Research Dept. News
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Monthly Report, num 328 - October 2009
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European Union - Fiscal stimulus plans and their impact on the economy
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These were needed to halt recession but now make containment of government deficit difficult
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The reaction of the economic authorities when faced with the biggest recession since World War II was to launch major fiscal stimulus packages in order to halt the drop in economic activity. The recession now seems to have abated and it is even possible to see the end of the tunnel. The fiscal accounts, however, are showing up with a menacing colour of red. Should the fiscal stimuli now be withdrawn with the subsequent risk of setting back the incipient recovery? Or should they be maintained in spite of the danger of a spiralling worse situation in fiscal balances?
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Until quite recently there was something of a consensus that the use of discretionary measures did not contribute to economic stability and could even have prejudicial effects. Nevertheless, the alarm caused by the world recession and the depletion of monetary policies seemed to justify a change in focus. At the end of 2008, the International Monetary Fund (IMF) launched a strong recommendation for all countries to adopt fiscal stimulus plans timely large, diversified and coordinated internationally. They should also be sustainable, that is, they should not involve a huge boost in government debt.
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The response was not long in coming. Most of the developed and emerging economies launched major fiscal stimulus packages. Outstanding because of their size were those adopted by the United States and China but in relative terms the measures taken by Russia, South Korea and Saudi Arabia were remarkable. The European Union (EU) took on this idea and at the end of 2008 the European Council also recommended that each member state put into effect discretionary fiscal stimulus packages of at least 1.5% of GDP. Within the EU, Spain is the country to adopt the biggest package of discretionary measures. In July, the IMF estimated that the discretionary measures for the G-20 as a whole would amount to 2% of GDP in 2009 while in 2010 they would come to 1.6% of GDP.
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The measures launched and their aims have been quite varied and included helping the spending capacity of consumers, the reduction of taxes, government investment and other measures aimed at improving the state of the labour market and business activity. The biggest volume of funds, especially in the emerging economies, is going into spending on infrastructures while also having significant weight in the developed economies are aids to sectors of the population most affected by the recession and cuts on personal and corporate income taxes.
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What have been the effects of these discretional fiscal moves? To begin with, it is clear that they have contributed to increase public deficits that were already in poor shape because of the effect of the automatic stabilizers and measures aimed at stabilizing the financial system. But have they helped ease the recession? What has been their effect in terms of growth of the various economies? Unfortunately, it is not possible to answer these questions because of the short time since they were implemented and the subsequent lack of empirical data. As an analysis, we may cite the simulation of the impact carried out by the European Commission using an econometric model the result of which, in the case of the EU, shows a total effect on GDP of 0.75 percentage points in 2009 and 0.33 points in 2010. Theoretical estimates for the G-20 made by the IMF run within the range of 1.2-4.7 percentage points for 2009 and 0.1-1.0 points in 2010. In any case, these are results that must be taken with care seeing that is not the same to simulate an ex ante impact than measuring it ex post. The hypotheses used for models greatly affect the result of an ex ante analysis.
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The debate also involves the actual nature of stimulus measures. The logic of these measures is that government spending (or lower revenues) provides a multiplier effect in private spending. For example, a reduction in taxes raises household incomes and turns into consumer spending which, in turn, generates an increase in economic activity, new incomes, and so on. The final result is that a fiscal impulse of 1 brings about an increase of more than 1 in GDP. This view, however, is not shared by all economists by any means. In the matter before us, a cut in taxes in a situation of severe recession will more likely be converted into savings, or the reduction of debt, and even more so at the tail-end of a real estate recession and a drop in financial markets. This could be so in the case of measures such as the «household cheque» provided by the US government in 2008 or the tax deduction of 400 euros on personal incomes in Spain. In these cases, the multiplier may be lower than one or even zero, although the improvement in household balance sheets would show a positive result. In the case of an increase in government spending, in consumption or investment, the multiplier effects may be clearer given that they mean an increase in aggregate demand. However, they are still open to discussion. For example, one of the measures most applied, aids for buying new cars, present uncertainty about whether their effects are those of substitution (the purchase of a car instead of other consumer goods), a change in season (taking advantage of the subsidy to bring forward an outlay that would be made in any case), or benefiting foreign producers, given that they bring about an increase in imports. With regard to government investment, discussion is centred on the difficulty of implementing this quickly enough and on the economic and social returns that come from chosen projects.
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In view of the worsening of government deficits, the question arises whether to remove fiscal stimuli in order to contain the negative figures in public finances. The message put out by the G-20 is to maintain these stimuli until recovery is strong, which would mean to continue them in 2010. Certainly, a rash withdrawal of these stimuli could put the incipient international recovery in jeopardy. Nevertheless, in a situation such as the present, which is much less dramatic than that in the Autumn of 2008, it is worth calmly looking at the measures adopted or planned in the light of current experience. This means discriminating according to their contribution in cost-benefit terms both over the short and long term and, at the same time, thinking about the possibility, in those cases where it may be opportune, to replace them with measures that may be better suited to a scenario following the economic crisis, such as incentives to private investment, for the creation of businesses, innovation and the adaptation and flexibility of companies and markets. And, naturally, taking into account that there are no universal answers and that measures in each country must meet their own particular conditions.
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This box was prepared by Joan Elias
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European Unit, ”la Caixa” Research Department
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