Abstract
The chapter presents a discussion on the indicators used by the European Commission to assess fiscal sustainability in EU Member States. In the context of the European Commission’s multi-dimensional approach to fiscal sustainability analysis, the fiscal sustainability indicators S0, S1 and S2 are designed to allow for the early identification of sustainability challenges over the short, medium and long term, so as to support the devise of appropriate policy responses. The chapter provides an analysis of the genesis of the indicators, detailing the reasons for their introduction and modification towards their current definition. A concrete example of their use in policy analysis is provided, together with a broader explanation of how these tools provide input to the EU’s integrated cycle of economic policy coordination.
Figures in this chapter have been originally published in the European Commission, 2015, Fiscal Sustainability Report 2015, http://dx.doi.org/10.2765/412671.
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Notes
- 1.
The European Semester is the EU’s integrated annual cycle of economic and budgetary policy coordination, as will be explained better in what follows.
- 2.
In more technical terms, the value of the S2 indicator is derived from the solution of the government inter-temporal budget constraint over the infinite horizon, including its implicit liabilities from ageing, under the assumption that the no-Ponzi game condition is satisfied (i.e. debt and interests on debt are not systematically paid by issuing new debt). The ageing cost projections incorporated in the indicator are the result of joint work between the European Commission and the Member States. The projection results are published every 3 years (see European Commission 2015d, for the latest public release) and are regularly updated with peer-reviewed pension reforms that take place in the meantime.
- 3.
In fact, the initial budgetary position is not defined in exactly the same way for the S1 indicator as for S2, in that S1 includes both a first element that relates to the gap to the debt-stabilising primary balance and a second element that relates to the cost of delaying the fiscal adjustment (the indicator assumes a gradual linear fiscal adjustment taking place over 5 years from the year after the forecast). See European Commission (2015a) for further details.
- 4.
The definition of fiscal stress refers to instances of: (a) very high inflation (above 35%), (b) significant sovereign bond yield spreads (two standard deviations above the mean), (c) public debt default/restructuring/rescheduling and/or (d) a large-scale IMF-supported programme in place.
- 5.
The logic behind the methodology for calculating the thresholds (i.e. the “signals approach”) rests on the observation that economies behave in a systematically different way in periods preceding fiscal stress. According to this, time series of the variables used in the analysis (the 28 fiscal and financial competitiveness variables) and the series of fiscal stress episodes recorded in the past are used together to determine an optimal fiscal risk threshold for each of the variables in question, based on its past behaviour ahead of fiscal stress episodes. These optimal thresholds are determined by maximising the “signalling power” of the model, that is, its ability to correctly predict past fiscal stress. By first distinguishing between the two types of errors that can be made in such a prediction (predicting fiscal stress for a variable value beyond the threshold ahead of no fiscal stress episode, type I error, and predicting no fiscal stress for a variable value on the safe side of the threshold ahead of a fiscal stress episode, type II error), the optimal threshold is then determined in a way to minimise the share of missed (in the sense of not signalled) stress episodes plus the share of non-fiscal stress episodes wrongly signalled as upcoming fiscal stress. The thresholds for the S0 indicator and the two fiscal and financial competitiveness sub-indexes are calculated following exactly the same procedure. The thresholds, signalling power and type I and type II errors are reported in Table 10.1 for the S0 indicator, the two sub-indexes and each individual variable.
- 6.
Values of the sustainability indicators are presented here for all the countries for which results were published in the European Commission’s 2014 Staff Working Documents.
- 7.
The European Commission’s macroeconomic forecasts cover a 2-year horizon. The 2014 SWDs were based on the Commission’s spring 2014 forecasts, for which 2015 was the latest forecast year.
- 8.
Based on the medium-term fiscal sustainability indicator S1, countries are classified as: (a) “low risk” if the S1 value is less than zero, (b) “medium risk” if S1 is between 0 and 2.5% and (c) “high risk” if the S1 value is greater than 2.5% (implying a structural fiscal adjustment of more than 0.5% of GDP per year—with the latter representing the benchmark adjustment in the Stability and Growth Pact) (see European Commission 2015a).
- 9.
For the long-term fiscal sustainability indicator S2, the following thresholds are used to assess the scale of the sustainability challenge: (a) if S2 is lower than 2, the country is assigned “low risk”; (ii) if S2 is between 2 and 6, the country is assigned “medium risk”; and (c) if S2 is greater than 6, the country is assigned “high risk” (see European Commission 2015a).
- 10.
The AGS conclusions are discussed and adopted by the Council. The economic priorities based on the AGS are later adopted by the European Council.
- 11.
Starting from the European Semester 2015, the Staff Working Documents and the In-depth Reviews (the reports that follow up the Alert Mechanism Report in the context of the Macroeconomic Imbalances Procedure) were merged into a comprehensive single economic assessment for each Member State, providing the basis for the recommendations to the Member States.
- 12.
Table V in the Annex to the 2014 SWDs, for instance, reported values for all three fiscal sustainability indicators, together with the values of their components.
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Berti, K. (2018). The European Commission’s Fiscal Sustainability Indicators and Their Use in the EU’s Integrated Cycle of Economic Policy Coordination. In: Malito, D., Umbach, G., Bhuta, N. (eds) The Palgrave Handbook of Indicators in Global Governance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-62707-6_10
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