COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on the establishment of a European Investment Stabilisation Function

EN EN
EUROPEAN
COMMISSION
Brussels, 31.5.2018
SWD(2018) 297 final
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT
Accompanying the document
Proposal for a Regulation of the European Parliament and of the Council
on the establishment of a European Investment Stabilisation Function
{COM(2018) 387 final} - {SEC(2018) 277 final} - {SWD(2018) 298 final}
Europaudvalget 2018
KOM (2018) 0387
Offentligt
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Table of contents
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT.....................................3
2. PROBLEM DEFINITION ..........................................................................................5
2.1. Business cycles in the EA/EU ...........................................................................6
2.2. Fiscal developments and implications for public investments..........................9
2.3. Other instruments and policies ........................................................................13
2.4. Conclusion on problem definition...................................................................16
3. WHY SHOULD THE EU ACT? ..............................................................................17
3.1. Existing lines of defence .................................................................................17
3.2. The need for economic stabilisation at the European level.............................18
3.3. Stakeholders’ views.........................................................................................21
3.4. Legal basis.......................................................................................................23
4. OBJECTIVES: WHAT IS TO BE ACHIEVED? .....................................................23
4.1. General objectives ...........................................................................................23
4.2. Specific objectives...........................................................................................24
5. WHAT ARE THE AVAILABLE POLICY OPTIONS? ..........................................25
5.1. What is the baseline from which options are assessed? ..................................26
5.2. Description of the policy options ....................................................................28
6. IMPACT EVALUATION OF THE OPTIONS ........................................................33
6.1. Selection of the activation trigger....................................................................34
6.1.1. Choice of trigger variable........................................................................... 34
6.1.2. Choice of trigger design and parametrisation............................................. 36
6.1.3. The total support envelope for option 2 ..................................................... 40
6.1.4. A modulated amount of loans can provide larger and more targeted support...... 43
6.1.5. Simulation of past functioning ................................................................... 45
6.1.6. The financial calibration of the insurance mechanism............................... 46
6.2. Stabilisation impact .........................................................................................48
6.2.1. Main qualitative impact.............................................................................. 48
6.2.2. Quantitative estimates of the stabilisation impact...................................... 50
6.2.3. Stabilisation impact of a euro area budget ................................................. 52
6.3. Cross-country neutrality..................................................................................53
6.4. Environmental and social impact ....................................................................56
6.5. Conclusions, preferred option and implementation plan.................................57
6.5.1. Implementation plan................................................................................... 59
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7. HOW WILL ACTUAL IMPACTS BE MONITORED AND
EVALUATED?.........................................................................................................60
7.1.1. Macroeconomic impact .............................................................................. 61
7.1.2. Use of funds................................................................................................ 62
7.1.3. Quality of public investment management................................................. 62
Annex 1: Procedural information.......................................................................... 65
Annex 2: Stakeholder consultation........................................................................ 69
Annex 3: Analytical methods................................................................................ 72
Annex 4: References.............................................................................................. 73
Annex 5: Glossary and acronyms.......................................................................... 79
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1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT
On 2 May 2018, the European Commission adopted its proposals for a new
Multiannual Financial Framework (MFF) for 2021-2027. Under these proposals1, the
European Investment Stabilisation Function will have an overall ceiling for lending
backed by the EU budget of EUR 30bn over this period. This impact assessment report
reflects the decisions of the MFF proposals and focuses on the changes and policy
choices which are specific to this instrument.
The financial turbulence and severe economic downturn of the late 2000s and early
2010s stress-tested the foundations of the euro and the EU. While important
governance changes have been undertaken in response, the euro architecture remains a
vulnerable construction. Policy leaders at the national and the European level are
therefore engaged in a discussion to learn the lessons of the past years and further bolster
the resilience of the zone.2
One focal point of that debate is the appropriate euro area
fiscal framework and in particular the adequate arrangements for providing fiscal
stabilisation.
The topic of a common stabilisation function to underpin the single currency has
garnered much attention over the years and decades. Over 40 years ago the Mac
Dougall report (European Commission, 1977) already emphasised the desirability to
accompany the creation of a single European currency with a common budget of
meaningful size. As of today the euro area remains an area with a centralised monetary
authority and a plurality of national fiscal actors. Developments since the inception of the
euro have however shed a new light on this discussion. Indeed, the events unfolding as
part of the euro area sovereign debt crisis in the early 2010s have pointed out the limited
resilience of the euro area to macroeconomic shocks, thereby renewing interest for such
an instrument.
At present, there is a lively debate on the need and form that could take such a
stabilisation function. Some Member States positively support further fiscal integration
as a crucial component of EMU deepening. The case for ambitious fiscal integration, in
the form of a euro area budget that would notably provide stabilisation, has been made by
the French President. The national ministries of economy or finance from Italy and Spain
have issued papers lining out proposals for specific funds providing macroeconomic
stabilisation. However, doubts have also been raised in other constituencies on the value
1
https://ec.europa.eu/commission/priorities/democratic-change/future-europe/eu-budget-future_en
2
6 December Package. Commission Communication on “Further steps towards completing Europe's
economic and monetary union: a roadmap” - COM(2017) 821: http://eur-lex.europa.eu/legal-
content/EN/TXT/PDF/?uri=CELEX:52017DC0821&from=EN ;
White paper on the future of Europe - COM(2017)2025: https://ec.europa.eu/commission/sites/beta-
political/files/white_paper_on_the_future_of_europe_en.pdf
Five Presidents’ Report: Completing Europe's Economic and Monetary Union:
https://ec.europa.eu/commission/sites/beta-political/files/5-presidents-report_en.pdf
4
added and risks from a common stabilisation instrument. The Prime Minister of the
Netherlands has been explicitly sceptical in a recent speech. Some Member States appear
open to further discussions without necessarily being supportive. The coalition agreement
underpinning the current German government mentions a future investment budget for
the euro area that could also provide stabilisation.
While registering this spectrum of views, the Commission has actively contributed
to this discussion. The Commission has made the case for a stabilisation instrument
while laying out important guiding principles, e.g. in its Communication on "new
budgetary instruments for a stable euro area within the Union framework" from 6
December 2017 and the Reflection Paper on the deepening of the Economic and
Monetary Union.3
Taking note of the diversity of views, the Commission has set out
different options and approaches were presented, thereby nourishing the discussion. The
introduction of a stabilisation function is also seen as part of a wider drive to modernise
the EU budget and maximise its impact. To this end, the 6 December Communication
proposed four new instruments: 1.) A new way to support national reforms identified in
the European Semester, 2.) a dedicated convergence facility for Member States on their
way to joining the euro, 3.) key features of a backstop for the banking union, and 4.) the
roll-out of a stabilisation function, which is the focus of this impact assessment. The
stabilisation function would tackle a vulnerability in the EMU architecture, which is why
access would be especially desirable for euro area Member States.
This Impact Assessment describes the current gaps in the euro area's capacity to
respond to shocks and discusses different policy options and the impact of possible
EU action. This document explains why and to which extent the euro area’s response to
the recent crisis was constrained. It assesses which factors contributed to its aggravation
and the increasing divergence among Member States. The analysis shows how the
institution of a common stabilisation function would raise the resilience of the euro area
by increasing the capacity to withstand future large asymmetric shocks, thereby avoiding
the risk of Member States departing from EU economic and social cohesion objectives.
Such a stabilisation function should be properly designed and may have to be built over
time. This document therefore also reviews the options for building a stabilisation
function, evaluates their respective effectiveness, motivate the proposals made by the
Commission, and explains how the stabilisation function will be monitored.
It is important to note that the quantification of impacts described in this document
does not capture the entire scope of the problem analysed. In terms of the quantitative
analysis presented, specific caveats should be borne in mind. These include technical
limitations of the statistical data and of the simulation models available. It is in the nature
of macroeconomic analysis that the assessment depends on (well-justified) assumptions
and that future outcomes are per definitionem not certain but will depend crucially on the
3
Communication on new budgetary instruments for a stable euro area within the Union framework -
COM(2017) 822: https://ec.europa.eu/info/sites/info/files/economy-finance/com_822_0.pdf
Reflection paper on the deepening of the economic and monetary union - COM(2017) 291:
https://ec.europa.eu/commission/sites/beta-political/files/reflection-paper-emu_en.pdf
5
– partially random – unfolding of events. In light of the above, this document presents a
proportionate assessment of impacts. The impacts are primarily described through a
qualitative assessment and, where possible, a quantification of impacts is outlined.
Procedural information regarding the preparation of this Impact Assessment can be found
in Annex 1.
2. PROBLEM DEFINITION
The problem to be addressed by this initiative, in summary, is the insufficient
ability of available instruments to absorb large macroeconomic shocks in the euro
area. In modern economies, fiscal and monetary policies are the main means for
managing business cycles. Monetary policy is generally viewed as the most flexible tool,
while fiscal policy responds in the first instance through the so called automatic
stabilisers. The euro area is however confronted with a particular set-up: monetary policy
can only focus on aggregate fluctuations of the zone, while fiscal policy is 'decentralised'
and in principle can respond to country-specific shocks. This arrangement appears viable
for normal times but it is confronted with critical problems whenever large economic
disruptions arise. This has especially been illustrated by developments in the economic
and financial and the euro crisis, which has evidenced strong limits to the functioning of
national automatic stabilisers for coping with asymmetric shocks, even sometimes in
Member States with sound fiscal credentials. This has resulted in a pro-cyclical pattern
for fiscal policies, which has also been detrimental to the quality of public finances and
in particular public investments. The sequence of recent events also suggests that too
much weight may be put on the monetary authority to provide stabilisation in severe
economic circumstances. These observations point to a stabilisation gap and the risk of
procyclical cuts in public investment in the current EA/EU setting, pointing to the need
for a common fiscal instrument for the future. In turn, that shortcoming has contributed
to widespread differences in macroeconomic performance between Member States,
imperilling the cohesion of the EU.
The remaining of this section documents this fundamental problem and identifies
problem drivers by shedding light on:
i) business cycles in the EA/EU, showing that business cycle fluctuations are large and
reflect both a common component and substantial country-specific components ;
ii) the experience over the years of the crisis that erupted a decade ago and saw the
occurrence of sizeable pro-cyclical fiscal adjustments that weighed especially strongly on
public investments.
It will then be explained (section 3) why these problems will continue to represent a
major threat in the future, even taking into account the existence or the development of
6
new instruments in the EA/EU setting and assuming that Member States preserve their
national fiscal space by strictly respecting the fiscal rules framework. This makes the
case for an EU-level instrument to provide stabilisation support in some circumstances
that characterise a large asymmetric shock.
2.1. Business cycles in the EA/EU
The overall macroeconomic performance in the euro area has been lacklustre since
the eruption of the crisis. The crisis and the subsequent double-dip recession in the euro
area has induced low growth. The low resilience of the euro area appears to have a
permanent effect on real GDP. The gap with the US in terms of growth performance has
widened over the past ten years and reflects a weaker capacity to absorb and recover
from shocks. While the US reached its pre-crisis real GDP level already in 2011, the EA
reached it only four years later, in 2015.
Beyond the aggregate growth performance, economic divergences between Member
States have resurfaced. In the decades running up to 2008, important economic
convergence took place in the EU. Since the crisis however, this trend has reversed, as
illustrated in Figure 1. In a number of Member States, GDP levels have only recently
recovered to their pre-crisis starting points.
Figure 1: Real GDP, selected Member
States
Figure 2: Unemployment rates, selected
Member States
Source/Note: European Commission 2017 autumn
forecast
Source/Note: EC 2017 autumn forecast.
These developments were mirrored in a jump in unemployment rates across some
Member States. Changes in unemployment rates are highly correlated with business
cycle fluctuations. Strong increases in unemployment rates are thus an important
indication for a large economic shock. During the recent crisis, unemployment rates shot
up across the euro area, and even more so in those Member States hit hardest by the
7
downturn (Figure 2). Overall, divergences in unemployment dynamics have increased
significantly with the crisis, even more than for GDP. Unemployment rates for the long-
term unemployed, the low-skilled and the young have peaked more than "headline"
unemployment and still remain at very high levels in the EA, while involuntary part-time
and hidden labour force signal that slack is still present in the economy.
The lack of monetary policy and exchange rate adjustment channels at the national
level hampers the resilience to asymmetric shocks. The introduction of the euro was
highly beneficial for the European Union and has contributed to prosperity and stability.
It has completed the single market and contributed to more intra-EU trade (see Baldwin
and others 2008; Berger and Nitsch 2008). Nonetheless, in a currency union, exchange
rates cannot adjust and monetary policy is set at the euro level. To facilitate
macroeconomic adjustment and cushion large shocks, Member States thus need to rely
more on the remaining instruments of economic policy, namely structural reforms and
fiscal policy instruments, making the adjustment more difficult overall. The lack of a
fiscal stabilisation at the centre also implies a heavier reliance on monetary policy to
stabilise overall economic activity.
Figure 3: Standard deviation of the output
gaps by Member States (2000-2017)
Figure 4: Standard deviation of the output
gaps across Member States
Source/Note: European Commission 2017 autumn
forecast, Authors’ calculations
Source/Note: European Commission 2017 autumn
forecast, Authors’ calculations
Twenty years after the introduction of the euro area, important asymmetries in the
business cycles remain across Member States. Since the early 2000s, the average
magnitude of the output gap fluctuations in the euro area is equal to 1.8% of GDP. This
aggregate volatility hides larger fluctuations at the national level and sizeable disparities
both between countries (Figure 3) and through time (Figure 4). Indeed, the Euro Area
aggregates smooth out the disparities between Member States and most countries
experience larger economic fluctuations than the Euro Area as a whole. In addition, in
8
the wake of the crisis disparities between Member States' output gaps have increased
(Figure 4). Each country's correlation with the others reveals the great disparities existing
across countries (Figure 5): the correlation of national output gaps with that of the other
Member States is on average around 60% but varies from close to 0 to 90%. For instance
the output gap correlation between Germany and Greece is only equal to 3%, and it is
only 7% between Portugal and Lithuania. It is however as high as 96% between France
and Italy.
Figure 5: Business cycle correlation across
EA19 Member States
Figure 6: Business cycle fluctuations in
EA Member States and their common
factor
Source/Note: European Commission 2017 autumn
forecast, Authors' calculations
The correlation of national output gaps with that of
the other Member States is on average around 60%
but varies from close to 0 to 90%
Source/Note: European Commission 2017 autumn
forecast, Authors' calculations
The Common Factor captures as much of the joint
fluctuations as possible and is computed by
Principal Component Analysis.
The business cycles convergence in the euro area remains partial. Since the late
nineties, for the 19 Member States of the euro area, at most 60% of the fluctuations in
output can be ascribed to a common factor (Figure 6). Therefore, more than 40% of the
fluctuations in output either stem from asymmetric sources, or at least reflect asymmetric
transmission across Member States of common shocks.4
Indeed, both common and
country-specific shocks can generate the desynchronised economic cycles observed in
the EMU. For example a common shock on the foreign exchange rate has an impact on
each Member State that will depend on its trade openness with the rest of the world, on
its export and import structure as well as on the size of its financial sector. Some Member
States are however more affected than other by idiosyncratic developments. For example,
if we restrict the analysis to the EA12 Member States, the common factor accounts for up
to 80%, leaving 20% of the fluctuations to be asymmetric. Overall, the limited business
cycle synchronisation can be considered a key problem driver.
4
Estimation based on a principal component analysis. A similar analysis on GDP growth or the
unemployment rate yield a similar estimate of 40% of asymmetric fluctuations.
9
2.2. Fiscal developments and implications for public investments
National public finances provide a crucial extent of stabilisation, via automatic
stabilisers and discretionary fiscal policies. National fiscal stabilisation operates
mainly via automatic stabilisers, meaning that a fall in tax revenues, an uptick in social
benefits and the inertia of other spending support the economy in downturns. European
Commission (2017 E) shows that, in the euro area average, around one third of a shock to
disposable income of households is absorbed by automatic stabilisers. However, the
importance of such smoothing differs widely across Member States. In addition to
automatic stabilisers, discretionary fiscal policies are an important tool to cushion large
shocks. As part of the policy response to the financial crisis of the late 2000s, the
European Recovery Plan was implemented, which provided discretionary aggregate
support. Fiscal rules as in the Stability and Growth Pact do give room for the automatic
stabilisers to play out and for discretionary fiscal policy under specific conditions. Still,
in particular situations they might also act as a constraint.
