DG ECFIN Sustainable public finances in a turbulent
DG ECFIN Sustainable public finances in a turbulent EU economy Lucio PENCH Head of Unit, Fiscal policies in the euro area and the EU , European Commission, DG ECFIN Federal Planning Bureau «Potential Growth and Fiscal Challenges» , Brussels 27 October 2009
DG ECFIN Outline I. Direct costs of the crisis II. Indirect effects on growth III. Long term sustainability and ageing IV. Consolidation and policy responses to ensure sustainability L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 2
DG ECFIN The public finance situation in the EU A looser fiscal stance L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 3
DG ECFIN Fiscal costs of the financial crisis Direct fiscal costs and total fiscal costs L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 4
DG ECFIN I. Fiscal costs of financial crises Direct Fiscal costs of past crises Past rescues of the banking sector have often been expensive L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 5
DG ECFIN Fiscal costs of financial the crisis Support to the banking system has focused on guarantees and liquidity measures EU public interventions in the banking sector (in % GDP) Capital injections Guarantees on bank liabilities Relief of impaired assets Liquidity and bank funding support Total Approved Effective Approved Effective Total EU 2. 7 1. 7 24. 6 7. 8 0. 9 0. 8 3. 2 2. 3 31. 1 12. 5 Total euro area 2. 7 1. 7 20. 5 7. 8 1. 1 1. 0 0. 4 25. 2 10. 9 25. Some selected countries Austria 5. 5 1. 7 25. 7 6. 8 5. 5 0. 4 1. 6 38. 3 10. 6 Belgium 5. 3 6. 1 70. 8 16. 3 8. 12 N/A N/R 84. 2 30. 6 Denmark 6. 1 2. 4 253. 0 2. 5 0. 0 0. 3 259. 4 5. 2 France 1. 2 16. 6 5. 5 0. 2 0. 0 18. 1 6. 9 Germany 4. 4 2. 0 18. 6 7. 2 1. 4 0. 0 24. 4 10. 6 Ireland 6. 6 6. 5 164. 7 0. 0 171. 3 171. 2 Italy 1. 3 0. 1 N/A 0. 0 0. 0 1. 3 0. 1 The Netherlands 6. 4 6. 8 34. 3 7. 7 3. 9 7. 5 1. 6 52. 0 20. 0 Sweden 1. 6 0. 2 48. 5 11. 0 0. 0 12. 6 0. 0 62. 7 11. 2 United Kingdom 3. 5 2. 6 21. 7 11. 3 0. 0 16. 4 14. 7 41. 6 28. 5 Notes: N/A: not available indicates that the amount is not available in the state aid decision N/R: not reported indicated that the amount was not reported by the Member States in its reply to the EFC questionnaire Source: Commission services L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 6
DG ECFIN Fiscal costs of the financial crisis Estimates of direct fiscal costs in the current crisis (net of recovery rates) Risk scenarios for direct fiscal costs 2/ ü Upper bound estimate of 13% of GDP is in line with average past direct fiscal crises costs (13% of GDP). ü In individual Member States the direct fiscal costs risk to be much higher than this average. ü Crisis is costly for the taxpayer. ü Policies need to ensure that crises costs are contained and long-term sustainability maintained. L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs (% of GDP) Based on effective approved measures A Recapitalisation A. 1 As of 21 October 2009 A. 1. 1 Loss rate (80%) A. 2 Assuming a doubling of recapitalisation needs A. 2. 1 Loss rate (80%) 1. 7% 1. 4% 3. 4% 2. 7% 2. 2% 5. 4% 4. 3% B B. 1 B. 2 2. 3% 0. 2% 0. 7% 3. 2% 0. 3% 1. 0% 8. 6% 25. 5% 1. 3% 2. 6% 3. 8% 7. 7% C C. 1 C. 2 Liquidity and bank funding support Loss rate (10%) Loss rate (30%) Govt. guarantees on bank liabilities and relief of impaired assets 1/ Loss rate (15%) Loss rate (30%) TOTAL net fiscal costs Lower bound(=A. 1. 1+B. 1+C. 1) 2. 9% 6. 3% Higher bound(=A. 2. 1+B. 2+C. 2) 6. 0% 12. 9% Notes: 1/ In percent of 2009 GDP (European Commission Spring Forecast 2009). Includes blanket guarantees (AT, ES, IE, NL) but not the potential shortfalls of deposit insurance schemes nor government guarantees where amounts have not been specified (e. g. BG, IT, PL, UK). Source: Commission services. 7
DG ECFIN Fiscal costs of the financial crisis Real economy support EERP: 1. 8% of GDP discretionary stimulus measures in addition to large automatic stabiliser effects. Discretionary fiscal stimulus measures in the EU (2009 -10) 1/ 1. 2 1. 1 EU-27 Euro area 1. 0 0. 8 0. 7 0. 6 0. 5 0. 4 0. 3 0. 2 0. 1 0. 0 2009 2010 2009 Total 2010 Revenue 2009 2010 Expenditure 2009 2010 Public investment Notes: 1/Figures for 2010 include permanent measures taking effect in 2009 plus measures taking effect in 2010. Source: European Commission L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 8
DG ECFIN Fiscal costs of the financial crisis Automatic stabilisers and discretionary policies lead to large deficits Government balances in 2007 -10 in the Commission Services’ Spring 2009 Forecasts L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 9
