Fiscal Policy Challenges Facing the New EU Member States

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Fiscal Policy Challenges Facing the New EU Member States

  1. 1. Fiscal Policy Challenges Facing the New Member States in a Period of Large Capital Inflows & Substantial Investment Requirements Armin Riess European Investment Bank International Seminar for Experts “ Catching up after Enlargement” Cicero Foundation October 14-15, 2004
  2. 2. Main questions <ul><li>Public debt & fiscal deficits that countries can “afford”? </li></ul><ul><li>Role of public investment and other expenditure? </li></ul><ul><li>Role of balance of payments position (notably capital inflows)? </li></ul>
  3. 3. What do we need to examine? <ul><li>Key features of CEE economies </li></ul><ul><li>Public debt sustainability </li></ul><ul><li>Mixed blessing of capital inflows </li></ul>
  4. 4. Real GDP growth projection (in %), 2004 Source: European Commission, Economic Forecast, Spring 2004 EU-15 potential Long-run CEE growth potential 4-5%
  5. 5. Consumer price inflation (in %), 2004 Source: European Commission, Economic Forecast, Spring 2004 2004 CEE average EU-15/eurozone target
  6. 6. Public debt in CEE & EU-15 (% of GDP), 2004 Source: European Commission, Economic Forecast, Spring 2004 Maastricht 60% criterion
  7. 7. Key features of CEE economies - Summary - <ul><li>Real economic growth: CEE > EU 15 </li></ul><ul><li>Inflation: CEE > EU 15 </li></ul><ul><li> Nominal economic growth: CEE > EU 15 </li></ul><ul><li>Public debt: CEE < EU 15 </li></ul>
  8. 8. Public debt sustainability ( ad hoc criteria ) <ul><li>Keep public debt/GDP-ratio constant ! </li></ul><ul><li>D ebt/GDP should converge to 60% (Maastricht) ! </li></ul><ul><li>D ebt/GDP should fall to zero </li></ul><ul><li>(Stability & Growth Pact) ! </li></ul>
  9. 9. Debt dynamics Change in debt/GDP ratio = fiscal deficit/GDP ratio – nominal GDP growth • debt/GDP ratio
  10. 10. Fiscal deficit that leaves debt/GDP unchanged 4.2% 3.0% 2.4% 60% 2.8% 2.0% 1.6% 40% 1.4% 1.0% 0.8% 20% Debt in % of GDP Fiscal deficit (in % of GDP) 7% 5% 4% Nominal GDP growth
  11. 11. Where does public investment fit into this picture ? <ul><li>Fiscal deficit can be higher if … </li></ul><ul><li>… public investment is large today, but expected to fall in the future . </li></ul><ul><li>Is public investment high in CEE? </li></ul>
  12. 12. Public investment in CEE & EU-15 (% of GDP, 1999-2003 average) Source: European Commission (2003 Spring Forecast) and IMF (Staff Appraisal Reports) EU15 average 2.3% CEE average 3.9%
  13. 13. What about other public expenditure ? <ul><li>High investment today can justify higher fiscal deficit, but … </li></ul><ul><li>… other government expenditure may be low today relative to their future level. </li></ul><ul><li>Example: public pension expenditure </li></ul>
  14. 14. Public pension expenditure in selected CEE countries (in % of GDP) Source: European Commission; Occasional Paper 4, July 2003
  15. 15. Public debt sustainability - Summary - <ul><li>Debt sustainability does not imply the same fiscal deficit for all countries </li></ul><ul><li>Some government expenditure (investment) may justify higher fiscal deficits, others (pensions) call for fiscal restraint </li></ul><ul><li>Public debt sustainability is one thing, macroeconomic stability is another </li></ul>
  16. 16. Capital inflows (in % of GDP) (2001-2003 average for CEE, peak inflow periods otherwise ) Source: IMF (Staff Appraisal Reports); Begg et al. (2002) 1987-91 1996-9 1998-9
  17. 17. Capital inflows & current account deficits (in % of GDP, 2001-2003 average) Source: IMF (Staff Appraisal Reports) Capital inflows Current account deficit
  18. 18. Why do large capital inflows occur? <ul><li>Higher returns on physical investment </li></ul><ul><li>Expected trend appreciation of currency (Balassa-Samuelson effect) </li></ul>
  19. 19. Why are capital inflows a mixed blessing ? <ul><li>What’s good: </li></ul><ul><li>Investment finance  higher growth </li></ul><ul><li>Too much of a good thing: </li></ul><ul><li>Overheating of economy (inflation) </li></ul><ul><li>Credit boom & banking sector stability </li></ul><ul><li>Excessive currency appreciation & competitiveness </li></ul>
  20. 20. How to cope with large capital inflows? <ul><li>Banking sector stability </li></ul><ul><ul><li>Effective prudential regulation & supervision </li></ul></ul><ul><li>Overheating of economy </li></ul><ul><ul><li>Revaluation of exchange rate/exchange rate flexibility </li></ul></ul><ul><ul><li>Fiscal austerity </li></ul></ul>
  21. 21. Fiscal deficit & exchange rate regime (% of GDP, 2001-2003 average) Source: IMF (Staff Appraisal Reports) Hard currency pegs “ Flexible” exchange rates
  22. 22. Conclusion <ul><li>Fiscal policy assessment requires a country-by-country approach </li></ul><ul><li>Coping with ‘dark side’ of capital flows is key (fiscal) policy challenge </li></ul><ul><li>Fiscal policy challenges other than those concerning the ‘bottom line’ </li></ul>

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