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Towards a Positive Euro Area Fiscal Stance. Supporting public investments that increase economic growth

by EPSC Strategic Notes*. Issue 20 23 November 2016

Monday 28 November 2016, by Carlos San Juan

Reducing unemployment, strengthening the euro area’s growth prospects and ensuring the future resilience of the European economy require better tailored fiscal tools at euro area level. Today, the limits of the EU’s fiscal framework mean that the euro area has had to rely excessively on the monetary policy of the European Central Bank (ECB) to ensure macroeconomic stability. As these monetary policy tools are increasingly stretched, calls for a more balanced policy mix that includes more supportive fiscal policies have been voiced by the EU – including by Commission President Jean-Claude Juncker in his 2016 State of the Union ‘Letter of Intent’1 and by ECB President Mario Draghi – as well as by a very broad set of stakeholders, from international organisations to academics. Against this backdrop, the Commission presented on 16 November a Communication ‘Towards a Positive Fiscal Stance for the Euro Area’, confirming its intention to promote a more supportive fiscal policy in the euro area. Given the challenges that lie ahead and the current economic juncture, there is a strong case for increasing public investments in areas that increase the resilience of the European economy. In short, there is both a need and a unique window of opportunity for the EU to take action on the fiscal front at this precise point in time. This increased fiscal responsibility must be implemented in combination with supportive structural reforms and investments, making sure the elements of the ‘virtuous triangle’ are mutually reinforcing

EPSC Strategic Notes*. Towards a Positive Euro Area Fiscal Stance. Supporting public investments that increase economic growth

Economic Context Calls for Fiscal Expansion

In certain circumstances, such as in prolonged periods of sub-par growth and monetary policy at the ‘zero lower bound’, there are good reasons to expand discretionary fiscal policy in order to support aggregate demand. The euro area currently meets these criteria, despite recent improvements in the economic outlook.

Low Interest Rates Favour Fiscal Expansion

Some Member States have the fiscal space to engage in an expansionary fiscal policy but they do not use it due to limitations in the Stability and Growth Pact. Yet, there is a strong case for taking advantage of today’s very low funding costs to invest in the economy. The largest beneficiary of any fiscal expansion will be the Member State that undertakes it.

Monetary Policy Needs Support

A positive fiscal stance is needed to support the accommodating monetary policy of the ECB, which currently bears the largest burden in terms of stabilising the euro area. The ECB has repeatedly warned of the increasing constraints it faces on the use of monetary tools, calling for a euro area fiscal counterpart to its monetary policy efforts. Positive Fiscal Stance Reinforces.

Virtous Triangle

In combination with reforms and public investments supported by EU-level financial instruments, a positive fiscal stance will support the modernisation of the economy, as additional investments are channelled into strategic areas, opening up new markets and further developing existing ones.

*EPSC Strategic Notes are analytical papers on topics chosen by the President of the European Commission. They are produced by the European Political Strategy Centre (EPSC), the European Commission’s in-house think tank.

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