Assessment of the fiscal stance appropiate for the euro area in 2020

On 25 June 2019, the European Fiscal Board published its assessment of the general orientation of fiscal policy in the euro area for 2020. The main forecasters currently consider that the euro area economy is going through a temporary period of weaker growth before picking up again, but they also flag downside risks. The Board concludes that, in an economy operating around potential and in view of economic and geopolitical uncertainty, a neutral fiscal stance is appropriate for the euro area as a whole in 2020. This can be achieved with differentiated fiscal stances at the country level. Member States that have not yet achieved sound fiscal positions need to build fiscal buffers, in line with the rules of the Stability and Growth Pact. Especially countries with a high public debt need to put it on a firm downward path. Conversely, large Member States whose budget surpluses exceed the requirements of the Pact should use part of their available fiscal space to invest more and support economic growth. After several quarters of strong growth, economic activity in the euro area has disappointed since mid-2018. Most forecasters currently expect it to grow only at a slow pace in 2019, because of external and domestic factors. On the external side, escalating trade tensions and tighter financial conditions have affected world trade and manufacturing, dampening foreign demand. On the domestic side, some adverse temporary factors are at play in the largest euro area Member States, including a slump in the automotive sector, social protests and political uncertainty. In 2020, both domestic and external demand are expected to strengthen again, although with some risks. The unemployment rate is forecast to fall to its lowest level since the euro’s introduction, supporting wage growth and consumption. Global economic activity is expected to rebound and net exports should weigh less on growth. Thanks to these factors, and with continued support from monetary policy, economic growth is expected to regain some momentum in 2020. There are, however, downside risks to this scenario. Trade tensions could flare up, growth in emerging economies may be weaker than expected, the withdrawal of the United Kingdom from the EU is surrounded by uncertainty, and financing conditions may tighten up in high-debt countries. The policy measures announced so far in euro area Member States sum up to some aggregate fiscal expansion in 2020, which goes beyond what is allowed by the Stability and Growth Pact and risks being pro-cyclical. The Board is of the view that, in an economy operating around potential, a neutral fiscal stance is more appropriate. Moreover, a significant part of the expected fiscal expansion originates in countries where high government debt-to-GDP ratios rather call for steady consolidation. The Board advises countries to build fiscal buffers until they reach their medium-term budgetary objective (MTO) – a position that ensures sustainable debt levels while offering room for manoeuvre during downturns. On the other hand, large euro area economies with budget surpluses exceeding their MTO can make a timely use of their fiscal space to strengthen current and future growth, especially by spending more on public investment. The Board is aware of risks to the economic forecasts and its guidance applies to the central scenario of a moderate pickup in economic growth. Automatic stabilisers can take care of normal growth surprises, and the rules of the Stability and Growth Pact include provisions for additional margins when needed. However, in the absence of a central fiscal capacity, the current framework is not equipped to significantly mitigate the impact of very adverse common shocks.