Focus 8 The effectiveness of the medium-term budgetary objective

ECB

Economic Bulletin

Issue 4 / 2015

The effectiveness of the

medium-term budgetary

objective as an anchor of

fiscal policies

Boxes

Box 8

THE EFFECTIVENESS OF THE MEDIUM-TERM BUDGETARY OBJECTIVE AS AN ANCHOR OF FISCAL POLICIES

By the end of April 2015 all euro area countries not subject to an EU-IMF financial

assistance programme had to submit their stability programme updates to the Ecofin

Council and the European Commission. In line with the preventive arm of the Stability and

Growth Pact (SGP), these updates outline governments’ budgetary strategies for the current

year and at least the following three years. They also specify countries’ medium-term budgetary

objectives (MTOs) and planned progress towards them. Based on an assessment of the stability

programmes, the European Council will endorse country-specific recommendations for fiscal

policies on 25-26 June. These recommendations will take into account the January 2015

Commission Communication on flexibility within the SGP

, which provides new guidance on

the fiscal efforts required to achieve the MTOs. Against this background, this box reviews the

effectiveness of the MTO as an anchor of fiscal policies under the preventive arm of the SGP.

The medium-term budgetary objective is the cornerstone of the preventive arm of the

SGP. The MTO was introduced with the reform of the SGP in 2005 and reflects the budgetary

target of governments over the medium term. It is defined in structural terms, i.e. corrected

for the impact of the economic cycle and temporary measures.

MTOs are subject to regular

updates every three years to reflect the latest estimates of the economic and budgetary costs

of ageing, which are published in the triennial “Ageing Report”

. The SGP’s preventive arm

requires countries to make appropriate progress towards their MTO each year and, once they

have achieved it, to maintain this structural budget balance. Specifically, the SGP foresees a

benchmark structural adjustment of 0.5% of GDP towards the MTO, with higher adjustments in

good economic times and lower ones in bad economic times. At the same time, the preventive arm

regulation allows temporary deviations from a country’s MTO, or the adjustment path adopted

to achieve it, to take account of the implementation of major structural reforms that have direct,

long-term positive budgetary effects, provided that the country returns to its MTO within the

stability programme horizon.

The track record of achieving MTOs is poor. Even though the MTOs have been part of the

EU’s fiscal framework for ten years now, most countries have not achieved them in any single year

during this time period. Furthermore, euro area countries have regularly postponed the deadline

for achieving them, making MTOs “moving targets” instead of an anchor for budgetary planning.

As a consequence, the euro area entered the financial crisis with a sizeable structural deficit

which limited the scope for counter-cyclical policies and prevented automatic stabilisers from

working freely.

1 For further details, see the box entitled “Flexibility within the Stability and Growth Pact”, Economic Bulletin, Issue 1, ECB, February 2015.

2 MTOs are set by Member States according to country-specific circumstances. They must respect minimum values and are designed

to serve three goals: (i) Member States maintain a safety margin that prevents them from breaching the 3% Maastricht Treaty deficit

reference value during cyclical downturns; (ii) Member States’ debts are sustainable taking into consideration the economic and

budgetary impact of ageing populations; and (iii) Member States have room for budgetary manoeuvre, in particular when it comes to

preserving public investment.

3 See also Box 7 of this issue of the Economic Bulletin, entitled “The 2015 Ageing Report – How costly will ageing in Europe be?”.

4 The structural balance is also determined by the unobservable output gap, which is generally subject to considerable revisions over time.

The output gap is estimated to have had a negative real-time bias of around 1% of GDP over the 2003-13 period, which also implies

an overestimation of the structural balance in real time. See also Kamps, C., Leiner-Killinger, N., Sondermann, D., De Stefani, R. and

Rüffer, R., “The identification of fiscal and macroeconomic imbalances – unexploited synergies under the strengthened EU governance

framework”, Occasional Paper Series, No 157, ECB, Frankfurt am Main, November 2014.

ECB

Economic Bulletin

Issue 4 / 2015

The poor track record regarding MTO compliance was intended to be addressed as part

of a significant reform of the EU fiscal governance framework. Given the insufficient

enforcement of compliance with the structural effort requirements under the SGP’s preventive

arm, in 2011 the six-pack reforms

further reinforced it by defining a “significant deviation”

from the adjustment path towards an MTO that can eventually lead to financial sanctions being

imposed on a country. In 2012 the Treaty on Stability, Coordination and Governance in the

Economic and Monetary Union (TSCG) made MTOs more ambitious: signatory euro area

countries commit to MTOs not lower than -0.5% of GDP (compared with MTOs not lower

than -1% of GDP before), unless their debt level is significantly below 60% of GDP and the

risks to long-term sustainability are low. Furthermore, in 2013 the “calendars of convergence”,

i.e. country-specific time frames for achieving MTOs by a specified year, were put forward by

the Commission as a follow-up to the TSCG.