DG ECFIN Large deficits lead to rapid increases in debt Change in debt as a share of GDP – Commission Spring 2009 forecasts L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 10
DG ECFIN The effect of crises on debt Total fiscal costs of past crises Large fiscal deficits contributed to public debt-to-GDP ratios ratcheting them up by 20 points of GDP, on average. This impact has taken a long time to reverse in the past. L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 11
DG ECFIN Potential growth in the aftermath of the crisis Impact of the crisis on potential growth ü Critical challenges for the EU are to prevent reductions in potential growth from: § § § ü ü Case No 1: Full return to earlier path Lower or unproductive investment due to risk aversion, credit constraints or government intervention Permanent rebalancing of internal demand Labour market hysterisis Past crises (e. g. SE and FI) show that policy responses matter Case No 3: Permanent loss on growth rates Different scenarios are possible i. e. a full return to earlier path, a permanent loss in level terms only or a permanent loss on growth rates L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs Case No 2: Permanent loss in GDP level 12
DG ECFIN The path of actual and potential output in previous financial crises in Japan, Sweden and Finland L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 13
DG ECFIN Hypothetical GDP trajectory for Belgium Pre-crisis: average annual growth of 2. 3% Post-crisis: average annual growth of 1. 4% By 2020 and going forward: GDP 11% lower L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 14
DG ECFIN Fiscal sustainability Required consolidation to bring debt to 60% by 2020 L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 15
DG ECFIN Developments in debt up to 2020 L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 16
DG ECFIN Some background figures on demographics EU EU 15 Belgium 2008 2060 Fertility rate 1. 52 1. 64 1. 72 1. 75 1. 79 Life expectancy at birth – men 76. 0 84. 5 77. 2 84. 8 76. 7 84. 4 Life expectancy at birth – women 82. 1 89. 0 82. 6 89. 1 82. 3 88. 9 Old age dependency ratio 25 53 26 51 26 46 Net migration flows (thousands) 1683 804 1647 750 51 23 0. 2 0. 4 0. 2 0. 5 0. 2 Net migration flows (% population) L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 17
DG ECFIN Budgetary costs of population ageing Costs set to increase substantially but with wide variation between countries Pension spending Long-term care, unemployment and education Healthcare 2010 Change 2010 to 2060 Poland 10. 8 -2. 1 4. 1 0. 8 4. 2 0. 1 19. 1 -1. 1 Estonia 6. 4 -1. 6 5. 1 1. 1 3. 2 0. 4 14. 8 -0. 1 Latvia 5. 1 0. 0 3. 5 0. 5 3. 6 0. 8 12. 3 1. 3 EU-27 10. 2 2. 3 6. 8 1. 4 6. 1 0. 9 23. 2 4. 6 EA 11. 2 2. 7 6. 8 1. 3 6. 4 1. 1 24. 5 5. 1 Belgium 10. 3 4. 5 7. 7 1. 1 8. 9 1. 0 26. 8 6. 6 Slovenia 10. 1 8. 5 6. 8 1. 7 6. 2 2. 4 23. 1 12. 7 Greece 11. 6 12. 5 5. 1 1. 3 5. 2 21. 9 16. 0 8. 6 15. 3 5. 9 1. 1 5. 4 1. 7 19. 9 18. 2 Luxembourg L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 2010 Change 2010 to 2060 Total 18 2010 Change 2010 to 2060
DG ECFIN Fiscal sustainability Sustainability gaps (S 2 in percent of GDP) (latest available unpublished, data) L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 19
DG ECFIN Fiscal sustainability Decomposition of the S 2 indicator IBP: required adjustment given the initial budgetary position LTC: required adjustment given the long-term change in age-related expenditure L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 20
DG ECFIN Fiscal sustainability Comparing the sustainability gaps in 2009 and 2006 L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 21
DG ECFIN Examples of debt and consolidation in Belgium Trajectory of debt as a share of GDP based on different levels of consolidation L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 22
