It is easier to call for euro area fiscal easing than it is to credibly deliver it.Absent an economic shock or an acceleration of integration, we are notexpecting much easing of fiscal policy in 2017.
In this note we ask: What if Europe comes to the conclusion that monetarypolicy is insufficient to normalize economic conditions and a fiscal easingoutside the current rules is required With this in mind, we do two things
First, we quantify the fiscal easing required to close the unemploymentgap country by country over the next three years. The objective is to raisegrowth, absorb spare capacity and boost political support for the euroarea. This should help to reduce the local hurdles to structural reforms.
The additional easing of the structural budget deficit required is only 0.4%of GDP on average per year for the euro area in aggregate. For threeyears this is equivalent to about EUR130bn in total. There needs to bestrong commitment from all member states and no free-riding to ensurethe spillover effects between countries are maximized
The strategy should be self financing. The positive impact on GDP growthpushes the nominal fiscal deficit and public debt-to-GDP ratios belowwhat they would have been without this stimulus. It should also benefitthe ECB by pushing HICP inflation to target by 2019. That should reducepressure to ease monetary policy further and facilitate an earlier exit fromthe accommodative monetary policy stance.
However, there is a wide divergence in stimulus requirements acrosscountries - from no stimulus to at least 3% of GDP in some peripheraleconomies. This hints at the political challenge of such a fiscal strategy.
Second, we describe the necessary conditions for this euro area fiscaleasing to materialise. Some are coming in any case, if very slowly, forexample, fiscal coordination and policies to boost systemic resiliencelike the banking union. Others are more difficult, such as re-writing thefiscal rules. Some are extremely difficult to imagine, like an inversion ofGermany’s historic political belief in rules-based stability.
The bottom line is, we do not expect a large fiscal easing, particularly withthe very busy European political events calendar in 2017. Just like in 2016,some modest slippage relative to the fiscal rules might be as good as itgets in 2017.