Europe’s recovery requires that fiscal policy not be tightened prematurely
… that the mistakes of the post Global Financial Crisis period be avoided
- Fiscal policy worldwide has been expanded extraordinarily in response to the pandemic
- Support to incomes and employment has significantly moderated declines in real activity
- However, this has resulted in dramatic increases in public sector budget deficits and debt.
- Advanced-economy government debt ratios stand to rise by up to 20% of GDP.
- This could take the average ratio towards a record (for peacetime) 140% of GDP.
- A risk is that this fiscal support to economic activity is withdrawn too soon.
- This happened in the wake of the 2008 crisis, not least in the euro area:
- A sharp reversal of the fiscal stance from 2011 to 2013 caused euro-area GDP to drop far below trend, and pushed some economies back into recession.
Recovery resumed only when fiscal policy returned to neutral, or again became slightly expansionary.
- Looking ahead, the most constructive use of fiscal policy will be to shift from ‘filling a hole in demand’ towards ‘building a launch pad for sustainable expansion’:
- While not neglecting social safety nets and burgeoning inequalities, this means a shift from direct support to wages and jobs, towards public investment and measures that facilitate structural change, not least Active Labour Market Policies.
- The Next Generation EU recovery plan 2021 – 2027 is directed some way towards this end.
- Other countries’ fiscal policy strategies are, so far, less developed or suitably targeted.