Time to design exit strategies? DG ECFIN ü EU Council - 17 September “Exit strategies need to be designed now and implemented in a coordinated manner as soon as recovery takes hold, taking into account the specific situations of individual countries. ” ü Pittsburgh Summit – 24 -25 September “We will prepare our exit strategies and, when the time is right, withdraw our extraordinary policy support in a cooperative and coordinated way, maintaining our commitment to fiscal responsibility. ” ü Informal ECOFIN – 1 -2 October “In order to anchor expectations and reinforce confidence, it is necessary to start designing and communicating credible exit strategies, even if implementation will have to wait. ” ü IMFC Statement – Istanbul 4 October “As the recovery takes hold, we are committed to work together in articulating and implementing credible and coordinated exit strategies for the withdrawal of public support for the financial sector, orderly unwinding of monetary policy support, and fiscal consolidation needed to underpin long-term sustainability. ” ü ECOFIN Council – 20 October “The Council agrees that preparing a coordinated exit strategy for exiting from the broad-based policies of stimulus is needed. . The Council underlines that an early design and communication of such a strategy would contribute to underpinning confidence in our medium-term policies and to anchor expectations” L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 23
DG ECFIN ECOFIN Council 20 October 2009 Designing fiscal exit strategies ü Withdrawal of stimulus should be timely. Consolidation should start in 2011 at the latest, with some countries needing to consolidate earlier. ü Consolidation will need to go well beyond the benchmark 0. 5% of GDP per annum. ü Important additions: § § § Strengthened national budgetary frameworks to underpin credibility of consolidation. Measures to support long-term fiscal sustainability Strengthening of structural efforts to enhance productivity and support long term investment L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 24
DG ECFIN What do we know about how to consolidate successfully? ü Extensive literature on the subject including Alesina and Perotti (1995), Public finances in EMU 2007, Kumar et al. (2007). ü Consolidations based on expenditure cuts tend to be longer lasting § § ü Gradual adjustments have proven more effective (Public finances in EMU 2007) § ü Often accompanied by structural reforms Improvements in the fiscal institutions can be important complements to consolidation § ü Especially true if also focus on structural reforms increasing work incentives and public sector efficiency Tax based consolidation tends to work better if it is gradual and starts from a lower level Countries with existing strong institutions consolidate more effectively Difficult macroeconomic and public finance starting points can be catalysts for successful consolidations L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 25
DG ECFIN The quality of the public finances in Belgium Note: a higher value indicates outcomes more conducive to long-term growth L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 26
DG ECFIN Belgium – what choices are available? ü Reducing expenditure? § § ü Increasing tax? § § ü Tax and SS revenues high and relatively inefficient Increasing them further could be costly and hard Structural reforms? § ü Government spending is high, so possibility to reduce it Efficiency gains also possible The tax system has strong disincentives to work in it Pension changes for the long term? § Scope to change the pension system but can only be a part of the answer L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 27
DG ECFIN How to reduce the cost of ageing over time ü Stockholm strategy from the 2001 European Council ü Reduce debt to allow pre-financing § § § ü Increase employment rates and productivity § § ü Would need to be in addition to reversing debt increases due to crisis Could only be achieved very gradually Might add to global imbalances Can accompany fiscal consolidation May not reduce the cost of ageing much due to accrual of pension rights Reform pension, healthcare and long-term care systems § § § Shifting to private provision also has risks Adequacy of provision must be ensured to make any changes effective Raising retirement ages is a serious consideration L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 28
DG ECFIN Exit ages from the labour market L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 29
DG ECFIN How can changes to the labour market or pension structure aid sustainability? L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 30
DG ECFIN Conclusions ü Crisis had both a direct and indirect impact on public finances ü Increase in government debt substantial and worrying ü The existing challenge of ageing looms large over the future ü Exiting the crisis will be a delicate exercise ü Measures addressing both medium-term deficits and longterm increases in the cost of ageing are required L. Pench, Head of Unit, Fiscal policies in the euro area and EU European Commission, Economic and Financial Affairs 31
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