Adjusting to a credit cycle bust: The role of fiscal policy. CEPS Commentary, 27 July 2012

In response to the often-heard accusation that “austerity is killing growth in Europe”, Daniel Gros asks in this new Commentary: “What austerity?” Looking at the entire budget cycle, he finds that the picture of austerity killing growth simply does not hold up. Since the bursting of the bubble in 2007, Gros reports that the economic performance of the US has been very similar to that of the euro area: GDP per capita is today about 2% below the 2007 level on both sides of the Atlantic; and the unemployment rate has increased by about the same amount as well: it increased by 3% both in the US and the euro area. Thus, he concludes that over a five-year period, the US has not done any better than the euro area although it has used a much larger dose of fiscal expansion.

Fiscal policy, banks and the financial crisis. National Bank of Belgium Working Paper No. 234, October 2012

This paper studies the effectiveness of Euro Area (EA) fiscal policy, during the recent financial crisis, using an estimated New Keynesian model with a bank. A key dimension of policy in the crisis was massive government support for banks—that dimension has so far received little attention in the macroeconomics literature. We use the estimated model to analyze the effects of bank asset losses, of government support for banks, and other fiscal stimulus measures, in the EA. Our results suggest that support for banks had a stabilizing effect on EA output, consumption and investment. Increased government purchases helped to stabilize output, but crowded out consumption. Higher transfers to households had a positive impact on private consumption, but a negligible effect on output and investment. Banking shocks and increased government spending explain half of the rise in the public debt/GDP ratio since the onset of the crisis.

Towards a New (European Research) Deal: The Case for Enhanced Fiscal Policy Coordination on Research and Innovation. Bruges European Economic Policy (BEEP) Briefing 20/2008

The paper reviews the evolution of research and innovation in the EU and assesses how current policies and programmes have influenced the development of Europe's research landscape. Based on existing literature, evaluation reports and practice, the paper critically examines the effectiveness of current European research funding instruments in a context of open innovation and in the presence of global spillovers. It therefore develops a subsidiarity test to assess whether current rationales still prove sufficient to justify policy intervention in this area. The paper sheds light on how to improve the effectiveness of EU action by enriching it by the use of coordinated fiscal policy for research funding. This will constitute an incentive to genuine bottom-up research, development and innovation (R&D&I) and a stimulus to local investments in innovation. The paper also assesses the potentials of a reinforced open method of coordination as well as a review of state aid law in the field of research funding in the EU.

Economic Policy Coordination in the Economic and Monetary Union: From Maastricht via the SGP to the Fiscal Pact. CEPS Working Document No. 381, August 2013

This paper first takes a step backwards with an attempt to situate the recent adoption of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union in the context of discussions on the Stability and Growth Pact (SGP) and the ‘Maastricht criteria’, as fixed in the Maastricht Treaty for membership in the Economic and Monetary Union (EMU) in a longer perspective of the sharing of competences for macroeconomic policy-making within the EU. It then presents the main features of the new so-called ‘Fiscal Compact’ and its relationship to the SGP and draws some conclusions as regards the importance and relevance of this new step in the process of economic policy coordination. It concludes that the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union does not seem to offer a definitive solution to the problem of finding the appropriate budgetary-monetary policy mix in EMU, which was already well identified in the Delors report in 1989 and regularly emphasised ever since and is now seriously aggravated due to the crisis in the eurozone. Furthermore, implementation of this Treaty may under certain circumstances contribute to an increase in the uncertainties as regards the distribution of the competences between the European Parliament and national parliaments and between the former and the Commission and the Council.

Options for a Euro-area fiscal capacity. Bruegel Policy Brief 2013/01, January 2013

Europe has responded to the crisis with strengthened budgetary and macroeconomic surveillance, the creation of the European Stability Mechanism, liquidity provisioning by resilient economies and the European Central Bank and a process towards a banking union. However, a monetary union requires some form of budget for fiscal stabilisation in case of shocks, and as a backstop to the banking union. This paper compares four quantitatively different schemes of fiscal stabilisation and proposes a new scheme based on GDP-indexed bonds. The options considered are: (i) A federal budget with unemployment and corporate taxes shifted to euro-area level; (ii) a support scheme based on deviations from potential output;(iii) an insurance scheme via which governments would issue bonds indexed to GDP, and (iv) a scheme in which access to jointly guaranteed borrowing is combined with gradual withdrawal of fiscal sovereignty. Our comparison is based on strong assumptions. We carry out a preliminary, limited simulation of how the debt-to-GDP ratio would have developed between 2008-14 under the four schemes for Greece, Ireland, Portugal, Spain and an ‘average’ country.The schemes have varying implications in each case for debt sustainability