A build-up of fiscal buffers is thus needed in good times. In light of the crisis
experience, the fiscal framework was strengthened with the introduction of the Six-Pack,
Two-Pack and the “Treaty on Stability, Coordination and Governance in the Economic
and Monetary Union”. Member States need to build sizeable fiscal buffers in normal and
good times to afford the fiscal space needed for the free operation of automatic
stabilisers. Public deficits have recently been reined in and public debts put on a
downward path. Many Member States, however, still face a legacy of very high debt
burdens that will take time to wind down. In these cases, more efforts are needed to
replenish fiscal buffers for future downturns.5
Nonetheless, even Member States with
sound fiscal policies might become constrained in their fiscal policy choices due to
market pressure. Moreover, as a result of the crisis, public debt levels have increased to
fairly high levels, in some Member States above 100% of GDP. Due to this legacy of
high public debt, fiscal room for manoeuvre might be somewhat constrained until these
debt levels have be wound down.
Still, in the wake of large shocks, public finances can deteriorate strongly. As shown
in Figure 7, public deficits worsened strongly during the crisis. In the euro area as a
whole, the deficit surged by around 4% of GDP and public debt shot up by more than
30% of GDP. This slump was worse in Member States hit hardest by the downturn. One
important underlying reason was the often sudden and dramatic collapse of public
revenues. In normal downturns, revenues develop broadly in line with the economic
cycle, or more precisely in line with a constant elasticity linked to the relevant tax bases
(see Mourre et al., 2014). In case of a drop in GDP, this mechanism already leads to a
major fall in revenues compared to budgetary plans. In a large downturn, however, these
5
See European Commission (2017 G), 2018 horizontal DBP Communication on draft budgetary plans:
https://ec.europa.eu/info/sites/info/files/economy-finance/com-2017-800-en.pdf
10
developments can be exacerbated, i.e. they become more than proportional to the GDP
slump, and materialise as sizeable revenue shortfalls. In the case of the recent crisis,
revenues and budget balances fell dramatically, as illustrated in Figure 7 and Figure 8.
Cumulated revenue shortfalls reached several percentage points of GDP for programme
and vulnerable Member States, in addition to revenue losses due to lower activity.
Member States either need to run higher deficits to maintain spending plans or find other
savings to compensate.
A countercyclical conduct of fiscal policy, including the free operation of automatic
stabilisers, can be hindered by financial market instability and constrained market
access. In the early 2010s, a strong deterioration in public finances, jointly with doubts
about the functioning of the euro area under periods of intense stress resulted in
weakened investor confidence and significant financial market fragmentation during and
after the outbreak of the crisis, see Figure 9. Bold policy actions at several levels were
needed to re-establish market confidence and achieve a reversion of this fragmentation.
The European Central Bank’s (ECB) announcement of Outright Monetary Transactions
(OMT) led to a reduction in the perceived redenomination risk. Steps towards Banking
Union helped cushion sovereign-bank doom loops. Major reforms in the Member States
most affected by the crisis, including structural reforms and fiscal consolidation, were
undertaken and in some cases supported by provision of financial assistance.
Nonetheless, this experience reveals that national fiscal policies, even in cases where
initial debt levels are low, risk being overburdened in case of large shocks.
Figure 7: Budget balances, country groups Figure 8: Revenue windfalls/shortfalls,
country groups
Source/Note: Programme: IE, EL, PT, CY.
Vulnerable: IT, ES. Weighted avgs. Authors’
calculations based on EC 2017 autumn forecast.
Source/Note: Year-on-year windfalls/shortfalls.
Discretionary revenue measures taken into account from
2010 onwards. Authors’ calc. based on EC 2017 autumn
forecast
11
Figure 9: Sovereign bond spreads, selected Member States
Source/Note: ECB statistical data warehouse
To keep deficit and debt levels under control in the face of market pressures, there
is a risk that Member States resort to highly pro-cyclical and low quality fiscal
adjustments. Some of these Member States had failed to build sufficient fiscal buffers
ahead of the crisis. Others, however, were running prudent fiscal policies, at least at face
value, and had accumulated low levels of public debt before the crisis struck. In the
recent crisis, several Member States were under extreme market pressure, as their spreads
vis-à-vis the German sovereign bonds increased sharply, with important implications on
the cost of servicing their debt and running higher deficits. As a consequence, EL, IE, PT
and CY had to revert to financial assistance programmes. Overall, the euro area, in
particular in Member States without market access and vulnerable to financial market
instability, has undertaken strong fiscal adjustments (Figure 10).
On aggregate, the euro area has been prone to pro-cyclical fiscal consolidation in
the downturn. As a consequence of national consolidations, the euro area fiscal stance
turned highly restrictive in 2012-2013, while the downturn was still deep, see Figure 11.
To compensate, a very large weight has been put on the ECB, testing the limits of
monetary policy at times of unprecedentedly low interest rates. These weaknesses in the
architecture have contributed to further deepening the economic downturn.
12
Figure 10: Structural adjustment by
country groups
Figure 11: Euro area fiscal stance
Source/Note: EC 2017 autumn forecast. Change
in structural primary balances. Pre-2010 change
in cyclically-adjusted primary balances.
Source/Note: EC 2017 autumn forecast. Fiscal
adjustment is measured by the change in the
structural primary balance. Unused capacity is
measured by the output gap.
In many countries, the tightening of fiscal policy translated into severe cuts in
public investment. While these cuts may partly have been a response to previously
excessive spending, short-term budgetary pressures have in many cases led to myopic
policymaking in which governments slash public investment given their lower political
costs to achieve savings. Those Member States facing the biggest pressure for front-
loaded consolidation made significant cuts in public investment (Figure 12), on average
around 2% of GDP. These cuts in public investment came on top of decreases in private
investment. This type of adjustments has sometimes deepened and lengthened the
recession in those countries, negatively impacting the economic and social cohesion of
the Member States.
The EU budget has helped to some extent to weather the crisis. Thanks to its inherent
stability in the medium term, EU-funded public investments and transfers – e.g. for
training unemployed people or for urban and rural development – has acted as a
countercyclical force during the recession that began in 2009, despite the relatively
modest share of EU spending out of national governments' total expenditure.6
6
Financing the EU Budget: report on the operation of the own resources system, Commission Staff
Working Document, accompanying the Proposal of a Council Decision on the Own Resources of the EU
(SWD(2018) 172 of 2 May 2018).
13
Preserving growth-friendly public
investment is key to foster
(potential) growth also during
recessions. Weak investment
spending has not only negative
consequences for short-term growth
via its impact on aggregate demand,
but also for the medium-term
productivity via its impact on the
capital stock. Furthermore, the short-
term impact of high-quality investment
on growth is typically found to be
larger than that of other types of
spending. Therefore, it is important to
preserve growth-friendly public
investment also in economic bad times to ease the necessary adjustment burden and
return on a sustainable growth path as quickly as possible.7
2.3. Other instruments and policies
Some policies and instruments can reduce the need for providing stabilisation
through fiscal instruments. In the EMU setting, this concerns:
 Well-functioning markets and structural reforms which raise resilience
 Cross-border risk sharing through financial markets
 The action of the ECB
 The provision of financial assistance subject to strict conditionality, as provided
by the European Stability Mechanism (ESM)
Well-functioning markets are indispensable to absorb economic shocks efficiently
across Member States. Such market mechanisms form the first line of defence.
Conceptually, market mechanisms play a key stabilising role in monetary unions,
through greater internal resilience to shocks and improved mobility of the production
factors capital and labour.8
The efficient functioning of the single market, including in
the financial markets and labour markets, feature among the crucial ingredients to make
European economies more resilient. Labour mobility is another mechanism which
facilitates economic adjustment, although the room for further improvements appears
7
European Commission (2016): Public Finances in the EMU 2016; Barrios and Schaechter (2008): The Quality of
Public Finances and Economic Growth, European Economy Economic Papers 337; Barbieroand Cournède 2013): New
econometric estimates of long-term growth effects of different areas of public spending, OECD Economics Department
Working Paper, 1100.
8
Mundell (1973) and Eichengreen (1992) have suggested that a monetary union among countries keeping
their fiscal autonomy could potentially compensate the lack of a common fiscal capacity through the so-
called ‘private insurance channel’, brought forward by financial integration.
Figure 12: Public investment in selected
Member States
Source/Note: EC 2017 autumn forecast.
14
limited in the medium term. (Molloy et al., 2011; Beyer and Smets, 2015; Dao et
al., 2014).
Structural reforms can also increase the economic resilience of Member States.
They help address macroeconomic imbalances and lift economic potential. That is why
the Commission has proposed the creation of a Reform delivery tool on 6 December
2017 to further increase incentives for structural reforms. Still, structural reforms per se
would not stabilise demand fluctuations. On the contrary, in the short term, they can
weaken the recovery, in particular when implemented during the downturn or when
monetary policy is constrained.9
Such issues call for an appropriate 'sequencing' and
'packaging' of reforms that takes advantage of synergies and complementarities (Berti
and Meyermans, 2017).
Private sector cross-country risk sharing works through cross-border factor
income. With domestic productive assets partially held abroad, the consequences on
domestic income of a country-specific shock may be smoothed by reduced dividends and
interest payments to foreign residents, together with sustained earnings on foreign assets
held by domestic agents. This is the so called capital market channel for private risk
sharing. Labour compensation across borders may also contribute to smoothing domestic
incomes. In addition to these income smoothing effects, there can also be a consumption
smoothing channel through borrowing and saving on international capital market. This is
the so called credit channel of consumption smoothing. Consumption smoothing
behaviour is however conceptually distinct from risk-sharing stricto sensu (Alcidi and
Thirion, 2016).
The amount of private sector cross-country risk sharing through financial markets
remains low in Europe compared to other currency unions. Market mechanisms
allowing for higher mobility of capital consist of the so-called capital market channel, the
credit market channel, and the cross-border labour compensation channel. In the US and
other federations, private sector channels have been found to smooth out a significant
fraction of shocks on consumption, possibly of the order of 60% (when including the
credit channel). The contribution of public risk-sharing is generally found to be smaller,
of the order of 15-20%.10
Private risk-sharing appears far less developed in the case of
the EU (Berger, Dell'Ariccia, Obstfeld, 2018), providing a strong case for completing the
banking union and achieving a capital markets union raising the degree of cross-border
risk sharing.
The creation of Banking Union is underway, in order to severe bank-sovereign
doom loops. In the past, Member States repeatedly found themselves in situations where
large amounts of public money were spent to bail out failing banks, in some cases
9
See OECD (2015), Vogel (2014) and Duval and Furceri (2016)
10
See Nikolov (2016), Alcidi (2015) and Allard et al. (2013). There are nevertheless important
methodological challenges in these empirical studies. The results regarding the contributions of both
private risk-sharing and public risk-sharing, should be taken with caution (Clévenot and Duwicquet, 2011).
In the early 1990s, Sachs and Sala-i-Martin (1991) and Bayoumi and Masson (1995) found that in the US
automatic stabilisers of the federal budget would smooth around 30% of income shocks.
15
leading to doubts about the sustainability of their public finances. The creation of
common supervision for big banks and a common resolution framework and fund have
alleviated the burden on national sovereigns, thereby contributing to the severance of the
so-called sovereign-bank doom loop. To strengthen the resilience of the common
resolution approach, the Commission has proposed to create a common backstop for the
Single Resolution Fund. The Capital Markets Union, for its part, has the potential to
considerably broaden cross-border risk-sharing.
There is evidence that public risk sharing is a necessary catalyst for private risk
sharing in a currency union, especially in stressed times when it matters the most.
Private sector risk sharing can turn pro-cyclical in downturns and is more effective when
working in conjunction with public sector risk sharing (Kalemli-Ozcan et al. , 2014). In
other advanced currency unions, such as the US, Canada and Germany, private risk
sharing channels are supported by public mechanisms. Furceri and Zdzienicka (2015)
find that the degree of risk-sharing in the euro area falls sharply in severe downturns,
more precisely: "the amount of unsmoothed shocks in periods of recession is
significantly larger than during normal times, and the increased inability to smooth
output shocks is driven by the lack of consumption smoothing provided by private saving
via the credit channel. This is particularly true for severe downturns that are persistent
and unanticipated". The conclusion is therefore that a degree of public risk-sharing is a
necessary catalyst for private risk-sharing to work effectively in stressed times, when it
matters the most.
Among existing common European instruments, the ECB is at the forefront of
regular macroeconomic stabilisation. The common monetary policy provides a first
response to stabilise the economy in the event of shocks affecting the whole area, through
the pursuit of price stability. Its primary, traditional instrument is the interest rate. During
the crisis, the toolbox of the ECB has evolved, adding new unconventional instruments
such as the OMT and liquidity support to the banking sector. Nonetheless, there is a risk
of overburdening monetary policy, especially when the interest rate is close to the zero
lower bound (ZLB). In those cases, further reducing nominal interest rates may be
difficult. Unconventional tools can complement, but their impact might be decreasing
with increased use (see Blanchard et al, 2015). Moreover, a common monetary policy
cannot react to individual country shocks; thus the need for a fiscal instrument to
complement (Berger, Dell'Ariccia, Obstfeld, 2018).
During the past ten years, the ESM was created to deal with crisis situations. The
ESM provides financial assistance to Member States having lost market access subject to
strict conditionality. It thereby acts as a lender of last resort to national sovereigns.
However, the experience of sudden and sometimes excessive stops in market access calls
for a more preventive approach to support Member States hit by large shocks.
Concerning the institutional setup, the Commission has made proposals to strengthen the
16
ESM’s governance framework and integrate is into the community framework on 6
December 2017.11
2.4. Conclusion on problem definition
From the inception of the euro it has been asked whether the EMU set-up offered
enough space for macroeconomic stabilisation. This question arises naturally as
countries in a monetary union lose crucial channels of adjustment to asymmetric shocks
by giving up an own monetary policy and the possibility of nominal exchange rate
changes. The initial understanding over the euro was that this loss might be
'compensated' by a natural convergence of business cycles within the union. In addition,
national fiscal policies remained available in order to absorb country-specific shocks.
However, the experience suggests that these assumptions were too optimistic. Business
cycles remain sizeable in EMU, reflecting a key external problem driver. They reflect
both a common component and substantial idiosyncratic cyclical developments in
Member States, particularly in the more volatile economies of the euro area. The
behaviour of national fiscal policies is a key internal problem driver. National fiscal
stabilisers have functioned at times and in some countries but have also exhibited serious
limitations. In fact, fiscal policies have too often turned out pro-cyclical, and in particular
public investment cycles have followed a boom and bust profile that has been detrimental
to growth in both the short and long terms. Figure 13 provides an illustrative overview of
these key problem drivers.
Figure 13: Key internal and external problem drivers
Source/Note: Stylised illustration prepared by authors
While the euro area economy is now expanding again, these vulnerabilities remain
and the capacity of the euro area and Member States to smooth large
11
See Commission proposal for a Council regulation on the establishment of the European Monetary Fund
COM/2017/0827 final - 2017/0333 (APP): http://eur-lex.europa.eu/legal-
content/EN/TXT/?uri=CELEX:52017PC0827
17
macroeconomic shocks is not yet sufficient. The expansion appears solid at present, but
the heterogeneity in the euro area is fuelling the potential for further tensions that could
have severe consequences including for the very integrity of the euro area and the EU.
Therefore, a more complete set of collective defences to tackle large shocks and prevent
divergences among the Member States is needed. Such shocks and crises can persistently
alter growth trajectories to the detriment of welfare and cohesion. Underinvestment and
the persistence of high unemployment in some Member States are of particular concern
as they could inflict long-term economic and social damages. In part, the failings
highlighted above may have reflected an insufficiently sound conduct of fiscal policies in
the better part of the cycle. However, as will be argued in the next section, there are
inherent constraints to national fiscal stabilisation policies even when budgets respect
strictly the rules. As a result, the present EMU framework leaves a larger role for
macroeconomic stabilisation on the ECB jointly with national fiscal policies.12
3. WHY SHOULD THE EU ACT?
This section explains why the existing instruments do not suffice to provide enough
space for fiscal stabilisation in the EA/EU set-up. In line with the subsidiarity
principle, a stabilisation function is needed as a complementary tool in severe
circumstances. This section therefore:
- explains why private sector adjustment mechanisms do not suffice without an element
of fiscal risk sharing;
- then explains why the workings of national fiscal stabilisers, while essential, needs to
be complemented by the EU level in certain circumstances, in particular to protect public
investment;
- considers the state of play of stakeholders views in this respect;
- notes the availability of a legal basis (Article 175, TFEU) for building such an
instrument.
3.1. Existing lines of defence
In a currency union, there are several lines of defence against disruptive shocks.
Cœuré (2018) has pointed to a stylised description of three lines of defence needed to
deliver a stable currency. Flexible markets are crucial to start with, including also
12
In mature monetary unions (such as e.g. in the US), the single monetary authority has a counterpart of a
federal fiscal authority, which determines the fiscal stance for the monetary area and can support monetary
policy in its stabilisation policy. The euro area is marked by "an unprecedented divorce between the main
monetary and fiscal authorities" (Goodhart, 1998).
18
efficient financial markets across the zone (to which the banking union underway
contributes). Sound government policies are the second essential elements. In the fiscal
field, this includes in particular the need to build fiscal buffers in good economic times in
order to have space for absorbing shocks when those occur. Finally, some common
instruments have already been introduced to deal with crisis situations, notably the
European Stability Mechanism (ESM).
Integrated, European markets are indispensable to absorb economic shocks
efficiently across Member States. Such market mechanisms form the first line of
defence. The amount of private sector cross-country risk sharing through financial
markets remains relatively low in the euro area, providing a strong case for completing
Banking Union and capital markets union. Banking Union would also help severe
sovereign-bank doom loops. Nonetheless, private risk sharing is at the risk of running dry
in the downturn, mirroring the sometime pro-cyclical nature of market discipline, calling
for public risk sharing as necessary complement and enabler. Structural reforms can also
increase the economic resilience of Member States, as they help address macroeconomic
imbalances and lift economic potential.
National governments play a key role in the stabilisation of the European economy
against shocks. They can be considered as a second line of defence, as even well-
functioning markets cannot fully mitigate shocks. In particular, national public finances
provide a crucial extent of stabilisation, via automatic stabilisers and discretionary fiscal
policies. A build-up of fiscal buffers is needed in good times, but might still prove
insufficient in large downturns. Nonetheless, as analysed in section 2, even Member
States with strong fiscal positions might become constrained in their fiscal policy choices
due to market pressure.
Among existing common European instruments, the ECB is at the forefront of
regular macroeconomic stabilisation. The common monetary policy provides a first
response to stabilise the economy in the event of shocks affecting the whole area. Still,
there is a risk of overburdening monetary policy, especially when the interest rate is close
to the zero lower bound (ZLB). In addition, the European Stability Mechanism (ESM)
was created to deal with crisis situations. It provides financial assistance to Member
States and thereby acts as lender of last resort. However, markets tend to bite late but
harshly. The experience of sudden and sometimes excessive stops in market access calls
for a more preventive approach to support Member States hit by large shocks.
3.2. The need for economic stabilisation at the European level
Even with all these elements in place, national fiscal policies risk being
overwhelmed calling for support at the European level. In large economic downturns,
the combination of increasing deficits and falling nominal growth rates can generate
market uncertainty about the sustainability of public finances, even for countries whose
debt may be initially low. Limited fiscal space may prevent governments in a currency
19
union from efficiently and effectively using their national fiscal policy to smoothen the
impact of macroeconomic shocks. On the contrary, they may be hard pressed to cut
expenditures, with investment politically easier to cut, although with harmful economic
consequences in the short and longer term.
In normal times, the current setting, resting on prudent decentralised fiscal policy
and single monetary policy absorbing common shocks, seems to suffice in stabilising
the EU economy. This corresponds to the philosophy of the Maastricht Treaty: area-
wide shocks are tackled by monetary policy, while asymmetric shocks (affecting the
demand side) could be fixed by national fiscal policy. There is thus an important
justification to maintain a high level of subsidiarity in fiscal policy.
In this setting, fiscal prudence allows the automatic stabilisers to play in full,
absorbing the asymmetric economic shocks in real time, while ensuring the
sustainability of public finances in the medium term. National fiscal stabilisation
operates primarily via automatic stabilisers, meaning that a fall in tax revenues, an uptick
in social benefits and the inertia of other spending support the economy in downturns. To
enable the workings of automatic and discretionary fiscal stabilisers at the national level,
Member States need to create sizeable fiscal buffers, ensuring sustainable deficit and debt
positions.
However, in the presence of large shocks, the automatic stabilisers may become
insufficient to ensure proper stabilisation, especially in small open economies. Such
situations exemplify limits to the subsidiarity principle. Large shocks can put important
strain on a Member State's public finances, leading to a rapid increase in deficit and debt
levels. Significant market pressure can then build up, preventing the free operation of
national stabilizers. The crisis experience shows that even Member States with low levels
of public debt and seemingly sound public finances are not immune to this risk and might
be in need of further fiscal policy support. Figure 14 shows that small open economies,
such as Luxembourg, Ireland, Slovenia, Finland and the three Baltics, recorded very
large cyclical swings in output, much larger than the euro area average. These were
particularly acute during the financial crisis in 2008-10, with a sharp drop of output gaps
by around 14 percentage points and a strong persistence of negative output gaps in 2011-
2013. By contrast, the two largest economies of the euro area –also hit by the crisis –
experienced smaller cyclical fluctuations than the whole area. At the same time, the
automatic income stabilisation generated by the tax and benefits system represents below
40% for most of the euro area countries, as illustrated in Figure 15 (below 30% for one
third of them; see European Commission: Public Finances Report (2017) for a more
detailed discussion).
20
Figure 14: Disparities of cyclical variation
across countries (output gap)
Figure 15: Automatic income
stabilisation
Source/Note: The aggregate "Small open economies"
covers EE, IE, LT, LU, LV, SI, FI. The aggregate
"Two largest economies" covers DE and FR. based
on European Commission 2017 autumn forecast.
Source/Note: Degree of automatic income
stabilisation (in per cent) of the current tax and
benefit system with the degree of stabilisation
assuming a hypothetical average effective tax rate
(AETR). Authors’ simulations based on
EUROMOD using EU-SILC data. European
Commission: Public Finances Report (2017)
This is aggravated by the inability of an overburdened monetary policy to fully
respond to common negative shocks. When the monetary policy hits the zero lower
bound, that is, when key interest rates are very close to zero in nominal terms, it becomes
more difficult to relax it further to address negative shocks affecting the whole euro area.
Moreover, in better times, monetary policy will also be constrained if there is a risk for
financial stability.
The euro area therefore needs a fiscal instrument to help coping with large shocks.
In this sense European action is needed to overcome an overburdening of national
subsidiarity. As a vital complementary element, the stabilisation function should be
active in the event of large shocks affecting a Member State, or several Member States,
when the limits of other mechanisms and national policies materialise, posing great
economic risks for the Member State itself but also for the area as a whole. It would be
important to avoid that shocks and significant downturns result into deeper and broader
situations of stress. A stabilisation function would avoid such situations through the
possibility to support Member States under large stress. More adequate and
countercyclical fiscal policies at national level would also contribute to a more consistent
aggregate fiscal stance, entailing positive spill-overs for other Member States as well.
Moreover, the stabilisation function would support Member States when means for
stabilisation at the national level are narrowing down, but before recourse to financial
assistance is needed. Figure 16 summarises the value added of a stabilisation function.
21
Figure 16: The value added of a stabilisation function
Source/Note: Stylised illustration prepared by authors
3.3. Stakeholders’ views
There is a long history of public debate about a stabilisation function for Europe.
Before the creation of the euro area, reports committed by the European Commission,
namely the “Marjolin Report” and the “MacDougall Report”, pointed to the need for
sizeable central budgets, also to achieve fiscal stabilisation. At the launch of the euro,
only limited forms of fiscal union could realistically be contemplated. Proposals emerged
for mimicking the stabilisation properties of central budgets through tailored instruments
(e.g. Italianer and Vanheukelen (1993). The idea went partly dormant as the euro was
successfully introduced but renewed interest has come in recent years as the euro area
struggled to maintain balanced fiscal policies in the crisis aftermath.
Recently, the topic of a stabilisation instrument for the euro area has garnered
renewed attention. The political declarations from Member States in this debate have
been mixed, with some expressing strong support in principle for a stabilisation
instrument while others have shown scepticism. France has been amongst the most
ambitious advocates for central fiscal capacity, with President Macron (2017) proposing
a permanent, fully-fledged euro area budget that would finance common public goods
include migration, defence and disruptive innovation. The national ministries of economy
or finance from Italy and Spain have issued papers lining out proposals for specific funds
providing macroeconomic stabilisation (see below). While views floated in the German
government appear mixed, the coalition agreement includes a reference to "devoting
specific budget funds to economic stabilization, social convergence and structural reform
in euro zone. Those funds could form the basis for a future ‘investment budget’ for the
22
euro zone."13
In contrast, other Member States have been more sceptical of the need for
an instrument for the absorption of large economic shocks, as reflected in recent speech
by Dutch Prime Minister Rutte (2018). This was mirrored when the finance ministers of
six euro area Member States (Estonia, Finland, Ireland, Latvia, Lithuania, the
Netherlands) plus Denmark and Sweden did not mention a central fiscal capacity in their
priorities for EMU reform.
Other stakeholders than Member States have generally been supportive of the idea
overall. The European Parliament's Committees on Budgets and Economic and Monetary
Affairs issued a report on a budgetary capacity for the Eurozone in 2017 and the
European Parliament adopted a resolution outlining a roadmap for the creation of a
budgetary capacity for the Eurozone in 2017. The European Central Bank has seen a
fiscal capacity as an important part of EMU deepening (Coeuré, 2016). Other European
actors such as the European Economic and Social Committee14
have emphasized the need
for a fiscal union while the European Stability Mechanism has offered to support
financially a macroeconomic stabilisation function if one is created.15
In the academic literature, there is a wide array of papers supporting the case for a
stabilisation function for Europe, with some dissenters as well. Broad studies on
fiscal union have put forward the notion of a common stabilisation capacity for coping
with large shocks and share risks. This is in particular the case of surveys from
international organisations such as the IMF and the OECD (e.g. Allard et al. (2013);
Berger et al., 2018; OECD, 2018). These international institutions have made detailed
proposals for a central fiscal stabilization capacity, with variants of an insurance
mechanism and a common unemployment scheme. A non-exhaustive list of specific
proposals from economic papers includes Dullien (2009, 2013), Enderlein et al. (2013),
Pisani-Ferry et al. (2013), Delbecque (2013), Dolls et al. (2014), Drèze and Durré (2014),
Lellouch and Sode (2014), Beblavy and Maselli (2014, 2015), Carnot et al. (2015, 2017),
Benassy-Quéré et al. (2018), Arnold et al. (2018), Dullien et al. (2018) and Claveres and
Stratsky (2018). Some academics have however also warned against the notion of a
stabilisation function, or at least drawn attention to its risks (Feld and Osterloh, 2013;
Hebous and Weichenrieder, 2015).
In policy circles, there is an emerging debate when it comes to more specific
proposals. In October 2015, the Italian Ministry of Finance published a proposal for a
European Public Unemployment Benefit system, which was updated in August 2016.
Recently, the Spanish Ministry of Economy suggested a two-pronged stabilisation
instrument to help countries cope with large asymmetric shocks comprised of a grant-
based insurance mechanism and a loan-based scheme to support private investment. The
French Treasury published an outline of a euro area investment budget (Bara et
al., 2017). The European Commission outlined the need for a macroeconomic
13
Coalition agreement (2018)
14
Opinion: Euro area economic policy 2018, (ECO/444-EESC-2017-05444-00-00-ac-tra).
15
K Regling,Speech at the German Economic Institute and Association of German Banks, “The ESM’s
role in deepening monetary union”, March 2018.
23
stabilisation function in general in its "Reflection Paper on EMU" of May 2017 and
subsequently in its Communication to the European Parliament and European Council in
December 2017, where several options were considered.
Preliminary discussions among Member States at a more technical level have also
reflected varied views towards the value added and form of a central fiscal capacity.
First discussions at the Economic Financial Committee and among their alternates
confirm varied views. Notably, besides some supportive and some sceptical Member
States, there is a sizeable group of Member States who acknowledge the merit of in-depth
discussions but do not yet hold a firm view. The proposal to be presented by the
Commission in May could seek to bridge these gaps among Member States, although it is
likely that extensive subsequent discussions will be needed in order to create a consensus
on both the necessity and operational characteristics of such an instrument.
3.4. Legal basis
Article 175, paragraph 3, TFEU may be used as a legal basis for the stabilisation
function on condition that it can be established that that function is necessary to
strengthen the economic, social and territorial cohesion of the Union, in order to promote
its overall harmonious development, in particular by reducing disparities between the
levels of development of the various regions and the backwardness of the least favoured
regions. This would require that the functions deploys its aim of supporting the level of
public investment in specific sectors where it can be shown that maintaining that level
will lead to the economic, social and territorial cohesion of the Union. Besides, to
preserve the link with cohesion policy, financial consequences should ensue in case the
cohesion policy objectives have not been achieved.
4. OBJECTIVES: WHAT IS TO BE ACHIEVED?
4.1. General objectives
The general objective of a stabilisation function is to raise the cohesion and
resilience of the EU architecture, by supporting single Member States to withstand
large shocks. By reinforcing the capacity of Member States to withstand such shocks, it
should increase economic and social cohesion and convergence among Member States.
Such an instrument should allow national fiscal policies to follow a more predictable
course. It should complement the national fiscal stabilisers with a supra-national
intervention when needed, therefore removing a major source of disruption.
24
4.2. Specific objectives
More specific objectives can be delineated across six dimensions:
 First, it should contribute to a reduced amplitude and asymmetries of business
cycle fluctuations across Member States. To this end, it needs to be economically
meaningful, timely and effective. It would thus address the problem of sizeable
and only partially synchronised national business cycles.
 Second, it should contribute to a conduct of fiscal policies that is more counter-
cyclical, or at least reduce the risks of pro-cyclicality. It would thus help avoiding
the problems of strongly pro-cyclical consolidations and lack of building buffers
in good times.
 Third, it should contribute to smoother public investment trajectories and
economic cohesion, in particular to avoid ill-advised cutbacks in downturns with
negative impact on growth. It should preserve the flow of investments supported
by national budgets, ensuring stable levels of public investments, also in the event
of major downturns. It would address the problem of overreliance on cuts in
investment in periods of fiscal consolidation.
 Fourth, it should contribute to the prevention of full-fledged financial market
crises, including sovereign debt crises, through the provision of support when a
Member State faces difficult economic circumstances and tight financing
conditions on the markets. It should however not act as crisis management tool,
but rather a crisis prevention tool, making it distinct from the ESM and other EU
funds for investment. A stabilisation function is an in-between instrument. In this
logic, assistance from the ESM would be called upon if and after support from the
stabilisation function was not sufficient.16
 Fifth, it should preserve cross-country neutrality. The scheme is not aimed to
be redistributive and therefore should not lead to permanent transfers. It is also
necessary to preserve incentives for sound national policies. The stabilisation
function should in fact contribute to strengthening the economic governance
framework, including the application of rules for prudent fiscal policies. This
includes that it should be conditional on sound policies leading to convergence
within the euro area.
 Sixth, a stabilisation function should contribute to the integrity of the Union.
The setting up of a stabilisation function would send an important signal of
common commitment to the deepening of EMU. It would thus address the
problem encountered in the euro crisis when the currency union was questioned
in its very fundamentals.
16
In practice, in case of a very fast deterioration of public finances and significant market pressures, it is
not excluded that a Member State would take recourse to an ESM programme without prior support from a
stabilisation function.
25
A stabilisation function would find its place as a complement to existing tools in the
EMU architecture:
 It would act in conjunction with economic governance provisions, in
particular the rules governing the EU fiscal framework. To allow for an
adequate fiscal policy response in large downturns, the workings of a stabilisation
function and the application of the fiscal rules need to go hand in hand. As
discussed above, a stabilisation function would complement existing stabilisers,
in particular national fiscal policies. In deep downturns, the flexibility in the
Stability and Growth Pact allows for a measured fiscal policy response that
balances the primary objective of sustainable public finances with the dimension
of economic stabilisation. The stabilisation function could allow a better
reconciliation of the involved trade-off, by providing support in severe
circumstances and possibly also incentivising sounder positions in good times.
 A stabilisation function would operate as a crisis prevention tool, making it
different from existing forms of ESM assistance granted in support of a
macroeconomic adjustment programme, calling for a careful design of their
interaction. A stabilisation function would kick in case of a large shock, which is
less grave than a full-blown economic crisis. Ideally, it would allow cushioning
economic shocks to prevent recourse to the ESM. Still, in case financial
assistance becomes necessary, the operation of a stabilisation function needs to be
clearly delimited. For instance, support from a stabilisation function, which
operates via the provision of favourable loans, would cease with recourse to the
ESM in the event of full-blown financial assistance programmes. However, the
resources that would have been transferred by the stabilisation function to the
Member State would be covered by the programme envelope. By stopping the
stabilisation function when financial assistance is granted, the limited resources of
the stabilisation function could be used to stabilise economic activity in other
Member States particularly in those hit by negative spill-overs. By contrast a
stabilisation function, which operates via the provision of budget support or direct
spending programmes, would be complementary to financial assistance
programmes by the ESM and could thus operate in parallel and in conjunction
with those.
5. WHAT ARE THE AVAILABLE POLICY OPTIONS?
Different policy options are available for a stabilisation function, which are not
mutually exclusive. For the sake of simplicity, this section will focus on selected
stylised designs. It will link these to the proposal put forward by the European
Commission as part of the MFF proposal. All options have pros and cons vis-à-vis the
objectives of the stabilisation function. It should be noted upfront that the active policy
26
options below are non-exclusive and therefore can be combined. In this section, they will
be presented one by one.