The correction mechanism provided for in the

TSCG, which should be triggered automatically at the national level in the event of a “significant

deviation” from the MTO or the adjustment path towards it, was expected to ensure rapid

convergence of countries towards their respective MTOs.

However, available evidence suggests that compliance with the MTOs has not significantly

improved over recent years (see chart). Notably, MTO deadlines as set in the 2015 stability

programmes are, for a large number of countries, further in the future than prescribed in the

5 Five regulations and one directive on fiscal and macroeconomic surveillance in the EU.

6 The deadlines for achieving the MTOs were set on the basis of the medium-term budgetary plans presented in the 2013 update of the stability

and convergence programmes and in line with the SGP. See European Commission, “Report on public finances in EMU 2013”, Part 1,

Annex 1, European Economy, Issue 4, European Commission, Brussels, 2013.

Year of achieving the MTO as recommended in the 2013 calendar of convergence

and as implied by the 2015 stability programmes

(as recalculated by the European Commission)

at MTO

2013

2014

2015

2016

2017

2018

2019

at MTO

2013

2014

2015

2016

2017

2018

2019

beyond

horizon

beyond

horizon

BE DE EE IE ES FR IT LU MT NL AT PT SI SK FI

2015 stability programme update

2013 calendar of convergence

Source: 2015 stability programme updates, Commission staff working documents.

Notes: The chart compares the deadlines that the calendars of convergence set in 2013 for achieving MTOs with the year in which they are

expected to be achieved as set out by the 2015 stability programme updates. The years of achieving the MTOs are based on the structural

balances outlined in the stability programmes as recalculated by the Commission using the commonly agreed methodology and taking

into account the 0.25% compliance margin. Consequently, the year of achieving the MTO as planned within a stability programme may

differ from the year it is expected to be achieved according to the Commission calculations. For example, Portugal plans to reach its MTO

in 2016, Italy and Slovakia in 2017, France in 2018 and Spain in 2019. For MTOs that are planned to be reached “beyond horizon” no

recalculated structural balances are available. “Beyond horizon” denotes a time frame beyond the final year included in the 2015 stability

programme, which is 2018 for Belgium, Spain, France and Slovakia, and 2019 for Finland. The dotted line thus reflects the period beyond

the programme horizon. For Ireland the deadline has not changed.

ECB

Economic Bulletin

Issue 4 / 2015

The effectiveness of the

medium-term budgetary

objective as an anchor of

fiscal policies

Boxes

2013 calendars of convergence. The Commission Communication on flexibility within the SGP

released earlier this year may entail a slowdown in countries’ progress towards the MTOs.

This

clarified but also extended the SGP’s flexibility as regards the application of the rules in three

major areas: (i) cyclical conditions, (ii) structural reforms and (iii) government investment. When

eligible under the structural reform and investment clause, countries are allowed to deviate from

the adjustment path towards their MTOs.

For example, in their 2015 update of the stability

programmes, Latvia and Italy applied to be considered under the structural reform clause for

2016.

Latvia was not granted a deviation under the clause owing to the absence of a sufficient

safety margin towards the 3% deficit value. In the case of Italy, the European Commission

allowed it to temporarily deviate by 0.4% of GDP from the required adjustment towards its MTO

in 2016, after a zero adjustment requirement in 2014 and a reduced requirement in 2015 based

on changes in the treatment of cyclical conditions applied by the Commission in spring 2014 and

January 2015, respectively. Lithuania applied for the pension reform clause, but its eligibility

will depend on Eurostat’s confirmation of the systemic nature of the reform. Other countries,

e.g. Slovakia, may benefit from the cyclical conditions clause, as their adjustment requirements

have been lowered.

If used excessively, SGP flexibility could lead to further sizeable and long-lasting

deviations from the adjustment path towards the MTOs, which could increase risks to debt

sustainability. It is therefore essential to avoid the “moving-target syndrome” from which the

preventive arm of the SGP suffered before the crisis. If euro area countries fail to restore fiscal

buffers in a timely manner, they will be ill-prepared for adverse economic shocks, which is

precisely when fiscal stabilisation is most needed. The current environment of strengthening

economic recovery and favourable financial conditions should be used to accelerate progress

towards MTOs. This would increase the resilience of the euro area economy.

7 On 13 January 2015 the European Commission issued a Communication entitled “Making the best use of the flexibility within the

existing rules of the Stability and Growth Pact”, see http://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/2015-01-

13_communication_sgp_flexibility_guidelines_en.pdf.

8 For further details, see the box entitled “Flexibility within the Stability and Growth Pact”, op. cit.

9 In its 2015 convergence programme update, Romania applied to be considered under the structural reform clause, but its application

has not yet been accepted owing to an absence of sufficiently detailed information.