The financial stability risks of ultra-loose monetary policy. Bruegel Policy Contribution Issue 2015/03

Ultra-loose monetary policies, such as very low or even negative interest rates, large-scale asset purchases, long-maturity lending to banks and forward guidance in central bank communication, aim to increase inflation and output, to the benefit of financial stability. But at the same time, these measures pose various risks and might create challenges for financial institutions. • By assessing the theoretical literature and developments in the United States, United Kingdom and Japan, where very expansionary monetary policies were adopted during the past six years, and by examining the euro-area situation, we conclude that the risks to financial stability of ultra-loose monetary policy in the euro area could be low. However, vigilance is needed. • While monetary policy should focus on its primary mandate of area-wide price stability, other policies should be deployed whenever the financial cycle deviates from the economic cycle or when heterogeneous financial developments in the euro area require financial tightening in some but not all countries. These policies include micro-prudential supervision, macro-prudential oversight, fiscal policy and regulation of sectors that pose risks to financial stability, such as construction.

Benefits and drawbacks of European Unemployment Insurance. Bruegel Policy Brief 2014/06, September 2014

The issue: Unemployment in Europe has increased to high levels and economic growth has remained subdued. A debate on additional policy instruments to address the situation is therefore warranted. Fiscal stabilisation mechanisms have not provided adequate fiscal stabilisation during the crisis in some countries nor in the euro area as a whole. Different preferences and historical developments mean that national labour markets are differently organised, which sometimes hinders the efficient working of the monetary union. European Unemployment Insurance (EUI) has been proposed as a measure to contribute to fiscal policy management and improve labour markets. | Read more at Bruegel http://www.bruegel.org/publications/publication-detail/publication/847-benefits-and-drawbacks-of-european-unemployment-insurance/

The fiscal compact - Europe's "hard core" based on German economic conditions. OSW Commentary No. 71, 2012-03-07

On 2 March, the leaders of 25 EU member states signed the Treaty on stability, coordination and governance in the economic and monetary union. It will introduce new fiscal constraints and officially vest new competences in the eurozone countries. Thus, their right to coordinate economic policy among them will be sanctioned. So far, the Lisbon Treaty has only provided for organisation of informal Eurogroup meetings, to be attended by representatives of the European Commission. The principles introduced by the compact, if the eurozone countries are really determined to observe its provisions, will create a new way of managing the single currency. Within the next few years, the most indebted countries will have to carry out radical reforms to boost their competitiveness and adjust it to German standards. During this period the Federal Republic of Germany will most probably decide to offer higher loan guarantees to relieve these countries’ budgets. The compact’s political consequences are also of great significance, especially considering how the treaty was finalised. The eurozone states have in fact accepted that the direction for changes will be devised by France and Germany, and the role of European institutions such as the Commission or the Parliament may weaken. From the perspective of eurozone candidate countries, the introduction of the fiscal compact means expanding the scope of conditions they must meet to become members of the single currency area. In the future, a country, in order to adopt the single currency, will have to meet the structural deficit criterion, and also most probably carry out economic reforms such as unifying its fiscal system. These goals will be achieved across the eurozone gradually, in the subsequent stages of the economic governance reform.

Comparing fiscal multipliers across models and countries in Europe. National Bank of Belgium Working Paper No. 278, March 2015

This paper employs fifteen dynamic macroeconomic models maintained within the European System of Central Banks to assess the size of fiscal multipliers in European countries. Using a set of common simulations, we consider transitory and permanent shocks to government expenditures and different taxes. We investigate how the baseline multipliers change when monetary policy is transitorily constrained by the zero nominal interest rate bound, certain crisis-related structural features of the economy such as the share of liquidity-constrained households change, and the endogenous fiscal rule that ensures fiscal sustainability in the long run is specified in terms of labour income taxes instead of lump-sum taxes.

