Author Archives: Pekka Vanhala

Firstrun seminar “Fiscal Rules, Stabilization and Risk-Sharing in the EMU”

Firstrun seminar “Fiscal Rules, Stabilization and Risk-Sharing in the EMU” was held on 3 October 2017 in Helsinki, Finland.

The EMU fiscal governance framework has recently undergone several reforms. However, the framework is still being criticized on several grounds. There are also continuing disagreements about further reforms proposed by the Commission. These disagreements turn, above all, on the introduction of new mechanisms for risk-sharing, such as a common deposit insurance or EU fiscal capacity. In this seminar, we present new research on the functioning of the current fiscal rules and cross-country risk-sharing and discuss the future of fiscal coordination in the EMU.


Tero Kuusi (ETLA): EU fiscal rules, real-time uncertainty, and stabilization

Cinzia Alcidi (CEPS): Cross-country risk-sharing in the EMU: Current mechanism and new proposals

Iain Begg: The EU budget after 2020

Iain Begg: The EU budget after 2020. European Policy Analysis 2017:9. Swedish Institute for European Policy Studies.

The EU will need to begin soon to negotiate a new Multi-annual Financial Framework (MFF), to run from 2021, for the EU budget. The backdrop to the forthcoming negotiations is, self-evidently, very different because of Brexit, but also the many other pressures for reform, both of the budget itself and the Union more generally. This briefing paper explores the direct consequences of Brexit for EU resources as well as the wider ramifications of the departure of an influential Member State. Drawing on various recent contributions to the debate on the future of Europe, such as the European Commission White Paper and Jean-Claude Juncker’s 2017 State of the Union address to the European Parliament, it reviews likely demands for reform of the budget and how they might be accommodated in the next MFF. Three scenarios for the development of the EU’s finances are then set out, covering the status quo, moderate reform and the (admittedly implausible) prospect of a radical reconfiguration of public finances in the EU. Conclusions and predictions about likely outcomes complete the paper.

Download the paper here.


Deliverable 5.2: Formulating and evaluating long-term fiscal rules based on the Medium-Term Budgetary Objective

FIRSTRUN deliverable 5.2: Formulating and evaluating long-term fiscal rules based on the Medium-Term Budgetary Objective has been published.

The paper considers fiscal rules for Finland that are explicitly based on the Medium-Term Budgetary Objective (MTO) and aim at keeping public finances sustainable in the long run. We use a general equilibrium overlapping-generations model to study fiscal rules where consumption taxes are conditioned on observed and forecasted variables related to the MTO. The uncertainties considered include future demographics, productivity, and asset yields. We find that a rule based directly on the ‘implicit liabilities and debt’ part of the MTO keeps public debt at roughly acceptable levels. The rule, however, would work better, especially in timing the measures, if structural deficits would exclude social security funds. We also find that the MTO contains forecast elements that could be left out without essentially weakening the rule. Finally, additional forecast-based information is likely to improve the rule.

Jukka Lassila, ETLA


Deliverable 5.3: Population aging, pensions and cross-country spillovers in currency unions

FIRSTRUN deliverable 5.3 published: Population aging, pensions and cross-country spillovers in currency unions

Population aging challenges the financing of social security systems in developed economies, as the fraction of the population in working age declines. The resulting pressure on capital-labor ratios translates into a pressure on factor prices and production. While European countries all face this challenge, the speed at which their population ages differs, and thus the pressure on capitallabor ratios. If capital markets are integrated, differences in population aging may lead to crosscountry spillovers, as investors freely seek the best returns on capital. Using a multi-country overlapping-generations model covering 14 European Union countries, I quantify spillovers and find that capital market integration leads to redistribution across countries over the long run. For instance, GDP per capita would on average be 2.9 %-points lower in Germany in each of the next 50 years if capital markets were perfectly integrated and increases in labor income taxes maintained public debt constant, compared to a closed economy case; by contrast, GDP per capita would on average be 2.1 %-points higher in France, whose population ages slower than in Germany. I also show that pension reforms can change the cross-country redistribution patterns, some countries losing from capital market integration without the reform but winning with it. The research has policy and methodological implications.

