
2009 Report on Public Finances: fiscal stimulus was needed to support economy, but overall success depends on a credible exit strategy
As the European economy suffers its worst post-war recession, the European Recovery Plan provides needed fiscal support to ailing economies. But rising public debts and the contingent liabilities incurred by governments to support the financial sector, together with the prospected increases in age-related expenditure and slowdown in potential growth raise concerns about public finance sustainability. An exit strategy strengthening fiscal policy frameworks, reforming age-related spending and spelling out the broad consolidation measures envisaged when the recovery has taken hold is required to address these concerns and underpin consumer, business and financial market confidence, the 2009 Report on public finances shows.
"Past experiences teach useful lessons of how fiscal costs of banking crises can be contained and which factors can facilitate bringing the fiscal houses back in order. The effectiveness of the fiscal policy stimulus in the short run crucially depends on a credible commitment to withdraw the stimulus when the recovery is well established. Strong fiscal governance frameworks, notably national fiscal rules, are a factor of success. For what concerns the resolution of the banking crisis, a transparent, resolute and swift strategy, without regress to regulatory forbearance, as well as a fair and uniform treatment of market participants is key to reduce their impact on public finances.", said Economic and Monetary Affairs Commissioner, Joaquín Almunia.
This year's edition of the Report on Public Finances reviews how Member States' fiscal policies address the challenges from the financial and economic crisis. It assesses the prospects for public finances and policy needs ahead. Accounting for the effect of the automatic stabilisers, fiscal policy is providing support to the economy in the region of 5% of GDP over 2009-2010, equivalent to more than €600 billion. This does not include the measures to support banks. In 2009, the largest fiscal stimulus as a percentage of GDP is being implemented in Spain, Austria, Finland, United Kingdom, Germany and Sweden (see table p14 of the report).
The report shows that countries that experienced the strongest credit and property booms also had growing current account deficits and the most buoyant tax revenues and public expenditure growth. They are now experiencing the largest tax revenue shortfalls and deficit and debt increases. In a number of these countries with large macroeconomic imbalances, fiscal space available to run counter-cyclical fiscal policy without incurring sharp increases in sovereign and economy-wide risk premia was curtailed from the start of the crisis. Better tailored fiscal policy should aim at building-up surpluses to tame down buoyant demand during booms and allowing running counter-cyclical fiscal policies during busts.
The second part of the report examines developments in fiscal surveillance and focuses on (i) the challenging statistical treatment of public interventions in the financial system, (ii) ways to improve the measure of the cyclically-adjusted budget balance, (Iii) measures of the quality of public finances and (iv) the strengthening of Member States' medium-term budgetary frameworks.
The report examines the fiscal costs of past systemic financial crises and draws important conclusions for handling today's crisis. Experience shows that net direct fiscal outlays to rehabilitate the banking system averaged 13% of GDP in a sample of 49 crises that occurred since 1970 around the world. In some cases, notably in emerging market economies, the costs were even higher. A risk analysis for the direct fiscal costs of the current crisis in the EU gives an estimate of between 2¾ and 16½% of GDP depending on assumptions on the implementation of approved measures and recovery rates of the government capital injections and loans. Experience shows that the costs were lower when the banking crisis resolution strategy was implemented swiftly; was transparent and received broad political support. In particular fiscal costs were contained if the crises resolution strategy was backed by strong public institutions and legal frameworks; implied fair and uniform treatment of market participants; and included a clear exit strategy, including the restructuring of the banking sector.
In addition to these direct fiscal costs of interventions in the financial sector, the large fiscal deficits - incurred as a result of the pronounced slowdown - contribute to an increase of public debt-to-GDP ratios. During the past crises those increases went far beyond the direct costs attributable to tackling the financial sector problems and amounted to, on average, 20 percentage points. According to the Commission's spring forecasts, the EU public debt is expected to rise from an average of just below 60% of GDP in 2007, the lowest level since the Maastricht Treaty was agreed, to nearly 80% in 2010. Experience suggests that any lagging behind of bank resolution policies risks further adding to the overall fiscal bill. Efforts to restore the health of the financial sector, even when it implies high upfront fiscal outlays, are a condition to ensure the full effectiveness of fiscal measures in support of an economic recovery.
The Report is available on: