Global Economic Perspectives：Euro area fiscal easing: 'What if'?

20 September 2016Global Economic PerspectivesDeutsche Bank Securities Inc.DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.EuropeGlobalEconomicsGlobal EconomicPerspectivesDate20 September 2016Deutsche BankResearchEuro area fiscal easing: 'What if'?■It is easier to call for euro area fiscal easing than it is to credibly deliver it.Absent an economic shock or an acceleration of integration, we are notexpecting much easing of fiscal policy in 2017.■In this note we ask: What if Europe comes to the conclusion that monetarypolicy is insufficient to normalize economic conditions and a fiscal easingoutside the current rules is required? With this in mind, we do two things■First, we quantify the fiscal easing required to close the unemploymentgap country by country over the next three years. The objective is to raisegrowth, absorb spare capacity and boost political support for the euroarea. This should help to reduce the local hurdles to structural reforms.■The additional easing of the structural budget deficit required is only 0.4%of GDP on average per year for the euro area in aggregate. For threeyears this is equivalent to about EUR130bn in total. There needs to bestrong commitment from all member states and no free-riding to ensurethe spillover effects between countries are maximized.■The strategy should be self financing. The positive impact on GDP growthpushes the nominal fiscal deficit and public debt-to-GDP ratios belowwhat they would have been without this stimulus. It should also benefitthe ECB by pushing HICP inflation to target by 2019. That should reducepressure to ease monetary policy further and facilitate an earlier exit fromthe accommodative monetary policy stance.■However, there is a wide divergence in stimulus requirements acrosscountries - from no stimulus to at least 3% of GDP in some peripheraleconomies. This hints at the political challenge of such a fiscal strategy.■Second, we describe the necessary conditions for this euro area fiscaleasing to materialise. Some are coming in any case, if very slowly, forexample, fiscal coordination and policies to boost systemic resiliencelike the banking union. Others are more difficult, such as re-writing thefiscal rules. Some are extremely difficult to imagine, like an inversion ofGermany’s historic political belief in rules-based stability.■The bottom line is, we do not expect a large fiscal easing, particularly withthe very busy European political events calendar in 2017. Just like in 2016,some modest slippage relative to the fiscal rules might be as good as itgets in 2017.Peter Hooper, Ph.DChief Economist+1-212-250-7352Michael Spencer, Ph.DChief Economist+852-2203 8303Mark WallChief Economist+44-20-754-52087Torsten Slok, Ph.DChief Economist+1-212-250-2155Matthew Luzzetti, Ph.DSenior Economist+1-212-250-6161Distributed on: 20/09/2016 20:00:56 GMT 20 September 2016Global Economic PerspectivesPage 2Deutsche Bank Securities Inc.IntroductionThe argument that monetary policy is failing and that a fiscal policy or coordinatedmonetary and fiscal policy is necessary is building in markets again. With criticismof ECB policy on the rise — not least because of the counter-productive impact ofunconventional monetary policy on banks — and the euro area economic cyclestruggling to normalize, the question inevitably arises: will the euro area also easefiscal policy?When we last reviewed the euro area fiscal stance in April, we drew threeconclusions1:■First, the market was under-estimating the amount of fiscal easing in2016. At the time we projected an increase in the structural primarydeficit of 0.5% of GDP in 2016, the largest easing since the coordinatedEuropean response post-Lehman and a couple of tenths larger forecastssix months earlier. Since these bottom-up estimates do not capture theJuncker Investment plan, arguably the fiscal stimulus was larger than this.Since April, this estimate has been revised up to 0.7% of GDP.Figure 1: The fiscal stance has already eased in 2016; the concern is 2017Source: Deutsche Bank, European Commission■Second, the conditions were not right for a strongly coordinatedfiscal and/or monetary policy (including helicopter money). One of twoscenarios would have to apply: (a) a sharply worse economic outlook or(b) a leap forward for euro area integration. The two are not necessarilymutually exclusive. But while the recovery is weak, it is also relativelystable. Brexit has not yet been a significant shock.■Third, our concern was not 2016 but 2017. On current forecasts the fiscalstance will be less easy next year. Since it is the change in the fiscal stancethat correlates with economic growth, unless current plans change thefiscal impulse threatens to become negative for growth in 2017.Less austerity, more jobs. While the austerity pressure has eased, the pace ofimprovement in the euro area labour market has accelerated. Over the last yearthe European Co