Assessment of the fiscal stance appropiate for the euro area in 2021

Tn 1 July 2020, the European Fiscal Board has published its assessment of the general orientation of fiscal policy in the euro area. The economic consequences of the Covid-19 pandemic make the years 2020 and 2021 extraordinary and the assessment of the euro-area fiscal stance particularly relevant. All main forecasters anticipate a deep recession of around or more than 8% of GDP this year, followed by a partial recovery in 2021; downside risks are substantial. The fiscal measures adopted by individual Member States, flanked by the decisions of the European Central Bank and the proposals of the European Commission, in particular the Recovery Instrument are fully warranted. In light of the partial and fragile recovery expected for 2021, the Board cautions against a premature withdrawal of fiscal support measures at the Member State level and looks forward to a swift and effective implementation of recent EU proposals. It advocates a strong focus on growth-enhancing government expenditure including investment, to provide stabilisation in the short-term while bolstering prospects of stronger future growth. In 2020, containment measures taken in response to the Covid-19 pandemic have triggered an unprecedented recession in the euro area. The crisis simultaneously crippled supply and demand. The activation of the general escape clause of the Stability and Growth Pact was justified in light of the severe economic downturn and has enabled governments to make full use of their fiscal arsenal subject to the sustainability constraint. However, a review date and the conditions for an exit from the clause have not been indicated and should be discussed and agreed as soon as possible. Governments have reacted with discretionary fiscal measures estimated at 3¼ % of GDP on top of automatic stabilisers amounting to close to 5% of GDP. Recent announcements by Germany and France could increase the total amount of national discretionary measures to 4% of GDP. Several initiatives were also taken at the EU level. In its latest forecast, the Commission expects real GDP in the euro area to drop by close to 8% in 2020 followed by a sizable yet partial recovery in 2021, leaving the level of economic activity still 2% below its 2019 level. The expected recovery hinges on the assumption that demand rebounds strongly and no further general confinement measures are taken. The severity of the economic impact of the crisis varies greatly among Member States and regions, threatening to exacerbate existing differences in economic performance. The Board recognises that any prediction for economic growth in 2021 is subject to a high degree of uncertainty and that the balance of risks is tilted to the downside. As next year’s bounce-back of the euro area economy is expected to be limited, a withdrawal of fiscal support would be premature. The crisis has seen Member States with high levels of government debt prior to the outbreak of the Covid-19 pandemic hit especially hard in terms of the immediate health crisis as well as exposure to vulnerable sectors. As a result, negative growth combined with the fiscal response in 2020 will lead to a further major increase in government debt as share of GDP. For fiscally constrained Member States, a swift and effective implementation of the recent proposals for fiscal support at the EU level would be particularly welcome. The European instrument for temporary Support to mitigate Unemployment Risks in an Emergency (SURE) and particularly the Recovery Instrument have features of a genuine fiscal capacity, but they are designed as temporary instruments. The current economic shock has revealed once more the pitfalls of a monetary union without a meaningful and genuine central fiscal capacity. Against this backdrop, the Board sees the opportunity to kill two birds with one stone. Increasing government expenditure that stimulates demand while at the same time raising the long-term growth potential of the economy should be given particular prominence. Hence, the report published today includes a dedicated section outlining different approaches to support government investment and growth-friendly government expenditure more generally. Ideally, a central fiscal capacity or a dedicated investment fund would be complemented by a reformed Stability and Growth Pact that simplifies the fiscal framework while allowing governments to effectively protect growth-enhancing government expenditure.