Category Archives: Deliverables

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.

Abstract
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.

Author
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

Abstract:
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.

Author:
Thomas Davoine (IHS)

 

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

Abstract:
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.

Author:
Tero Kuusi (ETLA)

 

New deliverable on international financial markets and shock absorption in the euro area published

FIRSTRUN deliverable 1.5 published: International financial markets and shock absorption in the euro area

Abstract:
This deliverable investigates the role of financial markets in smoothing the impact of asymmetric shocks in the euro area. The first part offers an assessment of international risk-sharing through international capital markets relative to other mechanisms and compares the euro area to the United States. The second part focuses on the role of international credit markets in providing consumption smoothing, as opposed to inter-state risk-sharing. In doing this, it distinguishes the part driven by policies of the governments from that associated with private sector’s behaviour, and emphasizes the difference between domestic absorption and borrowing in international markets.

Authors:
Cinzia Alcidi (CEPS)
Paolo D’Imperio (CEPS)
Gilles Thirion (CEPS)

 

A description of the macroprudential policy block of the NiGEM model published

FIRSTRUN Deliverable 4.6 published: A description of the macroprudential policy block of the NiGEM model

Abstract: In this paper we incorporate a macroprudential policy model within a semi-structural global macroeconomic model, NiGEM. The existing NiGEM model is expanded to include two macroprudential tools: loan-to-value ratios on mortgage lending and variable bank capital adequacy targets. The former has an effect on the economy via its impact on the housing market while the latter acts on the lending spreads of corporate and households. A systemic risk index that tracks the likelihood of the occurrence of a banking crisis is modelled to establish thresholds at which macroprudential policies should be activated by the authorities. Explicit modelling of a systemic risk index also allows for a cost-benefit analysis of macroprudential policy.

Authors:
Oriol Carreras, NIESR
Philip Davis, NIESR and Brunel University
Iana Liadze, NIESR
Rebecca Piggott, NIESR
James Warren, NIESR

 

Fiscal rules and other rule-based mechanisms in practice: introduction to case studies of four Member States

One of the most striking economic governance trends of recent years has been the increased resort to fiscal rules. In the EU as a whole, the number of fiscal rules recorded by the European Commission in its fiscal rules database has risen nearly tenfold since the early 1990s. Such rules have varied considerably across countries. Nearly all EU Member States have also now established Fiscal Councils as independent agencies to monitor the conduct of fiscal policy.

Starting with the Stability and Growth Pact, the EU has been a prime mover in stimulating rule-based governance. Many of the reforms enacted in response to the years of crisis since 2008 were intended to tie the hands of governments even more by establishing norms not only for fiscal discipline, but also for curbing other macroeconomic imbalances. The changes also provide for more intensive monitoring of national policy-making by the EU level and undeniably constitute a far-reaching package.

The national case studies provide a detailed examination of fiscal and other rules in four EU Member States: Italy, Poland, Slovakia and the UK. Two of these are members of the Euro Area, Poland is a non-Euro signatory of the Fiscal Compact, but the UK, even before the Brexit referendum result, was bound much more loosely by EU rules.

The case studies have examined the application of the rules, drawing on a range of documents and on interviews with public officials responsible for the implementation of the rules and with experts knowledgeable about the respective countries. They sought to explore how the processes and mechanisms of fiscal governance function, the interplay between national and EU rules and what they imply for the coherence of the policy system and, more generally, to investigate the political economy of rules.

Deliverable 6.5: Fiscal rules and other rule-based mechanisms in practice: introduction to case studies of four Member States (LSE, LUISS, CASE, IER SAS)

New deliverables published

New deliverables published:

D1.4: Endogenous Asymmetric Shocks in the Eurozone: the Role of Animal Spirits (CEPS)

Abstract: Business cycles among Eurozone countries are highly correlated. We develop a two-country behavioral macroeconomic model in a monetary union setting where the two countries are linked with each other by international trade. The net export of country 1 depends on the output gap of country 2 and on real exchange rate movements. The synchronization of the business cycle is produced endogenously. The main channel of synchronization occurs through a propagation of “animal spirits”, i.e. waves of optimism and pessimism that become correlated internationally. We find that this propagation occurs with relatively low levels of trade integration. We analyze the role of the common central bank in this propagation mechanism. We explore the transmission of demand and supply shocks and we study how the central bank affects this transmission. We verify the main predictions of the model empirically.

D2.5: Analysing the Relevance and Predictive Power of the MIP Scoreboard’s Indicators (IERSAS)

Abstract: This research aims to evaluate crisis prediction ability of the Macroeconomic Imbalance Procedure Scoreboard’s headline and auxiliary indicators. We test the indicators separately by employing signals approach and loss and usefulness function of the policymaker and then as one system by estimating limited dependent variable models. We also evaluate the thresholds and estimate their optimal value subject to a policymaker with preferences assigning equal importance to both missed crisis and false crisis prediction errors. Moreover, impact of statistical data revisions on crisis predictions is examined. The results show, that the tested indicators perform better for the euro area in comparison to the non-euro area. The external sector indicators along with the new labour market indicators seem to have the best prediction abilities. Our outcomes also suggest that if the Macroeconomic Imbalance Procedure had been employed as an early warning system before the recession in 2009, it would have provided moderately useful alerts in terms of crisis prediction. However, this would mostly have applied to the EA countries and for only few indicators.