How EU Fiscal Norms Will Become a Safety Net for the Failure of National Golden Rules. European Policy Brief No. 6, January 2012

If introduced successfully, national Golden Rules will completely overturn fiscal governance in the eurozone. Golden Rules would almost always be more stringent than EU-level fiscal norms. EU fiscal norms will hence evolve into a safety net in case a Golden Rule fails. The possibility of such a failure is, indeed, not to be dismissed. Because of the severity of the Golden Rules, eurozone leaders should reflect on their design. There is a real risk that they will undercut public investment, which would be at the cost of the EU’s other long-term challenges.

A case for adjusting fiscal consolidation in the eurozone. European Policy Brief No. 14, January 2013

Fiscal consolidation is essential to ensure the sustainability of eurozone countries’ public debt. However, as a principle, consolidation should not be pursued at a pace unnecessarily undermining growth in the short term. Repeated downward revisions of growth call for the use of the flexibility foreseen in the EU fiscal framework. The Commission should adapt the deadlines for fiscal correction to prevent excessive, pro-cyclical adjustment in 2013. In turn, adequate surveillance and coordination must ensure structural adjustments constitute the core of fiscal consolidation plans.

Contractual arrangements: the overlooked step towards a fiscal union. European Policy Brief No. 18, December 2013

‘Contractual arrangements’ were proposed as an initial step towards a fiscal union that would consolidate the EMU. At this stage, the debate should be centred on the cornerstone of these contracts: the solidarity mechanism. The form of the financial support should not be limited to loans, and include the possibility for grants. Only the countries with the greatest adjustment needs should benefit from the financial support of other countries. This solidarity could be justified in principle by the intensity of the ‘shocks’ they experienced. In this way, contractual arrangement would facilitate the completion of the necessary adjustment in the current crisis – thanks both to more structural reforms and more mutual support within the eurozone.

spotlight europe #2015/04—October 2015: A Fiscal Union for Europe – Building Block and Not a Magic Bullet

The dramatic negotiations with Greece in the past few months have been a telling reminder of the weaknesses of the euro area. Most of the commentators are of the opinion that if the monetary union is going to be crisis-resistant and stable in the long term, certain very important elements will have to be changed. However, there is little or no agreement when it comes to specifying the "what" and the "how". In particular there are heated debates about the right steps to further integration in the area of fiscal policy. "Fiscal union can create stability only if it includes both credible budgetary rules and some kind of risk sharing", argue Katharina Gnath and Jörg Haas in the latest spotlight europe. However, "whilst it is an important and effective way of stabilizing the euro area, it should not exclude the use of other instruments."

Which fiscal union for the euro area? Bruegel Policy Contribution ISSUE 2016/05, February 2016

At the current level of political and societal integration, a large federal budget is unrealistic in the euro area. The authors make three recommendations that would lead national fiscal policies to be more stabilising with respect to the economic cycle, while achieving long-term sustainability. They also recommend a move towards a European unemployment insurance scheme targeted at ‘large’ shocks, and a minimum set of labour-market harmonisation criteria.

A proposal to revive the European Fiscal Framework. Bruegel Policy Contribution ISSUE 2016/07 MARCH 2016

Pro-cyclical fiscal tightening might be one reason for the anaemic economic recovery in Europe, raising questions about the effectiveness of the EU’s fiscal framework in achieving its two main objectives: public debt sustainability and fiscal stabilisation. • In theory, the current EU fiscal rules, with cyclically adjusted targets, flexibility clauses and the option to enter an excessive deficit procedure, allow for large-scale fiscal stabilisation during a recession. However, implementation of the rules is hindered by the badly-measured structural balance indicator and incorrect forecasts, leading to erroneous policy recommendations. The large number of flexibility clauses makes the system opaque. • The current inefficient European fiscal framework should be replaced with a system based on rules that are more conducive to the two objectives, more transparent, easier to implement and which have a higher potential to be complied with. • The best option, re-designing the fiscal framework from scratch, is currently unrealistic. Therefore we propose to eliminate the structural balance rules and to introduce a new public expenditure rule with debt-correction feedback, embodied in a multi-annual framework, which would also support the central bank’s inflation target. A European Fiscal Council could oversee the system.