Nothing Ventured, Nothing Gained: The Long-run Fiscal Reward of Structural Reforms

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Nothing Ventured, Nothing Gained: The Long-run Fiscal Reward of Structural Reforms

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Peter Hoeller
Claude Giorno

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Abstract

The recent reform of the Stability and Growth Pact provides more leeway for EU governments to temporarily breach the 3% deficit limit if this facilitates the implementation of initially expensive reforms. But the implementation of this principle is not obvious as budgets would need to specify the initial and multi-annual budgetary cost and benefit profile of reforms. Budgets should also be explicit about the fiscal cost of inaction to allow a balanced judgment of countries? trade-offs between the various options available. This paper first assesses the information requirements to implement this new form of flexibility built into the Stability and Growth Pact. It then provides simulation exercises to highlight the positive budgetary effects of coordinated structural reforms in the euro area as well as the need for an adequate monetary policy response to make sure that demand adjusts to the improved supply conditions swiftly. The budgetary gains would still depend on the type of reform and their impact on employment and productivity. On the other hand, national policy initiatives by a single country may only have a limited impact, especially in the short term and in the case of a large country. Indeed, in monetary union, the strength of endogenous adjustment mechanisms appears to be weaker in larger countries. Finally, the experience of New Zealand and Australia has shown that the longer-term benefits of reforms both in terms of the budget and overall economic performance are significant. Even so, it is not easy to disentangle the various forces at play. Fundamentally, structural reform and the implementation of smart fiscal frameworks tend to go hand in hand ? indeed may be two sides of the same coin.

Qui ne risque n'a rien : Les bénéfices budgétaires à long terme des réformes structurelles
La réforme récente du Pacte de stabilité et de croissance fournit davantage de marges aux gouvernements des pays de l'UE pour dépasser la limite de 3 % du déficit public si cela facilite la mise en oeuvre de réformes initialement coûteuses. L'application de ce principe n'est cependant pas évidente car les budgets devraient indiquer le profil des coûts et bénéfices budgétaires attendus de ces réformes, non seulement dans l'immédiat mais aussi dans une perspective pluriannuelle. Les budgets devraient aussi être explicites sur le coût budgétaire de l'inaction pour permettre une évaluation équilibrée des dilemmes auxquels doivent faire face les pays en fonction des diverses options disponibles. Cet article fournit d'abord une évaluation des besoins d'information pour mettre en oeuvre les nouveaux éléments de flexibilité inclus dans le Pacte de stabilité et de croissance. Il présente ensuite des exercices de simulation afin d'illustrer les effets budgétaires positifs de réformes structurelles coordonnées dans la zone euro ainsi que la nécessité d'une réponse de politique monétaire adéquate afin d'assurer que la demande s'ajuste rapidement à l'amélioration des conditions d'offre. Les gains budgétaires seraient alors variables selon le type de réformes réalisées et leur impact sur l'emploi et la productivité. D'un autre côté, des réformes menées dans un pays isolé pourraient n'avoir qu'un effet limité, notamment à court terme dans le cas d'un grand pays. En effet, dans l'union monétaire, la force des mécanismes d'ajustement endogènes semble plus faible dans les grands pays. Enfin, l'expérience de la Nouvelle Zélande et de l'Australie montre que les bénéfices à long terme des réformes sont importants à la fois sur le plan budgétaire et pour les performances économiques d'ensemble, même s'il n?est pas aisé de distinguer l'influence des différentes forces en jeu. Fondamentalement, la réforme structurelle et la mise en place d'un cadre budgétaire pertinent tendent à aller de pair - et semblent en effet être les deux faces d'une même pièce.

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Paper provided by OECD, Economics Department in its series OECD Economics Department Working Papers with number 493.

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Date of creation: 30 Jun 2006
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Handle: RePEc:oec:ecoaaa:493-en

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Find related papers by JEL classification:
E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
H6 - Public Economics - - National Budget, Deficit, and Debt
P52 - Economic Systems - - Comparative Economic Systems - - - Comparative Studies of Particular Economies

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-07-15 (All new papers)
NEP-EEC-2006-07-15 (European Economics)
NEP-MAC-2006-07-15 (Macroeconomics)
NEP-PBE-2006-07-15 (Public Economics)

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Kari E.O. Alho, 2006. "Structural Reforms in the EU and Political Myopia in Economic Policies," Discussion Papers 1050, The Research Institute of the Finnish Economy. [Downloadable!]

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