Thomas Davoine (IHS)


New working paper “Finding the Bottom Line: A Quantitative Model of the EU’s Fiscal Rules and their Compliance” published

A new FIRSTRUN working paper “Finding the Bottom Line: A Quantitative Model of the EU’s Fiscal Rules and their Compliance” has been published today.

The EU’s new fiscal framework is complex. It includes multiple rules and target measures that steer fiscal policy both in the short and long term. While the complexity may be necessary, it is not without problems, as ambiguous fiscal rules are hard to communicate, implement, and enforce. To provide more clarity, this paper uses a dynamic simulation model to quantify the constraint that the rules impose on fiscal policy during consolidations. In particular, the simulator quantifies multiyear adjustment programs that minimize the need of fiscal adjustments while being compliant with the key elements of the framework. By using the European Sovereign Debt Crisis data, the paper shows that the model is consistent with the actual consolidation programs. The paper also finds that revisions of the economic forecasts have a large effect on the simulated adjustments and may increase policy volatility. The positive early 2010 forecasts imply faster minimum adjustments than the weaker ex-post economic data. This feature corresponds well with the recent slowdown of the member states’ fiscal adjustments, and suggests that the policy change is in compliance with the rules.

Author: Tero Kuusi (ETLA)


Output gap uncertainty and the optimal fiscal policy in the EU

FIRSTRUN deliverable 2.7 published: Output gap uncertainty and the optimal fiscal policy in the EU

Using a novel dataset, I quantify the magnitude of the EU-27 countries’ output gap revisions in
2002-2014, and study the implications of this uncertainty for the optimal fiscal policy with a DSGE model. I find that taking into account the output gap uncertainty (i.e. the difficulty to distinguish between cyclical and trend shocks in real time) has large implications for both the net lending and fiscal policy. In the median EU country, the primary net lending turns mildly countercyclical; a feature that is consistent with the data, but contrasts with the procyclical net lending under the full output gap information. The optimal fiscal policy, as measured by the changes in the cyclically adjusted budget balance (CAB), is cautious and turns from strongly to weakly countercyclical because of the uncertainty. During fiscal crises, the CAB is allowed to deteriorate less and the adjustment of the CAB is gradual. The uncertainty generates a substantial amount of cross-country heterogeneity in the dynamics of the total net lending, but not so much in the CAB-based fiscal policy.

Tero Kuusi (ETLA)


Policy brief “Foreign fiscal policy spillovers on Austria”

A new policy brief by Thomas Davoine (IHS) has been published in the journal Wirtschaftspolitische Blätter.

The rationale for fiscal policy coordination within the European Union during normal times is weak because cross-country fiscal policy spillovers are found to be small. During crises, spillovers are larger, either because of constraints on monetary policy or because capital markets are well integrated. With a multi-country general equilibrium model assuming perfect capital market integration, I quantify the medium run impact of foreign fiscal actions on Austria. For instance, if Germany is hit by a negative shock and bails out its private sector, the predicted yearly average GDP loss in Austria is 15% of the yearly GDP loss in Germany. Bailouts in smaller European countries lead to weaker spillovers.

Read the full policy brief here



Iain Begg: Reflecting on the dosh

In its White Paper on the Future of Europe, published in March, the European Commission promised to bring out a series of ‘reflection papers’ on specific topics, the last of which, on the future of the EU’s finances, has now been released. While its main purpose is to inform public debate on how the EU budget should evolve during the next multi-annual financial framework (MFF), due to start in 2021, it also highlights a number of tricky issues deriving from the exit of the UK.

Read more


Iain Begg: Reflecting on how to run EMU more effectively

The European Commission published a reflection paper at the end of May on deepening economic and monetary union. Iain Begg assesses the strategy for reform put forward, writing that the paper is relatively guarded and does not convey an explicit trajectory for the next stages of development of EMU governance. He argues that unless and until there is a greater sense of urgency when it comes to pursuing reforms, the Eurozone will remain vulnerable and could easily drift into a fresh crisis which it is still ill-equipped to resolve.

Read more here