Hitting the structural deficit target

Article 3 of the Treaty on Stability, Cooperation and Governance states countries are to aim for a structural budget deficit of no more than 0.5% of GDP. 

The original balanced budget rule was introduced as part of the Stability and Growth Pact in 1997 when member countries committed “themselves to respect the medium-term budgetary objective of positions close to balance or in surplus”.  This was revised in 2005 and the rule was restated in terms of the structural balance rather than the overall balance.

At present this is not an issue for Ireland.  As our overall deficit is above 3% of GDP we are in an Excessive Deficit Procedure (EDP).  We will remain in the EDP as long as the deficit is above 3% of GDP.  This year it is forecast that the deficit will be around 8.3% of GDP and it is estimated that it will be 2015 before we leave the EDP.  On leaving the EDP we will then become subject to the balanced budget rule.

Ireland first set a Medium-Term Budgetary Objective (MTO) in terms of the cyclically-adjusted or structural budget balance in December 2005 when we set as “close to balance” (discussed here).  The current MTBO is a structural deficit of –0.5% as stated on page 31 in last week’s Stability Programme Update.

As discussed in last year’s SPU, Ireland’s ‘medium-term budgetary objective’ (MTO) currently stands at -0.5% of GDP. This objective was set well in advance of the Inter-Governmental Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the ‘Stability Treaty’). Ireland is making progress towards the achievement of its MTO, with further progress to be made in the post-2015 period on a phased basis, in accordance with a timeline to be agreed.

Up until 2015, or whenever it is achieved, the fiscal target will be to bring the overall deficit below the 3% of GDP limit.  In the post-2015 period we will be subject to the balanced budget rule and must move towards meeting the MTO (which is subject to revision).

Firstly, it is very impossible to know what the structural balance actually will be in 2015.  Tables A5 and A6 on page 53 of the SPU provide some estimates from the Department of Finance.  Using the European Commissions methodology they estimate a structural balance of –3.5% of GDP and using the approach of the IMF the figure is –2.5% of GDP.  Taking the midpoint (though the EC’s approach will take precedence for the EU’s fiscal rules) it seems we are set to have a structural deficit of around 3% of GDP in 2015.  At this remove these estimates can only be considered to be tentative.

So if the structural deficit is 3.0% of GDP how quickly does it have to be reduced to the 0.5% of GDP limit?  The SPU says it will be done “on a phased basis, in accordance with a timeline to be agreed.”  This is true and it is likely to be much more moderate than the current timeline to bring the overall deficit under the 3% of GDP limit.

The answer was actually provided in June 2005 in Council Regulation 1055/2005 which forms part of the Stability and Growth Pact.

The Council, when assessing the adjustment path toward the medium-term budgetary objective, shall examine if the Member State concerned pursues the annual improvement of its cyclically-adjusted balance, net of one-off and other temporary measures, required to meet its medium-term budgetary objective, with 0,5 % of GDP as a benchmark. The Council shall take into account whether a higher adjustment effort is made in economic good times, whereas the effort may be more limited in economic bad times.

This is confirmed in the revised Code of Conduct for the Stability and Growth Pact which was published in January of this year.  A slightly abridged version of the section on reaching the MTO is below the fold and, as can be seen, it is not lacking in get-out clauses.

2) The adjustment path toward the medium term budgetary objective and deviations from it

Fiscal behaviour over the cycle and adjustment path toward the MTO

Member States should achieve a more symmetrical approach to fiscal policy over the cycle through enhanced budgetary discipline in periods of economic recovery, with the objective to avoid pro-cyclical policies and to gradually reach their medium-term budgetary objective, thus creating the necessary room to accommodate economic downturns and reduce government debt at a satisfactory pace, thereby contributing to the long-term sustainability of public finances.

Sufficient progress towards the MTO shall be evaluated on the basis of an overall assessment with the structural balance as the reference, including an analysis of expenditure net of discretionary revenue measures.

Member States that have not yet reached their MTO should take steps to achieve it over the cycle. Their adjustment effort should be higher in good times; it could be more limited in bad times. In order to reach their MTO, Member States of the euro area or of ERM-II should pursue an annual adjustment in cyclically adjusted terms, net of one-off and other temporary measures, of 0.5 of a percentage point of GDP as a benchmark.

For Member States that have not yet reached their MTO and are faced with a debt level exceeding 60% of GDP or with pronounced risks in terms of overall debt sustainability, a faster adjustment path towards the medium-term budgetary objectives should be expected, i.e. above 0.5 of a percentage point of GDP as a benchmark in cyclically adjusted terms, net of one-off and other temporary measures.

Based on the principles mentioned above and on the explanations provided by Member States, the Commission and the Council, in their assessments of the Stability or Convergence Programmes, should examine whether a higher adjustment effort is made in economic good times.

In case of an unusual event outside the control of the Member State concerned and which has a major impact on the financial position of the general government or in periods of severe economic downturn for the euro area or the Union as a whole, Member States may be allowed to temporarily depart from the adjustment path towards the medium-term objective implied by the benchmarks for the structural balance and expenditure, on condition that this does not endanger fiscal sustainability in the medium-term.