Euro Macro: Eurozone has ‘fiscal space’ of up to 1.7% GDP – With eurozone economic growth having slowed to below trend rates, risks to the outlook to the downside and limitations on monetary policy, the potential need for fiscal stimulus has caught the imagination. France’s Finance Minister Bruno Le Maire has called for eurozone member states such as Germany to be prepared to use their ‘fiscal space’ in case the eurozone downturn worsens. Meanwhile, according the account of the ECB’s March meeting, officials called for ‘jurisdictions that had fiscal space (to) stand ready to use it, given the downside risks to growth’, apparently recognising the constraints on monetary policy. So how much fiscal space does the eurozone have in case the eurozone slowdown intensifies?
One way to approach this question is to assess how much room countries have to ease fiscal policy, while allowing their debt ratios to stabilise. A simple rule of thumb is that the debt ratio stabilises when the primary budget balance is equal to difference between nominal GDP growth and the interest payment ratio. The eurozone as a whole is running a primary budget surplus of 1% GDP, its nominal GDP growth is estimated to be around 2% this year (on the basis of our below consensus forecasts) and the interest payment ratio is 1.8% GDP. On this basis, the rule of thumb suggests that an additional 1.2% GDP stimulus would be possible (we estimate that a 0.4% GDP stimulus is already in place), while still leaving the debt ratio steady.
However, it is important to note that changes in fiscal policy according to this rule of thumb implies large differences in changes in the fiscal stance between countries. For instance, Italy and France would need to tighten policy to stabilise their debt ratios, while Germany, the Netherlands, Austria and Ireland would be putting in place an enormous fiscal stimulus. The weighted average of these moves then leads to a eurozone aggregate of 1.2% GDP. If we assume that the countries that have fiscal space go ahead with fiscal stimulus in line with the rule of thumb above, while France and Italy keep policy unchanged, then the weighted aggregate stimulus for the eurozone would then cumulate to around 1.7% GDP. Of course this is on paper. In reality, given that this stimulus relies heavily on aggressive fiscal easing by Germany and the Netherlands – two countries that might be politically reluctant to take such action – the real fiscal stimulus would probably be much less. (Nick Kounis)