On the question of the geographical scope, there are economic reasons to target a
stabilisation function on the euro area but a more inclusive approach can also be
defended. As lined out in the problem definition, the need for additional means of
macroeconomic stabilisation is particular pressing for the euro area, as national
stabilisers might become overburdened in absence of a country-specific foreign exchange
rates and monetary policies. This is why the adoption of such an instrument is more
especially desirable for euro area Member States, which is retained as working
assumption for the geographical scope in this impact assessment. However, it can also be
argued that participation in a stabilisation function would also be beneficial to non-euro
area Member States. Even before adoption of the euro, the additional macroeconomic
support provided by a stabilisation function could provide cushion for countries affected
by large shocks. There are also political considerations to assess in choosing between a
focused versus a more inclusive approach. One additional dimension to be considered is
that not-yet-euro area Member States may find it joining the scheme useful when joining
the ERM-II mechanism, since already at this stage their national monetary and exchange
rate policies might become constraint. This makes a case for extending the stabilisation
function to at least countries within ERM-II.
The categorisation of the policy options follows a taxonomy of designs. It focuses on
the conceptual nature of the instrument. This distinguishes between a borrowing-lending
scheme, an insurance mechanism, and a euro area budget.17
Within each of those general
options, sub-options and sub-varieties can be envisaged: sub-options pertain to issues
such as calibration, triggering criteria, eligibility conditions, and use of funds. Those
choices are also presented and discussed.
5.1. What is the baseline from which options are assessed?
Option 1: Status quo
The benchmark option would be to maintain the status quo. Over the past years, the
EMU architecture was strengthened and further improvements are underway, as
described in section 2. There could thus be a merit in further analysing the operation of
these innovations, also in light of political obstacles to additional innovations.
The status quo presumes that currently pending legislation and proposals by the
Commission would be adopted. Option 1 thus presumes that a backstop for the Single
Resolution Fund (SRF) is being put in place. This contributes importantly to furthering
the Banking Union but does not modify the analysis concerning the need for
macroeconomic stabilisation mechanisms. Option 1 presumes that the different proposals
17
A similar taxonomy was used in: “Options for a Central Fiscal Capacity in the Euro Area,” Euro Area
Policies, Selected Issues, IMF Country Report No. 16/220, July 2016.
27
for the capital markets union and the recent package on non-performing loans are in
place and yield the desired risk reduction in financial markets. Furthermore, the Reform
Delivery Tool is in place and creates additional incentives for needed structural reforms.
The status quo also assumes that the proposal for the creation of the EMF is
adopted, leading to more transparency and accountability in its operations and
decisions, but not per se entailing new instruments. It is possible that the ESM/EMF
shareholders establish new lending instruments, and in particular, eventually develop a
stabilisation instrument, which could be similar to the ones envisaged in the options
presented subsequently. The creation of such an instrument, while envisaged, is
nevertheless not enshrined in the legal provisions of the EMF proposed Regulation, and
therefore is not considered as being part of the baseline scenario. However, if the
ESM/EMF were in the future entrusted with such an instrument, it would be possible and
desirable that it works in complement to the options described below, in particular when
it comes to option 2. The possibility of complementary instruments backed by the EU
budget and by the ESM/EMF jointly contributing to enhanced macroeconomic
stabilisation is explicitly foreseen in European Commission (2017 D).
The status quo option would leave the euro area exposed to the risks evidenced over
the past and presented in previous sections. While the euro area economy is now
expanding again, the vulnerabilities exposed in sections 2-3 remain and the capacity of
the euro area and Member States to smooth large macroeconomic shocks is not yet
sufficient. In the presence of large shocks, even in highly integrated financial markets as
achieved by the completion of Banking Union, there is a risk of a pro-cyclical drop in
risk sharing in absence of central fiscal instruments (see section 2). Furthermore, the
automatic stabilisers may become insufficient to ensure proper stabilisation, especially in
small open economies. This may be aggravated by the inability of an overburdened
monetary policy to fully respond to common negative shocks (see section 3).
The cost of non-acting could range from moderate to very large. A moderate cost of
insufficient shock absorption capacities would consist in sub-optimal fiscal and public
investment policies, characterised as in the past by strong pro-cyclical tendencies,
notwithstanding the preventive effects of fiscal rules. This has significant costs in terms
of amplifying business cycles and their consequences on unemployment, as well as
compromising investments that foster long-run growth and productivity. But more
dramatic costs can also ensue in the baseline under a worst case scenario which would
involve a re-run of the past crisis or some variant thereof. This may eventually trigger
highly disruptive crises and increase risks of fragmentation of the zone, with the ultimate
risk involving a break-up with wide-ranging economic and political consequences for the
EMU and EU projects.
28
5.2. Description of the policy options
Option 2: Borrowing and lending scheme (favourable loans)
In a borrowing lending scheme a central agent, e.g. the European Union, borrows in
order to on-lend to the concerned Member State(s) at the same conditions it gets on
the market. Such a mechanism provides Member States with the necessary financing to
continue executing their budgets. In the Commission proposal, the support would be used
to maintain adequate levels of public investment in the cohesion sectors. In this particular
design, the loan is accompanied by a limited grant component in the form of an interest
rate subsidy. The latter would be used to further reduce the interest rate of the back-to-
back loan given to the Member State.
The size of the borrowing and lending scheme depends on the margin available
under the EU budget. In a similar fashion to the EFSM, all loans issued under this
option would have to be guaranteed in full by the EU's own resources. The ability to
issue loans would therefore be limited to an earmarked part of the headroom between the
own resources ceiling and the annual budget, the so-called margin. It would therefore
depend on the possibility to raise the own resources ceiling and on arbitrages with other
instruments based on the same margin. In numerical simulations, this document
considers a maximum volume of outstanding loans set between EUR 30 and 100 billion
(see section 6, in particular sub-section 6.1.3, for a discussion).18
Support is activated in case of large country-specific shocks, defined through
triggering conditions. Support should be targeted to situations where Member States are
especially hit by a large macroeconomic shock. To allow for timely and undisputed
activation, triggering should be automatic and rapid on the basis of pre-defined
parameters, as evoked in European Commission (2017 C). This document briefly review
some possible triggering criteria, including those based on output gap and GDP growth,
but favours and examines in more details triggering conditions based on unemployment
rates (see section 6, in particular sub-section 6.1).
A double condition on unemployment rates appears as a pragmatic option for such
an activation trigger. There is no perfect design or parametrisation of an activation
trigger, as the notion of an automatic criterion inevitably bears a degree of simplicity and
some imperfections. However, a pragmatic option, retained in the Commission proposal,
is a “double condition” on unemployment rates: it links the activation of the stabilisation
support to a condition involving both the level of the national unemployment rate
(compared to its past average) and the change in unemployment (compared to a certain
threshold). While not perfect, such a condition appears robust to characterise the
existence of large asymmetric shock and avoid significant 'mistakes'. Section 6 will
provide additional reflections on this matter, including simulations confirming the
adequacy of activation provided by the double condition.
18
Approximately 0.3% and 1% of GDP respectively.
29
To ensure that the availability of support through the stabilisation function does not
reduce incentives for prudent fiscal policy, strict eligibility criteria are needed. As
highlighted in section 3, prudent national fiscal policies remain primordial for an
effective fiscal policy response in case of large downturns. That is why conditions of
compliance with the EU surveillance framework appear needed as an eligibility criterion.
Given that option 2 entails mainly support in the form of loans which are legally required
to be repaid (as opposed to outright transfers, as would materialise notably in option 3),
the set of eligibility conditions could nevertheless be relatively focused.
A possibility to consider would be inspired by conditions employed in the
framework for macroeconomic conditionality. Those require that:
 Concerning fiscal surveillance, Member States in excessive deficit procedures
and in significant deviation procedures need to deliver effective actions.
 Concerning the Macroeconomic Imbalances Procedure, Member States shall not
repeatedly fail to deliver sufficient corrective actions plans or fail to take
recommended corrective action.
Therefore, under these conditions Member States could for instance be in an excessive
deficit procedure and still benefit from the stabilisation function, as long as they meet the
requirements from EDP recommendations. Such an approach avoids that Member States
are 'cut off' from the instrument at the very moment when they may need it the most.
In this approach, it is natural that the degree of support, as materialised by the
amount of lending granted, takes into account the size of the economic shock. Once
the triggering conditions for the stabilisation function have been met, the amount of
support given to a Member State could be determined as a function of an overall
envelope in conjunction with the severity of the shock. Box 1 provides a detailed
description. The use of an explicit formula for establishing the degree of support is
consistent with an instrument functioning in a quasi-automatic and predictable manner.
Timeliness and predictability are a key elements to ensure that support is available before
a full blown crisis could emerge. Automaticity also carries a signalling effect towards
financial markets, which can positively affect the borrowing conditions of concerned
Member States beyond the direct effect of the scheme.
The procedure for granting loans would be quasi-automatic. Once triggering
conditions and eligibility criteria are met, the concerned Member State would know that
it has access to the facility, should it wish so. A Member State would remain free to tap
into the lending made available by the stabilisation function, i.e. the procedure for
granting lending support would have to be initiated by the concerned Member State.
Once this is the case however, the support should come rapidly and in a quasi-automatic
manner. This is consistent with a timely stabilisation support and the objective of
preventing a difficult economic situation from getting worse. In this spirit, it would be
logical that once support is requested and again, assuming that the triggering and
eligibility criteria are met, the decision and implementation of support is left to the
European Commission, without involving a decision from the Council.
30
Box 1: Determination of size of the loan support
The maximum envelope for the loan support would be determined by:
𝐼𝑆 =
𝐴 𝑔 𝑃 𝐼 EU
𝐺𝐷𝑃EU
× 𝐺𝐷𝑃MS
The main component is the ratio of eligible public investment to GDP in the EU at current prices and on
average over a period of certain number of years (e.g. 5 years) before the request of the support:
𝐴 𝑒 𝑔𝑒 𝑃 𝑖 𝐼 𝑒 𝑒 𝐸𝑈
𝐺𝐷𝑃𝐸𝑈
. This ratio is calibrated by the GDP of the Member State concerned (𝐺𝐷𝑃𝑀𝑆 in
current prices and on average over a period of five years before the request for support). The underlying
logic is that an adequate level of public investment should be taken as a reference, while ensuring equal
treatment among Member States.19
The amount of the public investment level supported by the
stabilisation function is further scaled by a factor α. This factor reflects the maximum amount which can be
made available with the backing of the EU budget. This must be set taking into account the budget
constraint but also the probability and severity of shocks which could activate the stabilisation function in
the future. The latter two are estimated in reference to the past activation periods (see subsection 6.1.3 on
the numerical calibration of the parameters).
The actual amount of the loan to be granted would be a function of the severity of the shock. It
captures the increase of the national unemployment rate above the threshold that triggered the activation of
the stabilisation function. The formula below is applied:
𝑆 = × 𝐼𝑆 × 𝐼 𝑦 MS − ℎ ℎ
𝑆 ≤ 𝐼𝑆
Where β is a sensitivity parameter to the severity of the shock. The size of support is capped by the
maximum available level for a given Member State 𝐼𝑆 determined in the previous step.
In specific circumstances, the size of the loan can be topped up. In addition to the automatic
component, the Commission may decide, under specific circumstances to increase the loan up to the
maximum support Is. The Commission would take into account extraordinary factors including the increase
in the national unemployment rate of the Member State concerned.
To avoid budget overruns, two additional lines of defence should be introduced. At the aggregate
level, it could be provisioned that the outstanding amount of loans should not exceed a certain ceiling. In
addition, the support to a member state could be capped to avoid exhausting the remaining resources under
this ceiling. Although such provision may be required for budget certainty, to ensure that the loans
mechanism plays in full, it is important that they are binding only in exceptional and rare cases. For this
reason, the parametrisation of the support must be carefully calibrated.
This approach to decision-making would nevertheless differ from the procedure in
place for other instruments. In the case of financial assistance programmes such as
those granted under the EFSM, there is considerably more discretion in the decision-
making process, and the Council must make an explicit decision on a case by case basis.
However, these other instruments are usually related to a process of economic policy
coordination in the context of a macroeconomic adjustment programme and financing
19
An approach based on national public investment activity would entail that Member States with higher
levels of public investment would benefit more, raising questions of equal treatment.
31
needs are determined on a case-by-case basis. A heavy decision making process seems
therefore justified in these cases, while the stabilisation function would benefit from
having a light procedure given the quasi-automaticity of the formula.
To make the lending more attractive and effective, a grant component could be used
in order to de facto subsidize the interest rate charged on the back-to-back loans.
The purpose of such grants is two-fold: first, it can provide additional support to a
Member State undergoing an adverse economic event and facing particularly tight
financing conditions on the market without yet being in a financial assistance context.
Second, it would make the stabilisation function more attractive, also for Member States
benefiting from low interest rates on the market. A simple approach would be to
proportion the amount of grants to the interest costs pertaining to the back-to-back loan
that the Member State is availing of. The overall size and cost of the grant component
would therefore be limited and predictable. First, the interest subsidy could at most
compensate for the interest expenditure linked to individual loans. Second, the interest
subsidy would be proportional to the overall loan volumes.
This grant component could a priori be financed with different means, including
from the EU budget and/or from member states' contributions. As regards the
financing of the grant component, two options are possible. One possibility would be for
the EU budget to directly provide the interest subsidy. This would require a line in the
EU budget under the payments ceiling. That approach would have the advantage of
securing the interest subsidy as part of the EU budget, consistent with the provision of
lending also backed by the EU budget. A possible complication may nevertheless arise if
the geographical scope of the stabilisation function focuses on a subset of EU Member
States (such as the euro area). Still, amounts would be fairly small and this risk could be
attenuated by a careful design of the contributions to such financing. As another (non-
exclusive) possibility, Member States could voluntarily agree to pool national
contributions in order to allow for the financing of the interest subsidy. Irrespective of the
exact source of financing, the resources for a limited grant component could be pooled in
a dedicated fund.
Option 3: Insurance mechanism
An insurance mechanism would provide sizeable fiscal policy support to Member
States in the form of grants to cushion large shocks. Conceptually, it is comparable to
a rainy day fund, with or without the possibility of borrowing. Similar to an insurance, it
would provide pay-outs to Member States in pre-defined adverse circumstances. In
return, regular contributions or an own resource would be needed to balance the system
in the long run. The pay-outs could take the form of budget support or may be tied to
critical public expenditure, such as public investments or unemployment benefits.
Critically, an insurance mechanism would need to accumulate funds to be disbursed in
case of large shocks. At this stage, the Commission has not adopted a specific proposal,
but has stated the intention to complement option 2 with an insurance mechanism. A
stylised vision of an insurance mechanism is presented below, elaborating and discussing
selected design choices and sub-options.
32
Similar to option 2, the triggering and size of support in option 3 could be tied to a
double condition on unemployment rates. Also in case of an insurance mechanism the
double condition on unemployment would allow for a pragmatic measure of large
shocks. Similarly, the size of support would be tied to the size of the shock, e.g. the
increase in unemployment over and above a certain threshold increase, to ensure the most
effective distribution of means.
To ensure a balanced position a regular flow of resources is needed. They could take
the form of contributions from Member States or of a new own resource. Simulations
suggest that already a small, regular stream of resources would allow for disbursements
of sizeable support in the downturn. Resources could take the form of regular
contributions or could be scaled as a function of the business cycle and past access to the
insurance funds (in the logic of insurance premia). The latter features may be important
to ensure cross-country neutrality over time.
The possible addition of a borrowing capacity has important repercussions on the
functioning and impact of an insurance mechanism. In the absence of a borrowing
capacity, often referred to as a rainy day fund sensu stricto, an insurance mechanism
could only dispense support up to accumulated contributions. In practice, this could
entail that support runs dry during the downturn and/or create problems with regards to
the equal treatment of Member States due to the sequencing of support. A limited
borrowing capacity20
would solve these risks and allow for smaller accumulation of
funds ex ante. Nonetheless, it may complicate the political acceptability of such a
mechanism.
Option 4: A euro area budget
A common budget for the euro area would arguably be the most ambitious design
for a stabilisation function. The proposal was brought up several times in the past years
and has gained renewed attention. President Macron (2017) called for a euro area budget
for common investments and to ensure stabilisation in the event of economic shocks.21
In
practice, a common budget would involve permanent own resources on the revenue side
and permanent spending functions on the expenditure side.
In this case, the stabilisation effect comes from the cyclicality of the revenues or
expenditures comprising the budget. In option 2 and 3, the stabilisation properties of
the instruments are generated by their activation and dis-activation depending on
economic shocks. A common budget would not primarily target economic stabilisation,
but rather the provision of European public goods. Still, reliance on cyclical revenues
(e.g. corporate income tax) and countercyclical spending (e.g. unemployment benefits)
contribute to macroeconomic stabilisation via automatic stabilisers at the EU level. In
20
Borrowing against future incomes of the fund while maintaining solvability.
21
Macron, “Initiative pour l'Europe - Discours d'Emmanuel Macron pour une Europe souveraine, unie,
démocratique”: http://www.elysee.fr/declarations/article/initiative-pour-l-europe-discours-d-emmanuel-
macron-pour-une-europe-souveraine-unie-democratique/
33
addition, one could foresee discretionary elements which could further foster stabilisation
properties.
A combination of options
A combination mixing the above approaches is conceivable. As will emerge from the
assessments of the options (see notably the conclusions of sub-section 6.5), the options
can be seen as fulfilling the objectives in a complementary manner. It is therefore
conceivable that they co-exist in a long-term perspective. It is also possible to conceive a
step-based approach to the stabilisation function.
As a first step of a phased approach, one could envisage a loans facility, together
with limited grants that would allow favourable interest rates, in order to support
public investment. A Member State facing a large asymmetric shock would
automatically be entitled to benefit from available financing provided through the
stabilisation function. The support would mostly rely on loans, to be supplemented with a
limited grant support. The EU budget would provide back-to-back loans. Grants from the
EU budget would be used to achieve particularly favourable interest rates to the benefit
of Member States. Such an approach was discussed in European Commission (2017 D)
and corresponds to option 2.
In a later, second step, one could envisage the creation of an insurance mechanism.
This suggestion was proposed by European Commission (2017 D) as a second step to be
implemented in the future when conditions for it are met. This corresponds broadly to
option 3.
6. IMPACT EVALUATION OF THE OPTIONS
22
This section analyses qualitatively and quantitatively the value added of the various
options (laid out in section 5) in reaching the objectives (exposed in section 4).
Option 1 will serve as benchmark against which proposals are assessed. The section lays
out the main channels through which the different options would contribute to
strengthening the resilience of the European economies and to the achievement of the
specific objectives. As appropriate, quantitative methods, such as simulations and
regressive analysis, are used to substantiate the qualitative evaluation.
This section evaluates the choices to be made and the relevance of the different options
along three dimensions:
 The selection of the activation trigger, which needs to be timely. This is a
common issue for option 2 and option 3. Therefore, the discussion of the
22
This regroups the questions: What are the impacts of the policy options? How do the options compare?
What are the preferred options?
34
activation trigger will be made irrespective of that option. In the case of a full
budget (option 4), there is no need for a trigger.
 The stabilisation power. This is the effectiveness of the scheme in absorbing
asymmetric shocks, allowing the conduct of smoother fiscal policies, and
preserving public investments.
 The cross-country neutrality. This relates in particular to the absence of
permanent transfers, and means to secure that objective.
6.1. Selection of the activation trigger
An activation trigger is a crucial element in option 2 and 3. Its design and
calibration are discussed in detail in this sub-section. The Commission
Communication on new budgetary instruments for the euro area calls for a stabilisation
function that is 'timely and effective'. For eligible countries, "triggering should be
activated automatically and rapidly on the basis of pre-defined parameters (for example,
based on a large temporary negative deviation from their unemployment or investment
trend)". The objective is to complement the national stabilisers in the event of "large
asymmetric shocks".
6.1.1. Choice of trigger variable
The triggering criterion should be based on the evidence of large cyclical shocks
affecting the concerned Member State(s).
The possible options are:
i. The output gap. In theory, the output gap is the most straightforward indicator of
cyclical developments, but it faces implementation issues.23
In practice the output gap is
'unobservable' and its estimation reflects many assumptions. Given the possible
controversies over measurement and the large revisions of the output gap over time, it is
probably not the best option to base the activation of a macroeconomic stabilisation
function on.
ii. GDP growth. Two sub-options:
 Recession (negative growth) as the trigger. This option is limited by the large
differences between Member States regarding their potential growth (Malta:
5.6%; Ireland: 5.1%; Greece: -0.9%; Italy: 0.2% - figures for 2017 from
Commission autumn 2017 forecast). Using recession as a criterion would
massively skew the scheme in favour of countries with the lowest potential
growth.
23
The gap between actual GDP and potential GDP. This gap reflects mainly cyclical demand shocks, such
as a fall in export markets. The stabilisation function aims at smoothing out the effects of such large
shocks, without however providing permanent support and substituting for needed adjustments.
35
 GDP growth compared to trend growth. To correct for the limitation of the above
option, GDP growth could be compared to its trend. This indicator is therefore
equal to the change in the output gap. It is therefore exposed to the problem of
unobservable variables (although with lesser uncertainty than on the level of the
output gap). In addition, there would be situations where the sole information
from the change in the output gap is too limited: for example one may not wish to
support a country with a positive level output gap just because the output gap is
declining.
iii. An unemployment rate trigger. The unemployment rate has several valuable
properties: it is well-known, harmonised, available at high frequency with short delays,
and subject to limited revisions. It is an excellent indicator of the business cycle, purging
some of the short-term noise of GDP (Figure 17). It reacts however with some lag to the
business cycle. This may not be such an issue for a stabilisation function focused on large
shocks. Moreover the effects of shocks on public finances also tend to lag the growth
cycle and actually to more or less match the unemployment cycle. In addition, it is
important for the credibility of the system that in the initial phase of the shock national
automatic stabilisers and policies are
called to operate. Thereby the lag
reflecting the use of unemployment level
until the stabilisation function is
activated, would not undermine the
utility of the latter. A more significant
potential limitation of the unemployment
rate, however, is that its sensitivity to
cyclical shocks may differ across
Member States, for example because
some economies have more developed
working-time arrangements in
downturns.24
Another technical
consideration is the risk that the
assessment of cyclical developments are
affected by structural improvements in
labour markets, but such effects appear
limited empirically.
iv. Discretionary approach based on a set of indicators. A fourth option would be
based on a set of indicators to identify the presence of a large cyclical disturbance for the
Member State. The indicators can include notably business surveys, GDP, the labour
market and inflation. It is however likely that such an approach based on a range of
indicators would have to involve a degree of judgment (i.e., not just reflect a 'pre-defined'
algorithm, as the latter would be very challenging to write down to cover all possible
24
Working hours could be a superior indicator conceptually, but their harmonized measurement is much
less assured than for unemployment.
Figure 17: Cyclical indicators, the output
gap and the unemployment rate
Source/note: Eurostat, and AMECO. The opposite of
the unemployment rate (in blue) replicates closely the
fluctuations of the output gap (in yellow).
36
situations). This may be the most encompassing avenue from an economic viewpoint, but
it conflicts with the automatic nature of the triggering.
Overall, an unemployment based trigger appears as a viable pragmatic option for
the activation of support. This line of reasoning favouring the unemployment rate as the
indicator to trigger the mechanism is found in several recent studies (see Table 1) as well
as in the European Fiscal Board's Annual Report (2017). Across the literature, broad
support has emerged to favour the unemployment rate as basis for the trigger indicator.
6.1.2. Choice of trigger design and parametrisation
A stabilisation function for the euro area should cushion large asymmetric shocks
only, calling for prudent activation and limiting the risk of questionable support. As
highlighted in the 6 December Package, national fiscal policies, monetary policy and
structural reforms remain the core levers to ensure reliance in the wake of downturns.
The stabilisation function is supposed to complement these in case of truly large
asymmetric shocks, calling for a calibration which places much emphasis on avoiding
unduly support. Such a restrictive approach appears essential to prevent moral hazard and
permanent transfers. Nonetheless, it would entail an opportunity cost in the sense of
sometimes not providing support even though a case could be made for it.
The technical discussions around an unemployment-based activation trigger focus
on two designs: a simple trigger and a double trigger (Table 1). Simple triggers can
refer to either the level or the change in unemployment. Arnold et al. (2018) and Dullien
et al. (2017) propose the mechanism to be triggered if the level of unemployment rates is
above previous years averages. A group of French-German economists (Bénassy-Quéré
et al., 2018) propose to trigger the mechanism if the unemployment rate increases
significantly. In either cases, thresholds can be introduced to react only to large
deviations. Both concepts have merits, such as a higher extent of simplicity. A double
trigger, in contrast, combines both a condition on the level and on the change in
unemployment. It has been proposed by Carnot et al (2017) and Claveres and Stráský
(2018).
37
Table 1: Comparison of activation triggers proposed in the literature
Carnot et al.
(2017)
Dullien et al.
(2017)
Arnold et al.
(2018)
Claveres and
Stráský (2018)
Bénassy-Quéré
et al. (2018)
Double condition:
- unemployment
level above the 10-
15 years moving
average
- unemployment
rising, possibly
above a threshold
Level of
unemployment
rate exceeding
average level of
past 5 years, by 0.2
pp for national
compartment, by
2.0 pp for stormy
day fund
Level of
unemployment
rate above 7
year moving
average (in pp or
in %)
Double
condition:
- unemployment
level above the
10 year moving
average
- unemployment
rising
Change in
unemployment
rate,
employment or
wage bill
above/below a
threshold (e.g. 2
pp for
unemployment)
The specific approach that is favoured here relies on a condition involving both the
level and the rate of change of the national unemployment rate. Specifically, in light
of the simulations presented in what follows, the stabilisation support could be triggered
based on the observation of both:
 An unemployment rate above the historic average of the country, for example its
average over the past 10-15 years. This condition is needed to put countries on
par, irrespective of their permanent (structural) level of unemployment;
 An unemployment rate that is increasing over the past year. To restrict the
activation conditions further, it is considered that the increase should go beyond a
certain threshold, specifically 0.5-1.5 percentage point, with a value of 1.0
percentage point taken as the central assumption. The amount of support should
be linked to the increase in the unemployment rate (beyond the threshold if there
is a threshold).
Such a double condition, especially when incorporating a threshold, ensures with a great
degree of assurance that the Member State is indeed confronted with a large shock with a
temporary and country specific element. With a threshold set between 0.5 and 1.5
percentage point (i.e. increases below this value does not trigger the mechanism),
between one third and four fifth of the unemployment increases would be entirely left to
the responsibility of the national stabilizers (Figure 18). Based on past experience, for a
threshold of 1 percentage point, the frequency of activation would be slightly above 10%
(i.e. once per decade for a country) (Figure 19).
38
Figure 18: Proportion of unemployment
increases above a certain value
Figure 19: Frequency of activation
depending on the threshold
Source: Eurostat, authors’ calculations based on
year-on-year increases in quarterly unemployment
rates since 1985. Available data may start later for
some Member States.
Source/Note: Eurostat, authors’ calculations.
Based on simulation for the EA19 since 1985.
Coloured areas correspond to the range of values
for reference rates computed over10 to 15 years.
This dimension only has a secondary effect on the
frequency of activation especially with the double
trigger.
The double condition allows for support to be targeted at times of sizeable economic
worsening. Figure 20 and Figure 21 illustrates the application of the simple trigger and
the double trigger on the unemployment rate. The double trigger targets more specifically
the situations where unemployment is rising, i.e. times of economic worsening. In
comparison, a simple trigger offers support also when the recovery is already on track.
For both kinds of approaches (single or double trigger), a threshold can allow support to
be less often distributed (Figure 20.b. and Figure 21.b.). This option is not very attractive
for the simple trigger as it mostly delays the support, but for the double trigger it allows
not to provide support when the economic shock is deemed minor.
39
Figure 20: Illustration of activation of
support with simple trigger (Irish case)
Figure 21: Illustration of activation of
support with double trigger (Irish case)
a. no threshold a. no threshold
b. threshold 1 pp b. threshold 1 pp
Source/Note: European Commission 2017 autumn forecast, authors’ calculations
reference rate = 15 year moving average of the unemployment rate
Simulations for the EA19 since the mid-nineties confirm that the double trigger is
more targeted than the simple one. In particular, during the period 2009-2014 the
double trigger would have induced two peaks of support for 80% and 40% of the
Member States (Figure 22) which weighted for a similar fraction of the euro area GDP
(Figure 23). On average over the period, support would have been granted for almost
12% of the cases with the double trigger (more than 34% with the simple trigger). This
frequency of activation depends largely on the chosen threshold: a higher threshold
leaves the adjustment to larger shocks under the sole responsibility of Member States and
therefore provides support less often (Figure 19). Without threshold, the mechanism
proposed would provide support in up to 30% of the cases while with a threshold of 2.5
40
percentage points on the annual increase in unemployment this frequency would fall
below 5%.
Figure 22: Share of EA19 countries which
would have been under support
Figure 23: Share of EA19 countries which
would have been under support (GDP
weighted)
Source/Note: Eurostat, authors’ calculations
Reference rate computed as the average over the past 10 years.
6.1.3. The total support envelope for option 2
The parameterisation of the amount of support entails a trade-off between the
available budgetary means and the macroeconomic meaningfulness of the support.
Technically, the choice of the amount of lending available for a Member State fulfilling
the conditions is reflected in the parameters 'alpha' and 'beta' in the formula for granting
support (see Box 1 above):
 As lending would be backed by the EU budget, the setting of those parameters
has to be broadly proportionate to means made available for the purpose in the
EU budget. Specifically, the ability to issue loans under option 2 is limited to an
earmarked part of the headroom between the own resources ceiling and the
annual budget, the so-called margin. This limitation corresponds to a prudent
strategy by which the EU budget can guaranty in full all emitted loans.
 At the same time, the amounts made available must be of a meaningful
macroeconomic size in comparison with the borrowing needs of Member States,
particularly with regard to the financing of their investment expenditures. While
the shares of public investment of GDP vary across Member States within a range
of 2-4 percent, it can be considered that meaningful support in the event of a
severe shock should be sufficient to fund a significant fraction of that total. In
practice, it can be considered that the availability of financing support should
41
reach at minimum a few tenths of percentage points of GDP for large shocks.
More significant support would be of the order of 1 percent of GDP or even
above in the event of very large shocks.
Using backward simulations, it is possible to give a conservative estimation of the
maximum support affordable per Member State, given an overall ceiling for the
total lending capacity of the stabilisation function. This estimation is such that over
the past periods of activation of the scheme (and in particular the recent crisis), it would
have been possible to provide all the loans due without breaching a given overall total
ceiling. To provide an illustrative range, two values for such an overall ceiling are
considered, specifically EUR 30 billion and EUR 100 billion (i.e., between 0.3-
0.9 percent of euro area GDP). For these values of the total lending capacity of the
instrument, the maximum support affordable under option 2 for a Member States in a
given year ranges between 0.2% and 1.3% of the Member State's annual GDP, depending
on the choice of total ceiling and other parameter choices (Table 2 and Table 3).
Overall, a total ceiling for the lending capacity in the lower range envisaged
(30 billion) allows supporting a non-negligible but limited fraction of public
investment, while a higher overall ceiling (100 billion) allows supporting a
proportionally higher fraction of public investment:
 For an envelope of EUR 30 billion (0.28% of euro area GDP ), simulations run
for the period 1985-2017 show that the maximum support which could have been
provided on an annual basis ranges from 0.21% to 0.40% of the Member State’s
average GDP over the previous five years in current prices (Table 2). This
corresponds to a value for the parameter α ranging between 7% and 14%. It
corresponds for the parameter β to a value ranging from 0.5 to 2.
 For the higher total envelope of EUR 100 billion, the maximum support and the
parameter α must be scaled up while the parameter β is unchanged. The
maximum support then reaches up to 1% percent of national GDP or even a bit
more, depending on the other parameterising choices.
42
Table 2: (Option 2) Affordable maximum
support (on an annual basis, in percent of
national GDP) depending on the plausible
range of parameters and for an envelope of
0.28% of EA GDP (EUR 30 billion)
Table 3: (Option 2) Affordable maximum
support (on an annual basis, in percent of
national GDP) depending on the plausible
range of parameters and for an envelope of
0.93% of EA GDP (EUR 100 billion)
Threshold
Severe shock
0.5p.p. 1 p.p. 1.5p.p.
10 years
2 p.p. 0.21 0.26 0.32
2.5 p.p. 0.24 0.30 0.38
15 years
2 p.p. 0.24 0.29 0.35
2.5 p.p. 0.27 0.34 0.40
Threshold
Severe shock
0.5p.p. 1 p.p. 1.5p.p.
10 years
2 p.p. 0.68 0.85 1.05
2.5 p.p. 0.80 1.00 1.26
15 years
2 p.p. 0.80 0.97 1.15
2.5 p.p. 0.91 1.12 1.35
Source: Author's calculations
Reported numbers correspond to the maximum support, which can be provided as a percentage of the
Member State's GDP if it receives a maximum support for the quarters of the same year.
Concerning the setting of other parameters, the maximum support available to a
Member State is higher when (see Tables 2-3):
 the threshold on the increase in unemployment for triggering support is higher.
The maximum support is highest when the threshold is set at a 1.5 percentage
point increase in unemployment, and lowest for a threshold of 0.5 percentage
point increase. A value of 1.0 percentage point may be a good compromise
between maximising support on very large shocks and timely activation.
 the reference period for calculating average past unemployment is longer (15
years versus 10 years);
 the amount of support is modulated as function of the severity of the shock (i.e.,
is a proportion of the increase in unemployment rate beyond the threshold point,
as in the formula of Box 1, and as opposed to a fixed amount). This latter point is
further explained and documented below (see sub-section 6.1.4).
The grant component associated to the loans would only be a fraction of the loans
issued. To make the loans more attractive, it can be envisaged as noted above that the
interest rate cost would be (partially) covered by a grant. The estimation of the needed
resources for that purpose is highly uncertain as it depends on the degree of effective
take-up of the available loans, as well as the implied degree of subsidisation of the
financing. An upper bound can be gauged by assuming that the full lending capacity of
the scheme (EUR 30-100 billion) is being mobilised, with a significant interest subsidy
that can illustratively be set at 200 basis points.25
25
This assumption can be rationalised by assuming that the borrowing rate of instruments backed by the
EU budget is likely to revert up from its low level to at least 2% in the medium-term. A 200 basis points
subsidy can therefore allow the provision of lending which in the best of case would effectively be interest
free.
43
Under these assumptions, the amounts corresponding to the 'grant component' of
the scheme could reach a maximum of between EUR 0.6-2.0 billion per year. From a
macroeconomic viewpoint, this is relatively small, as it corresponds to between 0.006-
0.02 percent of euro area GDP.
6.1.4. A modulated amount of loans can provide larger and more targeted
support
When the mechanism is triggered, the support can either be a fixed amount or
modulated depending on the severity of the shock. For the loan mechanism (option 2),
both possibilities have pros and cons:
 An approach with a fixed amount is simpler but its main drawback is to treat quite
differently (no support vs. full support) two countries in almost identical
situations (just below and just above the triggers). However, as Member States
may use only partially the loan facility, some modulation may already be at play
even with the option of a fixed amount. This option may in addition be attractive
as it allows to control the budget envelope of the mechanism.
 The modulated amount option is not subject to the unequal treatment drawback
and can avoid budget slippages by setting a maximum support, as proposed by the
Commission (Figure 24). In addition, this option, for a given budget, will have a
larger macroeconomic impact in cases of severe shocks.
Figure 24:Commission proposal for a support
modulated by the severity of the shock to the
unemployment rate
Figure 25: Maximum support which can be
provided in the case of modulated amounts
over the fixed amount affordable with the
same envelope
Source/Note: Authors’ illustration
No support is available for an increase in unemployment
below the threshold. The amount of support is
proportional to the increase in unemployment beyond the
threshold. It reaches a maximum for a "severe shock".
Source/Note: Eurostat, authors’ calculations
Based on simulation for the EA19 since 1985. The
figure compares for a fixed budget the maximum
support which can be provided in the case of modulated
amounts and in the case of fixed amounts
"severe shock"
threshold Unemployment
shock
Max
support
Support
44
The balance of arguments is yet more
clearly in favour of a modulation of
support. For the same total available
envelope, a modulated amount option
can provide larger support to countries
under a severe downturn. Simulations on
the period 1985 to 2017 show that
modulating the support allows to provide
much higher support in cases of severe
shocks for the same total envelope (with
a threshold of 0.5 to 1.5 percentage point
and a severe shock set to be above 2 to
2.5 percentage points, the support
provided can be from 1.2 times as high
to 1.9 times as high, Figure 25).26
Taking into account the modulation of
the support, the stress put on the
mechanism would be lower at each
point in time. Figure 26 recalls that
Member States weighting up to 70% of
the EA GDP would have been under
support at the peak of the crisis.
Modulating the support based on the
severity of the shocks affecting each Member States however limits the "activity rate" of
the stabilisation function to 30%, i.e. only a fraction of the maximum support would have
been effectively made available.
Under the assumption that the recent crisis was exceptional in magnitude and
duration, a less conservative calibration could target larger maximum support. Over
the past four episodes of large downturns in the euro area, the recent crisis and its double
dip would have stressed the stabilisation function the most, leading to the highest activity
compared to maximum available loan support (see Figure 26). Cumulated support would
have been much smaller in the nineties and the early 2000s, suggesting that a more
generous calibration would be possible if these were considered representative. The
comparison between the first episode of stress and the last one exemplifies also the
different scope of support. In both cases the crisis was broad-based and affected large
Member States (Figure 23), yet the crisis was less severe in the nineties which explains
why the provided support would have peaked at a much lower activity rate.
26
The modulation of support with the severity of shocks is even more warranted in the case of option 3 (the
insurance mechanism) than for option 2. Indeed, the modulation is more in line with the spirit of insurance
and considerations of equal treatment are more prominent in case of payouts/grants. This assessment is
confirmed by the literature on insurance mechanisms, which exclusively considers amounts modulated
with the severity of shocks. See Arnold et al. (2018,) Claveres and Stráský (2018), Bénassy-Quéré et al.
(2018), Carnot et al. (2017).
Figure 26: GDP weight of supported
Member States and effective activity rate of
the stabilisation function
Source/Note: Eurostat, authors' calculations.
The share of supported GDP correspond to the one
reported in Figure 23. Activity measures the share of
the maximum annual loan support used in the euro
area.
Reference rate for the unemployment level is
computed as a 10 year average, threshold is set to 1
percentage point and maximum support is provided
above 2.25 pp. increase in the unemployment rate.
45
6.1.5. Simulation of past functioning
Figure 27: Support simulations over between 1985 and 2017
1985Q1 to 1986Q4 1991Q2 to 1995Q3
2002Q3 to 2005Q1 2008Q3 2014Q1
Source/Note: Eurostat, authors’ calculations
Based on simulation for the EA19 since 1985. "Inactive" means that the double trigger condition was not fulfilled in any of the
quarters by the Member State. A "small", "moderate", "large" and "maximum" support corresponds to respectively less than 25%,
50% and 75% and more than 75% of the maximum support on average over the period. In practice no Member State would have
received on average more than 75% of the maximum support (except Cyprus for which simulations are possible only since 2012), but
some would have received this maximum over a fraction of the period.
The stabilisation function would have been active in four periods since 1985. The
first period (1985Q1 and 1986Q4) corresponds to the end of a recession, which started
before the beginning of our sample. The second period corresponds to a recession in the
46
early to mid-nineties (1991Q2 and 1995Q3), the third to the aftermath of the burst of the
dotcom bubble (2002Q3 and 2005Q1) and finally to the recent crisis (2008Q3 2014Q1)
characterized in Europe by a double dip. During each of these periods, some countries
would have received some support from the stabilisation function. Outside these periods
none of the Member States in the sample would have been offered support.27
Across the four periods of activity, different member states would have benefited to
a different degree from support (Figure 27). The distribution of support reflects both
the intensity of the shock and its asymmetry. In the mid-nineties, Finland and Spain
would have benefited the most from support while many other Member States, less
impacted, would have received a small support. In the early 2000s, the euro area
underwent a moderate downturn and Portugal, Greece, Germany and its neighbours
would have benefited from the stabilisation function. In the recent crisis, more countries
are included in the sample. Simulations highlight the most crisis hit countries (Cyprus,
Greece, Italy, Spain, Portugal, Ireland, but also the three Baltics) as the main
beneficiaries of support.
6.1.6. The financial calibration of the insurance mechanism
For the operation of option 3, a regular flow of resources is needed to ensure a
balanced position. They could take the form of contributions from Member States or of
a new own resource. For the sake of simplicity, this Impact Assessment focuses on
contributions from Member States, in line with the literature (Table 4). Such
contributions can be a fixed fraction of the country's GDP (Arnold et al., 2018, Dullien et
al., 2017). It is also possible to modulate the contribution based on the volatility of the
Member States, i.e. on the probability that it requires support (Bénassy-Quéré et al.,
2018), or on the past use of the insurance (a form of experience rating, Claveres and
Stráský, 2018, Carnot et al., 2017). Contributions can also be called when the fund is in a
deficit (Claveres and Stráský, 2018) or when the Member State is in a favourable
economic situation (Carnot et al., 2017). These options are often combined (Table 4) and
aim at ensuring a neutral position on average of each Member State vis-à-vis the
insurance mechanism (see section 6.3).
Simulations suggest that already a small stream of resources would allow for
disbursements of sizeable support in the downturn. Regardless of the contributions
design, the insurance mechanism should be balanced: the expected pay-outs should be
equal to the expected revenues. Proposals from the literature suggest that average
contributions to the amount of 0.1% to 0.35% of GDP would already allow a significant
stabilisation potential (see section 6.2). Against annual contributions of 0.1% of GDP on
average, if Member States are entitled to a support from option 3 in the same conditions
as for option 2 (double trigger with a threshold on the change in unemployment between
0.5 and 1.5 percentage point) and if in addition the pay-out received is proportional to the
change of unemployment beyond the activation threshold (without a maximum),
27
Simulations presented in this section take a 15-year average for the reference rate, a 1 percentage point
threshold and a 2.25 percentage point "severe shock". Some small blips of activity can appear with less
restrictive parametrisation (e.g. around 1999-2000 in Figure 22)
47
simulations for the years 1985 to 2017 show that the insurance mechanism would be
balanced over time while providing 0.13 to 0.36% of the Member States annual GDP for
an annual increase in the quarterly unemployment rate of 1 percentage point above the
threshold.
Table 4: Comparison of the contributions to the insurance mechanism and its borrowing
capacity proposed in the literature
Carnot et al.
(2017)
Dullien et al.
(2017)
Arnold et al.
(2018)
Claveres and
Stráský (2018)
Bénassy-Quéré
et al. (2018)
Modulated
contribution:
~0.1% of GDP on
average
when
unemployment
below the 10-15
year moving
average and
decreasing
(proportional to
unemployment
decrease, fully
symmetric to
support), plus
experience rating
Modulated
contribution:
0.1% of GDP per
year
(80% going into
national
compartment, 20%
into stormy day
fund)
Higher
contributions for
countries with
'cumulative
deficits' when
unemployment
falls 0.5pp below
average of past 3
years
Fixed
contribution:
0.35% of GDP
per year
Modulated
contribution:
~0.15% of GDP
on average
Two
components
(i) 0.1% of GDP
by all countries
each time the
fund’s alan e
drops below -
0.5% of EA GDP
(ii) 0.05% of GDP
for every time
the support
scheme has
been activated
in the past 10
years
(experience
rating).
Modulated
contribution:
~ 0.1% of GDP
incl. during
crisis, modulated
depending on
countries
volatility
Borrowing capacityBorrowing capacity Borrowing
capacity
Borrowing
capacity
No borrowing
capacity
The insurance mechanism could not operate at its full potential without a
borrowing capacity. Most contributions in the literature suggest that the insurance
mechanism has a borrowing capacity (Table 4). If the insurance mechanism cannot
borrow against future incomes, its ability to operate in full is dependent on the sequence
48
of shocks and contributions. Simulations show that the net positions of an insurance
mechanism are bounded, whether contributions take the form of a fixed contribution
(Figure 28), or a contribution when the unemployment is low and decreasing (Figure 29).
The insurance mechanism would have been ineffective had it be put in place right before
one of the peak of activations. Most importantly, the insurance mechanism without a
borrowing capacity would not have been able to face the recent crisis' double dip, even if
it had been established in 1985.
Figure 28: Net financial position of an
insurance mechanism financed by fixed
contributions by starting date (% of GDP)
Figure 29: Net financial position of an
insurance mechanism financed by
modulated contributions by starting date
(% of GDP)
Source/Note: Eurostat, authors' calculations.
Calculations based on a threshold of 1 pp, a
reference rate computed over 15 years and a fixed
contribution of 0.1% of GDP
Source/Note: Eurostat, authors' calculations.
Calculations based on a threshold of 1 pp, a
reference rate computed over 15 years and an
average contribution of 0.1% of GDP
6.2. Stabilisation impact
6.2.1. Main qualitative impact
The main direct economic impact of a borrowing lending scheme (option 2) would
be to reduce the average cost of debt for a Member State facing a large shock. This
would provide an important signal and may help stabilise markets. It would also reduce
the interest burden of the concerned Member State, and provide financing to preserve
public investment. The loan would facilitate access to financial markets at favourable
rates, which would support the execution of the foreseen public investment. Box 2
provides econometric evidence of this channel.
The main economic impact of an insurance mechanism (option 3) would be to
provide significant breathing space to the national budget of a Member State facing
a large shock. This would allow in particular preserving public investment and running a
49
more supportive fiscal stance, thereby contributing to smoothing out the effect of the
shock on growth, employment and private spending. An insurance mechanism could
therefore replicate the stabilisation properties of a very sizeable common budget.
Some macroeconomic effects of an insurance mechanism are documented in the
literature. Claveres and Stráský (2018) find that for average contributions of 0.5% of
GDP an insurance mechanism could have mitigated the trough of the crisis by more than
1% of GDP. Assuming that the pay-outs from the insurance mechanisms would have
been spent on top of the observed past expenditure, Dullien et al. (2017) argue that for
Spain, GDP could have stayed 2.5% higher during the crisis. For Italy, they show that the
impact would have been lower than 1% of GDP because the increase in unemployment
was less marked. Arnold et al. (2018) exemplify the stabilising impact of an insurance
mechanism using macroeconomic model simulations similar to the ones presented below
with Quest. Their simulations show that one third of the shocks can be cushioned by the
insurance mechanism. Their simulations also confirm that a borrowing capacity is needed
for the insurance mechanism to operate at its full potential. A third result from their
simulations is that the insurance mechanism can substantially reduce the cross country
dispersion of the output gap.
Box 2: Relationship between interest rates and public investment
The literature on public investment shows that an increase in interest rates is detrimental to public
investment. European Commission (2017 E) provides a comprehensive empirical analysis of the determinants of
public investment, based on a panel spanning 21 years and the 28 EU Member States using of a wide set of
control variables and estimation strategies. In almost all specifications, it finds a highly significant and sizeable
causal relationship between market interest rates and public investment.
As part of this impact assessment, Commission staff has run an additional, more targeted regressive
analysis. Compared to existing work, it focuses on the recent crisis experience, namely the period 2009-2017.
The analysis aims to assess the relationship between sovereign financing rates (in times of large macroeconomic
shocks) and public investment.
The following regression equation was estimated:
GFCFct=α+β1ict-1+β2debtct-1+β3lendct-1+β4LGDPct-1+uct
Where GFCF is general government gross fixed capital formation at time t for country c, i is the nominal interest
rate, debt is public debt, lend is general government net lending, LGDP is logarithm of real GDP. GFCF, public
debt and general government net lending are measured as ratios to trend GDP, while i is the nominal interest rate
on 10-year government bonds. The estimations are based on a cross-country panel, including the 28 Member
States of the EU. The estimator used is pooled ordinary least squares with country fixed effects.
The results confirm the expectation that an increase in interest rates is detrimental to public investment.
The reported specifications take into account both current and lagged interest rates on public investment, as well
as at the impact of nominal and real interest rates. Overall, the negative effect of an increase in interest rates on
public investment is confirmed. Control variables turn out as expected: an increase in general government debt
and/or net lending is found to lead to a decrease in public investment. Overall, the analysis confirms that the
provision of loans at favourable rates would thus facilitate the continuous execution of public investment
projects. The results of the regressions are reported in Table 5.
50
Table 5. Panel estimation results EU-28, 2009-2017 (dependent variable public investment)
coeff. t-stat. coeff. t-stat. coeff. t-stat.
It
-
0.0012 -4.13
-
0.0012 -4.08 - -
it-1 - - - -
-
0.0005 -2.27
LGDPt-1 - - -0.005 -0.27 - -
debtt-1
-
0.0289 -5.83 -0.029 -5.77
-
0.0252 -5.05
lendt-1
-
0.0567 -2.85
-
0.0551 -2.65
-
0.0296 -1.57
R2 adjusted 0.31 0.24 0.34
F-stat F(26,186)=8.42 F(26,185)=7.84 F(26,186)=7.41
Nob 216 216 216
Note: Significance at the 5% confidence level is indicated in bold.
The loans granted under option 2 would
allow to reduce the interest burden on the
sovereign, and thereby support public
investment. The loan that would be granted
would be at an interest rate for a highly rated
issuance which, particularly in times of stress
on financial markets, could generate savings in
interest payments for the Member State
concerned. These savings would be spread over
the duration of the loan. The long-term interest
rate of EU bonds issuance follows the 10-year
nominal rate on German government bonds
with a slight positive spread compared to the
latter (Figure 30). Applying this rate to the
loan facility would allow for most Member
States some savings on the debt burden over the
duration of the maturity.
Figure 30; Long-term interest rates on EU bond
issuance compared to 10-year rates on German
government bonds (2009-2017)
Source/Note: ECB statistical data warehouse. COM treasury operations.
For 2009-2015 EU is proxied by average interest rate of EU back-to-back
loans. For 2016-2017 EU is proxied by 10-year nominal ESM rates.
