2009 Report on Public Finances: Fiscal Stimulus Needed, but Success Depends on Exit Strategy

As the European economy suffers its worst post-war recession, the European Recovery Plan provides needed fiscal support to ailing economies. But rising public debts and the contingent liabilities incurred by governments to support the financial sector, together with the prospected increases in age-related expenditure and slowdown in potential growth raise concerns about public finance sustainability. An exit strategy strengthening fiscal policy frameworks, reforming age-related spending and spelling out the broad consolidation measures envisaged when the recovery has taken hold is required to address these concerns and underpin consumer, business and financial market confidence, the 2009 Report on public finances shows.

“Past experiences teach useful lessons of how fiscal costs of banking crises can be contained and which factors can facilitate bringing the fiscal houses back in order. The effectiveness of the fiscal policy stimulus in the short run crucially depends on a credible commitment to withdraw the stimulus when the recovery is well established. Strong fiscal governance frameworks, notably national fiscal rules, are a factor of success. For what concerns the resolution of the banking crisis, a transparent, resolute and swift strategy, without regress to regulatory forbearance, as well as a fair and uniform treatment of market participants is key to reduce their impact on public finances,” said Economic and Monetary Affairs Commissioner, Joaquín Almunia.

This year’s ‘Report on Public Finances’ reviews how Member States’ fiscal policies address the challenges from the financial and economic crisis. It assesses the prospects for public finances and policy needs ahead. Accounting for the effect of the automatic stabilisers, fiscal policy is providing support to the economy in the region of 5% of GDP over 2009-2010, equivalent to more than €600bn. This does not include the measures to support banks. In 2009, the largest fiscal stimulus as a percentage of GDP is being implemented in Spain, Austria, Finland, UK, Germany and Sweden.

The report shows that countries that experienced the strongest credit and property booms also had growing current account deficits and the most buoyant tax revenues and public expenditure growth. They are now experiencing the largest tax revenue shortfalls and deficit and debt increases. In a number of these countries with large macroeconomic imbalances, fiscal space available to run counter-cyclical fiscal policy without incurring sharp increases in sovereign and economy-wide risk premia was curtailed from the start of the crisis. Better-tailored fiscal policy should aim at building-up surpluses to tame down buoyant demand during booms and allowing running counter-cyclical fiscal policies during busts.


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