The ECB wants fiscal stimulus to take more of the burden for solidifying growth, yet governments’ draft budgetary plans remain modest.
Nadia Gharbi, Europe Economist
At a time when monetary policy is looking tired and less effective than before, eyes are increasingly turning towards fiscal policy as the main vehicle to support growth and help the European Central Bank (ECB) to lift inflation back towards its target of below, but close to, 2%.
Yet the amount of fiscal easing planned by euro area governments remains modest, implying a limited boost to GDP growth next year. According to our calculations, based on the 2020 draft budget plans that governments have submitted to the European Commission, aggregate fiscal easing will be equivalent of 0.3 percentage point (pp) of euro area GDP in 2020.
A majority of euro area countries is planning fiscal easing in 2020, with Germany and the Netherlands aiming to ease the most as a percentage of GDP. But France and Spain have planned virtually no easing in 2020, while Ireland will tighten fiscal policy.
How much growth this fiscal easing will generate depends on the fiscal multipliers and on the type of easing (i.e. the split between tax cuts and investment spending, etc.). Our analysis suggests most of the planned fiscal expansion is aimed at boosting the purchasing power of households rather than increasing investment spending. The fiscal multiplier is likely to be less than 1, implying a GDP boost of around 0.1-0.2pp in 2020.
Budgets will be subject to parliamentary debate but must be approved by 31 December at the latest. Thus, there could still be some changes along the way. The European Commission has already asked for clarification on their budget plans from six countries (France, Italy, Spain, Portugal, Belgium and Finland). Given the current environment of persistent downside risks, low growth and subdued inflation pressure, the European Commission is likely to show some flexibility, as it has in the past.
The extent to which fiscal stimulus could alleviate pressure on the ECB is now a major issue—yet the fiscal plans announced so far remain modest. Pressure for governments to become more active is unlikely to lessen anytime soon. Persuading countries with fiscal space to use it in an effective and timely manner will probably be incoming ECB president Christine Lagarde’s most important mission. To paraphrase Lagarde’s predecessor, Mario Draghi, “with fiscal policy, the monetary policy objective will be reached sooner with less side-effects”. But even a best-case scenario will take time to materialise.