The wake-up call from the European Commission in relation to the situation of the public accounts of the member countries takes us back to the period before the pandemic. But that impression of deja vu it is partly misleading, due to the disruptions that have occurred in recent times in the economic and financial environment in which fiscal policy is framed. A change that Brussels should incorporate.
The need to balance income with current expenses —at least throughout the cycle, that is, discounting the fluctuations of the situation— continues to be valid. Together with France, we are the only EU country that has failed to eliminate the primary deficit (excluding interest) in any year since the start of the recovery phase following the financial crisis. In addition, Brussels proposes making the objectives more flexible, so that each country defines its own adjustment path. So when the fiscal rules are reactivated, in principle starting next year, the mix of measures —tax reform, ineffective spending cuts— would be entirely in our hands.
The expansionary impulse will come from European funds, which may be deployed until 2026, without computing in spending for the purposes of fiscal rules. The Next Generation program addendum, while these are loans, should be accounted for similarly. Therefore, it is feasible to embark on a path to correct deviations without traumatic effects on the economy or on society, that is, without austerity. The Commission estimates that a reduction in the primary deficit by one percentage point, to around -0.5% of GDP, half that before the pandemic, would facilitate a smooth de-escalation of public debt.
But this scenario does not include the radical change that has occurred in the monetary and macroeconomic context. Before the inflationary outbreak, interest rates were in net negative territory. As a result of this accommodative monetary policy, it was enough for the economy to expand, even modestly, for the efforts to contain the fiscal hole to result in less public debt. In effect, the key variable for the dynamics of the debt is the differential between the interest rate (determinant of financial costs) and the growth rate of the economy (on which the evolution of public revenue and spending depends). Before the pandemic, this differential was negative, that is, the interest rate was much lower than growth, facilitating de-escalation.
However, forecasts point to higher rates for a long time, until prices are back on track. On the other hand, economic growth may be constrained by the disruptions that have occurred in recent times, such as geopolitical tensions, the weakening of the multilateral system, or the increasingly perceptible costs of climate change and population ageing.
In short, it cannot be ruled out that an unfavorable differential appears between the interest rate and economic growth. This circumstance would drastically change the fiscal scenario. Under the relatively prudent assumption of a zero spread (interest rates that match growth), the benefits associated with containing the deficit would be lost, so that the debt burden would remain high. And if these containment measures were not put in place, the indebtedness would start an inexorable escalation. Brussels recognizes the high risk for sustainability derived from an unfavorable differential of interest rates in relation to the growth of the economy.
However, each country has to do its homework. But it is not a mere accounting exercise. Efforts to correct imbalances will only be successful if they are framed within a European strategy for investment, reforms and incentives, capable of facilitating the different transitions and thus strengthening the sustainable growth of the economy.
After the abrupt rise registered in 2022, the yield of the Spanish bond with a maturity of 10 years has stabilized at around 3.5% since the beginning of this year, evidencing the anticipation by the markets of a pause in rate rises of interest to the ECB. Similarly, the risk premium remains immune to the tightening of monetary policy: the yield spread over the German bond hovers around 100 basis points (a relatively low level), with no clear trend detected.
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