6.2.2. Quantitative estimates of the stabilisation impact
The potential effect of a stabilisation function can be illustrated with the
macroeconomic model QUEST. We simulate a crisis starting in 2018 against which for
3 years the economy faces a downturn which will then fade-out. This downturn is
calibrated to correspond roughly to the ordinary magnitude of the economic cycle in a
relatively volatile economy, i.e. Spain (4% loss in output). The crisis hitting the economy
is assumed to be caused by a combination of domestic and external demand shocks. The
simulated shock is therefore significant but not exceptional in terms of size and origin.
51
Without the stabilisation function, the government faces a stark trade-off between
controlling the public deficit and supporting activity (or at least not amplifying the
economic shock). In accordance with the provisions of the SGP, a counter-cyclical
strategy, without proactively steering the economy, the government could let the fiscal
stabilisers play in full. Under this strategy, tax revenues decline because of the erosion of
the tax bases, while unemployment benefits paid increase. This corresponds to a fiscal
policy whereby the structural deficit is stable and the expenditure benchmark is
respected. In the wake of the crisis, external constraints might push the government to run pro-
cyclical policies. In a case where a risk to public debt sustainability arises or simply where
financial markets over react to the rise in public debt, the government may feel forced to a pro-
cyclical fiscal policy response and consolidate even though its economy is facing a downturn. To
do so, we assume that the government decides a cut in both public investment and public
consumption by 0.4% of GDP each. This fiscal adjustment limits the debt increase to just below
10 percent of GDP but amplifies and lengthens the economic downturn.
Figure 31: GDP trajectory Figure 32: Debt trajectory
Source: Commission services, QUEST simulations
Options with a stabilisation function:
Support in the form of loans would allow for the Member State not to consolidate as much
but tensions on its indebtedness would remain. We assume that the loan allows the Member
State to broadly maintain public investment but not to avoid cuts in public consumption. Indeed,
the loans, even though at a smaller interest rate, still imply an increase in public debt which
Member States may still try to limit. In the first years, public debt follows the same trajectory as
when the country engages in fiscal consolidation for lack of a stabilisation function (Figure 32).
Then, as the Member State consolidates less, the debt trajectory reaches higher levels. This
strategy has a mitigating effect on the recession: the trough is less pronounced by 0.4 points of
GDP (Figure 31).
When provided through grants, the stabilisation function has a larger impact. Thanks to the
provision of the grant the Member State can maintain investment while also avoiding other
procyclical consolidation measures. Under this scenario, both public investment and public
52
consumptions are maintained. At the same time, the increase in public debt is lower than in both
the baseline scenario and the scenario with loans provision (Figure 32). By not consolidating,
the Member State lets the automatic stabilizers play in full. As a consequence, the recession is
much less severe by 0.8% of GDP (Figure 31). This means that 20% of the shock is absorbed in
this case.
6.2.3. Stabilisation impact of a euro area budget
The stabilisation properties of option 4, a common budget, could be significant, but
would strongly depend on its size and composition. Through its permanent spending, a
common budget would provide immediate aggregate demand support. In this sense,
during its automatic execution it could be more powerful than option 2. As opposed to
option 3, it would not provide active/scalable stabilisation. However, the exact
stabilisation properties would depend on the cyclicality of revenues and spending as well
as provisions for discretionary fiscal policies.
One analysis of a euro area budget shows that a well-conceived design can allow for
some stabilisation properties for a relatively modest size.28
The simulations focus on
different stylised specifications. A budget of around 2% of euro area GDP with
diversified revenue sources and expenditure is estimated to substitute 10% of the
stabilisation achieved at national level and stabilise 4% of shocks (against 17% for
national budgets). A design based exclusively on corporate income tax and spending
mostly focused on unemployment benefits is expected to substitute around 20% of
national stabilisation. A bigger budget would provide yet more stabilisation, but not
proportionally so.
In combination with discretionary elements, a euro area budget could provide
sizeable stabilisation. Trésor (2017) presents a blueprint of a common budget of at least
2% of euro area GDP. Expenditure would be stable over time, targeting public
investment. Assigned parts of value added taxes (VAT) and corporate income taxation
would provide each half of the needed revenues. In downturns, the budget would be
allowed to go into deficit, to allow for the free play of automatic stabilisers. In addition,
the paper suggests the possibility of temporary cuts in the assigned part of VAT, to be
triggered by sizeable output gaps. In this sense, the proposal combines elements of a
common budget with elements of an insurance mechanism. In addition, a more
countercyclical design of fiscal rules is assumed. According to simulations provided in
Trésor (2017), during the recent crisis, aggregate fiscal policies would have been much
more supportive of activity, leading to overall gains of around 3% of GDP in output in
2016 (in levels). The increase in public debt would have been partially offset by higher
growth and stricter rules in good times.
28
Trésor-Economics: “A Budget for the Euro Area” – 2013, No. 120:
https://www.tresor.economie.gouv.fr/Ressources/file/392340
53
6.3. Cross-country neutrality
In option 2 and 3, support is triggered by the objective criteria of an adverse
economic event, which could hit every Member State (section 6.1). With the proposed
mechanism and parametrisation, each Member State is expected to benefit from support
(Table 6). It should be noted that for some Member States benefiting most often the data
sample is fairly limited, thereby possibly biasing the results by the recent crisis. Still, as
discussed in section 3, national policies are critical for economic resilience, so it needs to
be verified that incentives for such policies are not reduced.
Table 6: Frequency of activation by country with the double trigger
total BE DE ES FI FR IE LT LU MT
activated 198 7 12 35 12 1 18 8 8 1
in sample 1777 132 132 132 132 132 132 52 132 52
frequency 11% 5% 9% 27% 9% 1% 14% 15% 6% 2%
NL PT AT CY EE EL IT LV SI SK
activated 9 22 4 9 7 19 10 6 9 1
in sample 132 132 95 23 39 74 131 51 36 36
frequency 7% 17% 4% 39% 18% 26% 8% 12% 25% 3%
Source/Note: Reference rates computed over15 years and threshold to 1 percentage point.
Simulations start in 1985 for BE, DE, ES, FI, FR, IE, LU, NL, PT, IT,, in 1994 for AT, in 1999Q2 for
EL, in 2005 for LT, MT, LV, in 2008 for EE, in 2009 for SI, SK and in 2012 for CY. Results for the latest
countries must therefore be interpreted with caution as they result only from a crisis period.
As support in option 2 is provided via loans, there is a limited risk of moral hazard.
Member States are required to pay back the loans received in line with their maturity.
The transfer received is thus by definition not permanent. To date, Member States have
always honoured their obligations vis-à-vis the EU. Still, the frameworks provides some
limited risk sharing as Member States availing of the scheme benefit from the favourable
interest rates, which stem from the high rating and the grant component. Those benefits
appear relatively small compared to the size of the support. They can thus not be
expected to be instrumental for national decisions to pursue reforms or not.
The eligibility conditions lined out in section 5 reduce risks of moral hazard in the
area of macroeconomic policy choices. Concerning fiscal policy, the proposed
eligibility criteria provide additional incentives to build fiscal buffers in good times and
correct gross policy errors. Concerning the Macroeconomic Imbalances Procedure, the
need to provide and follow up with adequate corrective action plans in case of an
excessive imbalances procedure ensures that structural macroeconomic problems are
avoided or corrected before they can be harmful to the fiscal outlook.
As support in option 3 is provided via pay-outs/grants, the risk of moral hazard and
permanent transfers is inherently bigger. Member States would receive significant
pay-outs/grants from an insurance mechanism in case of an adverse economic event. The
calibration of the system ensures that in the following upturn, Member States would
54
contribute to the fund. In practice, however, it cannot be excluded that support would be
more frequent or bigger.
Support and contributions need to be carefully designed to minimise these risks.
There are three design features to further minimise risks of permanent transfers:
 Linking support to changes in unemployment limits total support and by
construction makes it 'non-permanent'.
 Contributions could be designed to mirror the support in bad times with
additional payments in bad times, allowing for symmetric workings.
 Experience rating ensures additional contributions in exchange for more frequent
support.
Linking support to changes in unemployment limits total support and by
construction make it non-permanent. The fact that support is linked to a deterioration
in unemployment rates entails that the cumulated support to be received is overall limited
(by construction, the increase in unemployment is temporary, even if the level of
unemployment stays high). Similarly, caps on individual and the collective net position
would effectively limit total transfers, even in case of an unusual cumulation of periods
of support.
A symmetric design of contributions comforts the long term neutrality of the
insurance mechanism. Contributions could be increased in good times. The double
condition on unemployment could be used to this end, triggering supplementary
contributions when unemployment rates are low and falling. Such additional
contributions in good times would foster countercyclical policies. It would also ensure
that Member State with more volatile growth and unemployment patterns would not
benefit excessively from an insurance mechanism.
Experience rating and enhanced eligibility conditions could increase incentives for
prudent policies. Experience rating could be used to define additional contributions to
an insurance mechanism as a function of past access. Such an approach would mimic the
concept of insurance premia. It might also be justified to consider more stringent
eligibility criteria for an insurance mechanism than for a loans facility. Experience rating
could take several forms. Dullien et al (2017) propose to increase the contribution of
member states in deficit vis-à-vis the fund. Carnot et al (2017) suggest more specifically
that this premium correspond to the interest rate cost incurred by the fund on this
position. Claveres and Stráský (2018) suggest topping up contributions for countries who
benefited from the fund in the previous 10 years. On top of a similar usage premium,
Arnold et al (2018) also propose to cap cumulative payments and contributions. Bénassy-
Quéré et al (2018) propose to modulate the contributions depending on the volatility of
the trigger variable for each country.
55
The insurance mechanism could provide sizeable pay-outs while being broadly
balanced vis-à-vis each Member State.29
Figure 33 compares the net contributions to
an insurance mechanism (contribution minus pay-out received) for the euro area Member
States. Two cases are compared, a constant contribution and a contribution when the
unemployment rate is low and decreasing (double trigger symmetric to the one for pay-
outs but without threshold). In both cases, the annual contribution is calibrated to 0.1% of
GDP on average and the pay-out generosity is such that the insurance mechanism would
have been balanced. These simulations highlight three stylised facts: (i) the average net
contribution of each Member State is close to balance, (ii) against large shocks Member
States could have received large pay-outs, (iii) introducing modulated contributions
improves cross country equity as Member States with more volatile economies both
benefit and contribute more.
Figure 33: Net contributions to an insurance mechanism (% of Member States' GDP)
Source/Note: Eurostat, authors' calculations. Simulations based on the period 1985-2017.
Simulations start in 1985 for BE, DE, ES, FI, FR, IE, LU, NL, PT, IT,, in 1994 for AT, in 1999Q2 for EL, in
2005 for LT, MT, LV, in 2008 for EE, in 2009 for SI, SK and in 2012 for CY. Results for the latest countries
must therefore be interpreted with caution as they result only from a crisis period.
The cross-country neutrality of option 4, a common budget, would depend critically
of its revenues and spending functions. A common budget would not entail direct
contributions from and support to Member States and is thus less prone to the risk moral
hazard. However, it might indirectly result in income redistribution from richer to poorer
countries through permanent differences in tax bases and/or transfer needs. Similarly,
some spending functions could be more beneficial for certain Member States. This is one
of the reasons why a common budget could preferably focus on the provision of
European public goods. Nonetheless, broad political ownership and ambition are needed
for the proposal to go forward. Trésor (2013) acknowledges that a common budget
requires further political integration and political accountability, also linked to the
entailed greater extent of European solidarity.
29
This result is also to be found in (Carnot et al 2017; Arnold et al, 2018; Claveres and Stráský, 2018)
56
6.4. Environmental and social impact
This short subsection focuses on the environmental and social impact of the different
options. The economic impact of the different options is discussed in the rest of this
impact assessment.
In option 2, the loan-based instrument, the protection of public investment activity
could support “social investment”. According to the Communication of 6 December
the stabilisation function should also aim at supporting the upgrading/maintenance of
skills. According to the European public accounts (ESA2010), public gross fixed capital
formation also includes government R&D spending either protected through patents or
made freely available to the public, as well as basic research expenditure and spending on
education that can be considered as gross fixed capital formation. Therefore, the public
investment indicator also partly captures the maintenance/upgrading of skills aspect. In
addition, training programmes to support the employability and upskilling of displaced
workers, as well as support measures specifically targeted to young people could be
considered as particularly relevant in this context and could be factored in when
determining the size of the support for each Member State. The stabilisation function
would then also be geared towards supporting Member States' national expenditure on
active labour market programmes and services dedicated towards training, thereby
avoiding cuts to such programmes in periods of large adverse economic events.
However, that would depend to which extent such forms of investment could be captured
by objective, verifiable indicators.
In option 3, the insurance mechanism, the environmental and social impact would
be fairly indirect and difficult to assess. In the stylised insurance mechanism described
in sections 5 and 6, there is no immediate link to environmental and social outcomes. It is
fair to assume that a stronger response to large shocks would have beneficial spillovers
for environmental and social outcomes, but these indirect effects are extremely difficult
to assess at this stage. In option 1, the status quo, there is by definition no additional
impact.
In option 4, the euro area budget, the environmental and social impact would likely
be positive, but the definition of the option is not detailed enough to allow for an
assessment. According to President Macron (2017), a euro area budget should support
investment and Research & Development amongst others. It is thus natural to assume
that it would foster the transition to a green economy. According to Trésor (2013), a euro
area budget should provide unemployment benefits and would thereby contribute to a
positive social impact. However, at this stage, there is no sufficiently detailed proposal to
allow for a definite assessment.
57
6.5. Conclusions, preferred option and implementation plan
In option 1, the status quo, important vulnerabilities remain. In light of recent and
ongoing reforms, the European economic architecture is stronger today than ten years
ago. Risk stemming from the financial and banking sector are now detected earlier with
European supervision in place. Private sector risk sharing is benefitting from effort to
complete the banking union and the capital markets union. The ECB’s toolbox covers a
wider range of monetary policy instruments. European economic surveillance is keeping
closer tabs on fiscal and structural developments. The ESM stands ready to support
Member States in crisis resolution via conditional financial assistance. However,
important vulnerabilities remain. As lined out in section 2, public debt levels remain
high. The lack of a strong fiscal centre in the European economic architecture increases
the burden on monetary policy and national fiscal policies. That is why even Member
States with sound public finances are prone to the sudden occurrence of market pressure
and thereby at risk of running pro-cyclical fiscal policies in the downturn. Table 1 gives
an overview of the pros and cons of the different options along the main objectives
defined in section 4.
Option 2 (borrowing lending scheme) would contribute to the cohesion objective by
offering financing support in the event of a large asymmetric shock affecting a Member
State. This support would target the benefit of public investments in priority sectors and
be subject to a trigger and eligibility conditions. This provision of support will provide a
strong incentive to protect key public investments and thereby preserve at an appropriate
level expenditures which are essential for the future growth of the economy. As such the
scheme would foster outcomes in sharp contrast to the past crisis in some countries
where public investment was sizeably cut, although the powerfulness of the scheme
would depend on its precise parametrisation. The macroeconomic stabilisation impact in
this option is limited by the fact that support takes the form of a loan. Confronted with a
large shock, the concerned Member State would face a broadly unchanged trade-off
between supporting activity via deficit spending or controlling the increase in its public
debt. This trade-off would nevertheless be mitigated as the Member State would be given
access to cheaper financing than on the market. Moreover, the provision of EU financing
may exert a strong signalling effect to market participants, which can act as a catalyst for
avoiding the loss of market access and a full-blown financial adjustment programme.
This option is also consistent with a requirement for no permanent transfers, in the sense
that loans are by nature temporary support and the Member State concerned is legally
required to pay it back. Option 2 would therefore bring value added with respect to all the
objectives identified in this Impact assessment, as summarised in Table 7. Option 2 is
also feasible within the current EU legal framework, using article 175 as a base.
Importantly, option 2 may also be politically more feasible, at least in the near future. As
underlined in this document (see in particular the introduction and sub-section 3.3), the
views of stakeholders remain divided at this juncture on the need and form of a
stabilisation function. One key concern of the more sceptical stakeholders concerns the
risks that a stabilisation scheme could entail in terms of moral hazard and generating
permanent transfers, in other words violating the objective of cross-country neutrality. As
58
noted, this is an area where option 2 fares well in comparison to alternative options (apart
from the status quo), as it relies essentially on temporary lending. For this reason, it can
be considered that option 2 is a more realistic option at this point in time. Overall, given
these considerations option 2 is at this stage the preferred option. It would bring an
important contribution to all the objectives lined out in section 4. It could also lay the
grounds for a further maturing of the debate and the possible future development of other
options.
