Over optimism9/19/2023 Source: European Commission, successive vintages of stability and convergence programmes and compliance tracker of the EFB secretariat ( ) Deviation = Budget balance in % of GDP in year t minus -3% of GDP. Notes: Forecast error = Real GDP growth in year t minus forecast of real GDP growth for year t made in t-3. It plots the three-years-ahead forecast error on real GDP growth for a given year t and contrasts it with the observed deviation from the 3% of GDP reference value of the SGP in the same year t (a positive value indicates a headline balance above the reference value).3įigure 2 Forecast error on medium-term economic growth (real) and deviations from the 3% of GDP reference value of the SGP Figure 2 illustrates the point based on the stability and convergence programmes of EU countries in 1998-2019. Sanguine views of where the economy will be in a couple of years will motivate equally sanguine expenditure plans with the risk of politically not being in a position or willing to make adjustments in case economic growth turns out lower. The first channel is well understood it simply follows from the basic mechanics of government budgets outlined above. While this is a step in the right direction, the EU fiscal framework still pays little attention to medium-term growth forecasts.2 There are at least two interlinked channels to be taken into account: optimism about the medium term (i) weighs on future fiscal outcomes, and (ii) can be used to justify fiscal expansions in the short run. With the exception of Poland, every EU member state has an independent fiscal council, which either produces the macroeconomic forecast to be used by the budgetary authorities or assesses the degree of realism of the government’s own growth projections. Under current practice and EU law, quite some energy goes into making sure annual budget plans are built on realistic macroeconomic forecasts. As a result, optimism in projecting the future contributes to the notorious deficit bias of fiscal policymaking.1 Once agreed, spending programmes exhibit a high degree of inertia they are not adjusted in the event of lower-than-expected economic growth, at least not immediately. When setting the path of future expenditure, budgetary authorities need to make assumptions about government revenues, which in turn are directly linked to the projected level of economic activity. That growth forecasts shape budgetary outcomes is a well-established result, even a truism. Medium-term growth forecasts and fiscal outcomes Source: European Commission and successive vintages of stability and convergence programmes. The country was exempt from submitting stability programmes while under macroeconomic adjustment programmes. Results were mixed: some countries managed to better align medium-term plans with outcomes, others stuck to the moving-target approach (Figure 1).įigure 1 Budget outcomes versus plans in stability and convergence programmes (SCPs) domestic procedures that extend the horizon for fiscal policymaking beyond the annual budgetary calendar. In 2011, as part of the six-pack reform of the Stability and Growth Pact (SGP), member states were invited to enhance their national medium-term budgetary frameworks, i.e. Instead of acting as a goalpost for the medium term, in many countries stability and convergence programmes turned into tales of moving targets where budgetary objectives would steadily move out of reach. However, right from the start, experience fell short of expectations. EU law asks member states to formulate fiscal plans for at least three years in advance and to send them to Brussels every year in the form of stability and convergence programmes for peer review. These basic tenets have inspired the EU fiscal framework since inception. At the same time, lawmakers and governments are generally advised to look beyond the short term and give budgetary planning a medium-term orientation for a number of very good reasons: (i) most fiscal measures have a multi-year impact (ii) the annual headline balance is a poor gauge of the underlying fiscal position and (iii) multiannual expenditure ceilings help stabilise the economy while strengthening fiscal performance. Hence, outcomes rarely met annual targets. But unlike movie directors, finance ministers do not control outcomes: economic agents may behave in ways not anticipated and the economic cycle usually takes unexpected turns. Budget plans are the screenplay of fiscal policymaking.
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