Carsten Brzeski's blog

Eurozone: Trumped?

The European Commission yesterday officially executed a paradigm shift, calling upon several countries to move towards a positive fiscal stance.

While the world is still trying to find out what president-elect Donald Trump means for the economy and whether he will really deliver a huge fiscal stimulus programme, the Eurozone yesterday almost unnoticed followed in Trump’s footsteps – at least to a small extent.

To some, yesterday’s messages from the European Commission could sound almost as contradicting as some comments and ideas heard during the US presidential election campaign. While the European Commission reprimanded eight governments for being at risk of “non-compliance” with the fiscal rules, the Commission at the same time issued a 12-page communication on how to move towards more expansive fiscal policies in the Eurozone.

Both messages were sent in the context of the so-called European semester. One of the achievements of the crisis is to further streamline and harmonise fiscal policy coordination. In this exercise, the European Commission examines the fiscal plans of all Eurozone member states. In its assessment, the Commission concluded that Belgium, Italy, Cyprus, Lithuania, Slovenia, Finland, Spain and Portugal were at “risk of non-compliance” with the fiscal requirements for 2017, either in terms of the adjustment path towards the so-called medium-term objective or in terms of having a fiscal deficit higher than 3% of GDP.

The more interesting part was the official communication on a positive fiscal stance in the Eurozone. In short, the official communication formalizes and echoes earlier recommendations and comments from the ECB, the OECD or the IMF, ie, that countries with a budgetary margin should spend and invest. Countries that are not compliant with the Eurozone’s fiscal rules would not get additional room for manoeuvre.

According to Commission estimates, a fiscal expansion of up to 0.5% of GDP would be desirable for 2017. The actual budget plans for 2017 would imply “a moderately restrictive fiscal stance” for the Eurozone as a whole in both 2017 and 2018. In the official communication, the Commission does not really state how this fiscal stimulus should be achieved if at least eight countries are still recommended to continue with austerity measures. In the annex to the communication, however, it becomes clear that the Commission has six countries in mind: Estonia, Luxemburg, Latvia, Malta, the Netherlands and Germany. Needless to say that given the relative sizes of their economies, a fiscal stimulus for the entire Eurozone would have to come from the Netherlands and Germany. Given that the Netherlands and Germany together account for roughly 35% of total Eurozone GDP, both countries would have to implement a fiscal stimulus of more than 1% GDP each. A stimulus which – if sustained over 10 years – would according to the Commission increase domestic GDP by around 1% in both countries. Over the 10-year period, real GDP could increase by more than 2%.

All in all, even though the substance of the European Commission’s communication was not new, officially announcing the need for a positive fiscal stance could mark a paradigm shift. Whether this shift will actually be implemented, remains more than uncertain. The fact that the stimulus would have to come from the Eurozone’s two probably most convinced believers in fiscal austerity does not make the mission any easier. It does not look likely that the Eurozone will be fully trumped any time soon.