D3.3: Fiscal risk-sharing in response to shocks: New lessons for the euro area from the US (CEPS)

Abstract: Discussions on European integration have been influenced for a long time by the experience of the US, whose unemployment insurance (UI) system is often portrayed as an effective tool to respond to idiosyncratic shocks and one that missing in the euro area (EA). This paper investigates the extent to which this is the case in reality. It first offers empirical evidence that EA member states manage to provide a higher degree of insurance against asymmetric shocks (about 20%) than that provided by the US federal budget, which insures through inter-state fiscal risk-sharing (11%). It also shows that the larger budgets of EA member states do not explain this trend alone. Second, the paper finds that the US UI system is mostly relevant a as stabilisation mechanism in the face of US-wide shocks, rather than idiosyncratic shocks. We explain this by highlighting the institutional features of the US UI system as well as the existence of market mechanisms for inter-state risk-sharing. We draw two main lessons for the EA. First, the same system is unlikely to produce the same effects, given the structural features of the EA economies and the lack of effective market mechanisms. Second, a key role of the US federal UI system is to extend the duration and generosity of unemployment benefits in order support states, this tends to be associated with nation-wide recessions and it is the result of a discretionary Congress decisions rather than automatic mechanisms.

D3.4: Towards an EU budget with an effective stabilisation function (CEPS)

Abstract: This policy paper reviews to what extent EU budgetary tools provide a shock mitigation function and aims at exploring potential avenues to reform them to strengthen their stabilisation role. The EU budget is based on principles of medium-term budgeting, co-financing rules with fixed areas of intervention and a very limited possibility for budgetary reallocations. This rigid system makes EU financial support rather ill-suited to address a situation of fiscal emergency when a member state has to react to shocks. Nevertheless, there is evidence of a growing mandate for a stabilisation function within the EU budget, developed particularly in response to labour market shocks. The Youth Employment Initiative and the European Globalisation Adjustment Fund, despite their modest results, represent a concrete step toward introducing shock mitigation among the objectives of EU expenditure. Flexibility arrangements introduced over recent years within the EU budget also move in the direction of adapting the EU budgetary architecture to make it better suited to medium-term ex post shock mitigation. The revenue side of the EU budget is also found to contribute to stabilisation. We argue that the EU policy design to address stabilisation, as developed so far, is not performing and is not apt to the task. As resistances to enhancing the stabilisation capacity are lower at EU than EMU level, we explore room for reform for the post-2020 budget and propose and integrated approach to boost the responsiveness of the EU budget to unforeseen event throw the establishment of an EU fund for Employment and an extended mandate for the European Union Solidarity Fund.

New deliverable on government debt deleveraging published

A new deliverable on government debt deleveraging by Alexandre Lucas Cole (LUISS Guido Carli), Chiara Guerello (LUISS Guido Carli), and Guido Traficante (European University of Rome) has been published today:

D4.4: Government Debt Deleveraging in the EMU

Abstract: We evaluate the stabilization properties and welfare implications of different government debt deleveraging schemes and instruments for deleveraging in a currency union. In a two-country new-Keynesian DSGE model, with a debt-elastic government bond spread and incomplete international financial markets, we study the effects of government debt deleveraging, under a range of alternative shocks and under alternative scenarios for fiscal policy coordination. We find that greater stabilization is achieved by backloading the deleveraging process and when the two countries reduce the net exports gap. Moreover, taxes are a better instrument for deleveraging compared to government consumption or transfers. Our policy prescriptions for the Eurozone are to reduce government debt more gradually over time and less during recessions and to do so using distortionary taxes, while concentrating on reducing international demand imbalances.

 

New deliverable on EU fiscal rules published

Deliverable 6.4 by Iain Begg (LSE) has been published today:

Fiscal and other rules in EU economic governance: helpful, largely irrelevant or unenforceable?

Abstract: EU Member States have been pushed to adopt more extensive and intrusive fiscal rules, particularly in the euro area, but also in other EU Member States, yet evidence that they are succeeding is, at best, tentative. The EU level Stability and Growth Pact (SGP) has been – and remains – the most visible such rule, but has been complemented by a profusion of national rules and by new provisions on other sources of macroeconomic imbalance. Much of the analysis of rules has concentrated on their technical merits, but tends to neglect the political economy of compliance. This paper examines the latter looking at compliance with fiscal rules at EU and Member State levels, and at the rule-based mechanisms for curbing other macroeconomic imbalances. It concludes that politically-driven implementation and enforcement shortcomings are given too little attention, putting at risk the integrity and effectiveness of rules.

 

New deliverable on revisions of the cyclically adjusted balances published

A new deliverable on Revisions of the cyclically adjusted budget balance published (D2.4, CEPS).

Abstract: The aim of this study is to analyse the revisions of the cyclically adjusted balances of the EU15 countries in order to learn whether the turn of the cycle is particularly prone to error and to evaluate whether the EU’s fiscal framework is well equipped for dealing with potential revisions. The analysis is conducted with real-time fiscal data published by the European Commission for the years 2003-2016. Our study finds that the cyclically adjusted balance forecasts as well as in-year estimates are heavily revised in the following years. Moreover first ex-post data are still significantly revised in the following years. We find no strong evidence to support the notion that these revisions are larger at the turn of the cycle and thus conclude that revisions are of a systematic nature. The revisions are large enough to cause significant differences in the ex-ante and ex-post assessments by the European Commission on whether member states achieved their structural targets. This study elaborates on the built-in flexibility in the Stability and Growth Pact (SGP), on which the Commission can capitalise to avoid unwarranted ex-post sanctioning. Moreover, the SGP entails several safeguards against revisions negatively affecting the policy advice given to member states, particularly with regard to sanctioning.