Effects of a decline in structural unemployment with a more active fiscal policy
52. Our final set of simulations is designed to examine the role of upfront cost, and more generally to
look at the possibility that countries use a more activist fiscal policy to accompany their structural reform
programme. A rise in potential output due to a decline in structural unemployment improves the structural
budget balance. In the absence of monetary policy, euro area member countries may be tempted to use the
room for fiscal manoeuvre to accompany reforms to speed up the adjustment of demand to the improved
supply conditions. Moreover, the reforms could have a budgetary cost, for instance, making a cut in social
security contributions necessary.
53. To illustrate the joint effect of a decline in structural unemployment and of a more active fiscal
policy to scenarios were run for France. The first assumes that the structural budget balance is kept at the
baseline level. The second assumes that the decline in unemployment is accompanied by a permanent
reduction in employers’ social security contributions by ½ per cent of GDP. The results are presented in
Figure 10. They clearly show the limits of an expansionary fiscal policy accompanying structural reforms.
The macroeconomic gains are very limited, while the budget deteriorates significantly.
Some policy implications
54. The recent reform of the Stability and Growth Pact provides more leeway for EU governments to
temporarily breach the 3% and close to balance or surplus rule if this can be shown to facilitate the
implementation of effective, but initially expensive, structural reform. While this principle is underpinned
by a clear economic rationale, its implementation is less obvious. Indeed, for it to be properly implemented
a number of conditions will need to be met:
• Budgets would need to clearly identify the structural policy measures that are being
taken and specify their immediate and multi-annual budgetary cost and benefit profile.
So far, there is very little evidence of this happening, with probably the
United Kingdom being at the frontier (and even there the picture is not always clear).
Indeed, given the absence of an explicit structural reform programme and its costing,
the SGP revision seems rather premature.
• Budgets would also need to be explicit about the fiscal cost of inaction, i.e., report the
budgetary developments in the absence of structural reform. This is a form
transparency that is necessary for the European authorities to call a balanced judgment
on countries’ trade-offs between the various options available, like reform health care
but not pensions, or any other combination of reform programmes. However, it is very
rare to find such costing in budgets.
• Budgets would, finally, need to give some indication of the broader economic effects
of action or inaction, in order to be able to call a judgment on the ex ante effectiveness
and efficiency of the proposed measures. However ex ante cost-benefit analysis is rare
- not to mention ex post cost-benefit analysis. The experience in countries like
New Zealand and Australia has shown that the longer-term benefits both in terms of
the budget and overall economic performance may be significant. Even so, it is not
easy to disentangle the various forces at play. Fundamentally, structural reform and the
implementation of smart fiscal frameworks tend to go hand in hand - indeed may be
two sides of the same coin.
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