He runs one of the most prestigious think tanks in Europe, the Bruegel in Brussels. An economist with proven experience, Jeromin Zettelmeyer (of a Spanish mother and a German father) was invited to Barcelona a few days ago by the Cercle d’Economia to discuss “The international economic and financial order after the pandemic and the war” and has been co-author of a report on this same topic, coordinated by IESE professor Xavier Vives.
What effect have the pandemic and the war had on the public finances of European states?
The main conclusion is that fiscal sustainability has worsened, but we are talking about a moderate effect. One way of putting it is that on average countries will now have to run a 1% higher GDP fiscal surplus than before the pandemic in order to stabilize their debts. They will have to make an additional fiscal effort.
Because?
Basically due to the rise in real interest rates, which have increased since October 2019, more or less 1.5%. It is an important effect. But since we were coming from a super favorable situation of negative rates, it is not a desperate situation, let’s say.
But the European rules, even the new ones, foresee that the indebtedness trend has to go down.
We do not believe that there is any country in Europe where the debt is not sustainable, in the sense that the fiscal effort to control it is more than a country can bear. For example, in Greece, in 2010, the effort that the Europeans and the International Monetary Fund required from Athens was not plausible, it was not reasonable, and there had to be a very substantial debt restructuring. It was a self-destructive recipe that required beastly austerity. Is there a similar situation in Europe today? I think not, we do not see it. The efforts are within a historically plausible range.
Does Spain comply or not?
Spain will have to adjust a lot, but it is not among the most vulnerable countries. According to the European Commission, the primary structural fiscal deficit (that is, without considering the cyclical effects excluding interest, primary spending and collection) is 1.2%, half that of France or the Netherlands. The current government has a slightly more optimistic version than the Commission regarding the starting point. The Executive thinks that the primary deficit is 1% and intends to reach a surplus of 0.4% in 2026. As of 2024, in principle, Spain will have four years to make the adjustments, with a fall in debt of 1% annually, and possibly this period will be extended to seven years if the reforms of the Recovery and Resilience plan count. In other words, they do have to go further, but it is not much. It is not a dramatic situation. It is somewhat doable.
Do the plans presented by the other European countries incorporate the necessary adjustments?
There are a dozen states in Europe where, according to the latest plans, which are the ones that just came out in May, the fiscal adjustment that they have scheduled from now until 2026, does not arrive. It is not enough to lower the debt, they will have to try harder. For example, the probability that a country will have to adjust 2% of GDP or more above its 2025 target to reach its debt-stabilizing primary balance in 2029 is over 70% for the Netherlands, roughly 50% for Italy, Romania and the Czech Republic and over 40% for Belgium, France and Spain. In turn, the Commission must make its own diagnosis and will require a fiscal plan for the country, associated with spending ceilings for a period of between four and seven years. Always taking into account eventual escape clauses, which the Germans don’t like very much. Now, there is one aspect that worries me a bit.
Which?
In addition to the goal of stabilizing or reducing debt, states have to deal with other circumstances that complicate the problem. And it is the need to increase public investment, especially in the climate issue. We may also have to increase defense spending, where we are too low in Europe, below 2% of GDP. This messes up the plans a bit.
When you talk about “adjustment”, is it better to raise taxes or cut spending?
This will depend on each country. In general, both components in Europe are high. Rather, I am concerned about something else: if a country wants to adjust, for example, by raising taxes or lowering spending, but also wants to finance a large investment program with debt, then this strategy, under this framework, may be impossible.
Does the restrictive monetary policy strategy adopted by central banks seem appropriate to you?
It is difficult to assess. I think that the central bankers are aware of their mistake in starting the monetary contraction too late and may now be going a little the other way. In other words, they don’t want to be accused of inaction again. This is a bit the problem I see.
Why is inflation so hard to come down?
If you have inflation that is largely caused by supply shocks, which begins in the energy sector, these shocks take time to be transmitted to other sectors of the economy, and therefore the disinflation process is prolonged. The most dangerous thing that can happen is that people get used to inflation and incorporate it into their expectations.