Option 3 (insurance mechanism) would offer significant payouts in the event of a large
asymmetric shock affecting a Member State, subject to the trigger and eligibility
conditions. These 'insurance payouts' would reduce the short-term trade off faced by the
concerned Member States between supporting activity and controlling the rise in their
debts and deficits. The payouts would therefore complement the national automatic
stabilisers in adverse circumstances. They would facilitate the conduct of a smoother and
more counter-cyclical fiscal policy throughout the cycle, which would also be beneficial
for the quality of national public finances and the avoidance of booms and busts in public
investments. Depending on its parameterisation, that option can offer a powerful demand
stabilisation impact, even for a limited amount of contributions. Option 3 is however
relatively challenging to reconcile with the objective of country neutrality, as some
Member States could benefit from payouts more often or more than others, for example
because their economies feature more volatile cycles. Some design features could be
important to improve on the objective of country neutrality, such as higher contributions
in good times (which would ensure that volatile economies contribute more and would
accelerate the constitution of buffers), and a form of experience rating (contributions
modulated as a function of past usage). Overall, option 3 can offer very effective
stabilisation properties and may be consistent with country neutrality if well-designed. It
could therefore provide a highly valuable strengthening of the EMU architecture.
However, the political support for this option appears mixed at best at this stage, as some
stakeholders may see it as entailing too many risks and going beyond a proportionate
response to the challenges at hand. Given the state of play of the debate, further
reflections and discussions appear needed to assess the viability and raise the political
acceptability of such an option. Still, the framework for putting in place an insurance
mechanism may to some extent be framed by the setting up of a borrowing lending
scheme as envisaged under option 2, as some of the mechanisms and conditions (for
instance, the triggering criteria) could be similar in both options. The limited grant
components that could accompany a borrowing lending scheme in option 2 in order to
make the loans more attractive could in fact be seen as an embryo for an insurance
mechanism that could be extended at a later stage. Such a combination would create a
consistent ensemble enabling significant stabilisation.
Option 4 (euro area budget) would contribute to the stabilisation of large shocks through
the automatic fluctuations with the cycle of the revenues and/or expenditures of that
budget. The effectiveness of that mechanism depends on the cyclical sensitivity of the
composition of the budget and on its size. The implications of option 4 would go
somewhat beyond that of providing a stabilisation function, as a full budget implies that
59
allocative competences on the revenues and on the expenditure sides are shifted from the
national to the European level, in addition to the current EU budget. The setting up of
such a budget would therefore require strong political will and consensus. Overall,
option 4 can offer some stabilisation properties, the extent of which greatly depends on
its size and composition, but further reflections and discussions are needed to assess its
content and raise its political acceptability.
Table 7: Comparison of options along main objectives
Objectives
Option 1
(status quo)
Option 2
(BLS, loans)
Option 3
(insurance mech.)
Option 4
(EA budget)
1. counter business cycle
fluctuation - + ++ +
2. more counter-cyclical
fiscal policy - + ++ +
3. smoother public
investment trajectories - + + +
4. prevention of financial
market crisis - + ++ +
5. preserve cross-country
neutrality + + - o
6. contribute to integrity
of the Union o + + ++
Source/Note: illustration prepared by authors
6.5.1. Implementation plan
Overall, the different options have different main channels and merits. A loans
system would facilitate the execution of ongoing investment plans and provide a helpful
signal to ensure financial stability. An insurance mechanism would have more
stabilisation power in the traditional sense of demand support. A common budget could
allow for the stable provision of European public goods.
As already noted (see the end of secton 5.2), the different options should not be
considered as mutually exclusive. They have different pros and cons and can also be
combined. Importantly, the different options can also be combined over time. A
stabilisation function could be phased-in, for instance first via loans and then through an
insurance mechanism.
Option 2 would be the preferred option at this stage and could be implemented with
the next MFF. A political agreement on the MFF is targeted for 2019. A loan-based
stabilisation function could thus be implemented and available with the start of the new
MFF. Such a timeline would allow for the instrument to be available in time for the next
cyclical downturn. An insurance mechanism is a necessary complement, but will take
more time to mature. More ambitious steps should be taken as a second step. An
insurance mechanism (or a euro area budget) would be more effective in providing
60
macroeconomic stabilisation. It would a highly desirable complement to option 2. Both
should be considered as a package jointly providing the stabilisation function in the long
term. Still, in case of an insurance mechanism there is arguably a bigger risk as to cross-
country neutrality. While these risks can be overcome, further work on building a
common understanding across Member States and on an adequate design appear needed
before proceeding with a legal proposal.
Overall, a phased approach is the most promising. As already announced in the 6
December Package, the Commission approach could be to first put in place an instrument
based on loans with a limited degree of interest rate subsidies. In a subsequent step, an
insurance mechanism could be proposed and put in place. There is thus a need for such a
follow-up discussion. In practice, this could take the form of a 'review clause' after a few
years, which would give the opportunity to: i) assess the effectiveness of the borrowing
lending scheme; ii) re-examine the case for more ambitious proposals, in the light of
experience and of the evolving political debate.
A regulation appears as the most adequate legal instrument for option 2. The
instrument proposed entails the central provision of loans to Member States to ensure the
protection of adequate levels of public investment. A regulation as legal instrument
allows for this central provision of loans. On the contrary, a directive would by definition
not be suitable since it would require the national, tailored transposition for the operation,
which runs counter the desire for a central mechanism. As mentioned in the conclusions
section, the legal basis of 175 TFEU appears adequate for option 2, the loans instrument.
The link to cohesion objectives is less direct and straightforward in options 3 and 4.
7. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?
The monitoring and evaluation of the stabilisation function could be done along
three dimensions. First, it would assess the macroeconomic impact and adequacy of the
instrument as part of the ex post evaluation. Second, the use of support provided by the
stabilisation function would be continuously monitored. Third, the efficiency of public
investment management in the respective Member State would be assessed to ensure
sound quality of public investment, ex ante before the instrument starts operating.
The Commission could proceed to evaluations of both the instrument and each loan:
 An evaluation of the mechanism in its entirety would be conducted after a certain
number of years (possibly 3-5 years).
 For each loan an ex-post evaluation would be carried out. This could occur e.g. 2
years after the support has been granted.
61
7.1.1. Macroeconomic impact
The expected macroeconomic outcomes from the stabilisation function are:
 more synchronisation of the business cycles across the Member States
 lower volatility of public investment
 less pro-cyclicality of the fiscal policy.
The assessment should therefore be carried out along these dimensions. An additional
dimension to consider is whether the instrument can be deemed to have helped
preventing full-blown financial crises and financial assistance programmes.
The evaluation of the instrument would review the degree of (cyclical) convergence
in the EU/EMU. Such an evaluation would be conducted based on macroeconomic data
(in particular, GDP, output gap, unemployment rate) specifically with a view to assessing
whether the marked differences in economic and financial performances observed in the
recent past have been attenuated.
Building on the evaluation of each loan, the overall evaluation of the scheme should
investigate the trajectory of public investment. Based on the national accounts data (in
particular gross fixed capital formation of the general government and more generally the
general government accounts), it should be analysed whether boom bust cycles in
investment have been limited by the introduction or the use of the stabilisation function.
The Commission would also assess whether the stabilisation function has been
conducive to smoother fiscal policies. This assessment would build on macroeconomic
data for fiscal policy (budget balance, cyclically adjusted budget balance, fiscal stance) to
assess in particular whether fiscal policy has been less pro cyclical. Looking at financing
conditions of the public debt (sovereign spreads), it should also be evaluated whether the
stabilisation function has had an impact on market expectations.
The evaluation could also draw lessons in terms of the calibration of the scheme(s),
such as on adequacy of the amount of resources available given the magnitude of shocks,
and whether the triggering criteria are appropriate. The analysis could also examine the
distribution of beneficiaries/contributors to the stabilisation function.
Box 3: Macroeconomic indicators
A non-exhaustive list of indicators to be mobilised for the assessment of the stabilisation
function could include: GDP, the output gap, the unemployment rate, gross fixed capital
formation of the general government and the general government accounts, including the
budget balance, the cyclically adjusted budget balance, the fiscal stance and sovereign
spreads.
62
7.1.2. Use of funds
The use of funds could be continuously monitored as Member States benefit from
support from the Stabilisation Function. In addition, the analysis and results from this
continuous monitoring could also be used in an ex post evaluation of the instrument.
Specifically, the stabilisation function could contain a post-access monitoring
mechanism which confirms that the Member State has upheld its commitments in
terms of public investment. This mechanism would check that the data reported ex-post
in the national accounts of the Member State is consistent with the objective of the
stabilisation function to support public investment. When establishing the threshold
under which the public investment level should not decrease a number of caveats need to
be taken into account. First, the level of general government gross fixed capital formation
reported in the national accounts includes co-financing for projects supported by ESIF
funds. If gross fixed capital formation decreases, then it is necessary to ensure that the
decrease is not due to a decrease in the EU co-financing part (typically because of end-
year shortness of funds on the EU side) while the national financed part of public
investment has been maintained at the agreed levels. Second, the threshold should also
take into account the volatility due to the structural funds financing cycle where typically
public investment is very high at the end of a programming period and very low at the
beginning of new programming period. Third, the threshold should also take into account
the cyclicality of public investment and ensure that the Member State is not forced to
maintain a level of public investment that is characteristic in a peak of the economic
cycle when it is in a downturn of the cycle.
Monitoring would also include spending in the area of “social investment” if and
once it is included in the stabilisation function. In addition to the monitoring of public
investment through the data reported in the national accounts, the ex-post monitoring
mechanism would then need to also ensure that the Member State does not decrease
spending on the concerned social investment. Additional data on such training
programmes would be needed to ensure regular and timely monitoring.
On a regular basis, the Commission should consult the member states who did not make
use of available loans in order to identify the limitations of the scheme.
7.1.3. Quality of public investment management
The quality of public investment management would be monitored ex ante before the
instrument starts operating. In addition, the merit and lessons learnt from this exercise
would also be used in an ex post evaluation of the instrument.
The ex-ante assessment would examine the quality of a Member State's public
investment management capacity, with the aim of ensuring that there are no
bottlenecks within their public investment management system that lead to an inefficient
use of the resources provided by the stabilisation function. Moreover, a high quality
63
public investment management process would also ensure that the support given to
public investment in the event of a downturn would produce the desirable
macroeconomic effects and lead to sustainable investment.
The ex-ante assessment would be done by monitoring the efficiency of public
investment management system. This could be done by using the IMF Public
Investment Management Assessment Framework (PIMA) and other frameworks, such as
those proposed by OECD (2013 and 2014) and European Commission (2017 F). The
framework would evaluate the public investment management process at three key stages
of the public investment cycle: planning sustainable investment across the public sector
("planning phase"), allocating investment to the right sectors and projects ("allocation
phase"), implementing projects on time and on budget ("implementation phase"), and
possibly ex post evaluation of projects (“evaluation phase”). See box 3 for details on the
IMF PIMA framework.
64
Box 4: The assessment of the public investment framework (IMF, 2015)
The following indicators could be used when assessing the planning phase:
• National fiscal rules and budgetary planning are such that they ensure that overall levels of public
investment are adequate, predictable and sustainable;
• National and sectoral plans are such that they ensure public investment decisions are based on clear and
realistic priorities, cost estimates and objectives for each sector;
• Central and local coordination arrangements are such that public investment plans are integrated across
levels of government, provide certainty about funding from the central government and ensure
sustainable levels of subnational borrowing;
• Management of public-private partnerships (PPP) are such that they ensure an effective evaluation,
selection and monitoring of PPP projects and liabilities;
• The regulation governing infrastructure companies is such that it ensures open and competitive markets
for the provisions of infrastructure services, an objective pricing of infrastructure outputs and the
effective oversight of infrastructure company investment plans.
The following indicators could be used to assess the allocation phase:
• Multi-year budgeting that provides transparency and predictability regarding levels of investment by
ministry, program and project over the medium-term;
• Budget comprehensiveness which will be reflected by the fact that all public investment regardless of
the funding channel is authorised by the legislature and disclosed in the budget documentation;
• Budget unity which will be reflected by the fact that decisions about individual projects take account of
both their immediate capital and future operating and maintenance costs;
• Project appraisal according to which project proposals have to be subject to published appraisal using
standard methodology and takes potential risk into account;
• Project selection according to which projects are systematically selected and approved on the basis of
transparent criteria and included in the pipeline of approved investment projects.
The following indicators could be used to assess the implementation phase:
• Protection of investment which will be reflected by project appropriations which are sufficient to cover
total project costs and cannot be diverted at the discretion of the executive;
• Availability of funding which allows for planning and commitment of investment projects based on
reliable forecasts and timely cash flows from the Treasury;
• Transparency of budget execution: major investment projects are tendered in a competitive and
transparent process, monitored during project implementation and independently audited ;
• Project management: an accountable project manager is identified and is working in accordance with
improved implementation plans and provides standardized procedures and guidelines for project
adjustment;
• Monitoring of public assets: assets are properly recorded and reported and their depreciation is
recognized in financial statements.
Based on these 15 indicators, countries are given a score between 0 (no key features are in place) and 10
(all key features are in place). The evaluation conducted by the IMF gave a mean PIMA score of 7/10 to
the European countries in their sample. The current evaluation framework would consider that the public
investment management capacity in a given country would be of sufficient quality if the country obtains a
PIMA score of at least 8/10.
65
Annex 1: Procedural information
Lead DG, Decide Planning/CWP references
The lead Directorate General is the Directorate General for Economic and Financial
Affairs (DG ECFIN).
The initiative is foreseen in the 2018 Commission Work Programme (CWP) under the
header “Deeper and Fairer Economic and Monetary Union”: “We will also propose to
create a dedicated euro area budget line within the EU budget in order to provide for
four functions: structural reform assistance; a stabilisation function; a backstop for the
Banking Union; and a convergence instrument to give pre-accession assistance to
Member States on their way to euro membership.” (Authors’ highlight)30
Political steer and support for this initiative is also reflected in a number of Commission
Communications. The Commission Communication on "new budgetary instruments for a
stable euro area within the Union framework" from 6 December 2017 and the Reflection
Paper on the deepening of the Economic and Monetary Union have called for the
creation of a stabilisation function. Earlier, the White Paper on the Future of Europe and
the Five Presidents’ Report have suggested the creation of such an instrument as well.31
Organisation and timing
The works for this initiative have been launched in December 2017.
The following Directorates General were invited to the Inter-Service Steering Group
(ISSG): BUDG, ECFIN, EMPL, JRC, SG, SJ
The Inter-Service Steering Group was chaired by the Secretariat General.
The Inter-Service Steering Group has met for a number of three times to discuss the file.
The last meeting of the steering group took place on 19 March 2018. The minutes of this
meeting are reported at the end of this annex. In addition, there was a conference call
with JRC colleagues located at the Ispra site.
30
see Commission Communication on “Commission work programme 2018 – an agenda for a more united,
stronger and more democratic Europe” – COM(2017) 650:
https://ec.europa.eu/info/sites/info/files/cwp_2018_en.pdf
31
Communication on new budgetary instruments for a stable euro area within the Union framework -
COM(2017) 822: https://ec.europa.eu/info/sites/info/files/economy-finance/com_822_0.pdf
6 December Package. Commission Communication on “Further steps towards completing Europe's
economic and monetary union: a roadmap” - COM(2017) 821: http://eur-lex.europa.eu/legal-
content/EN/TXT/PDF/?uri=CELEX:52017DC0821&from=EN ;
Reflection paper on the deepening of the economic and monetary union - COM(2017) 291:
https://ec.europa.eu/commission/sites/beta-political/files/reflection-paper-emu_en.pdf
White paper on the future of Europe - COM(2017)2025: https://ec.europa.eu/commission/sites/beta-
political/files/white_paper_on_the_future_of_europe_en.pdf
Five Presidents’ Report: Completing Europe's Economic and Monetary Union:
https://ec.europa.eu/commission/sites/beta-political/files/5-presidents-report_en.pdf
66
Consultation of the RSB
An informal upstream meeting was held on 28 February 2018 with RSB representatives
and the participation of SG, DG BUDG and JRC. During this discussion Board members
provided early feedback and advice on the basis of an annotated outline. Board members'
feedback did not prejudge in any way the subsequent formal deliberations of the RSB.
The Impact Assessment report was examined by the Regulatory Scrutiny Board on 25
April 2018. Based on the Board's recommendations, the Impact Assessment has been
revised in accordance with the following points:
Main considerations Modifications to take into account the RSB
remarks.
The Board understands that the policy intention is to
contribute to a stabilisation function at EU level to
address large asymmetric shocks. The Board notes
that the scheme is a new tool to address a well-
understood problem but controversial project for the
completion of the Economic and Monetary Union.
The Board acknowledges the economic research
and analysis that feed into the report. However, the
report still contains significant shortcomings that
need to be addressed. As a result, the Board
expresses reservations and gives a positive opinion
only on the understanding that the report shall be
adjusted in order to integrate the Board's
recommendations on the following key aspects:
Specific comments below were duly acknowledged
and incorporated.
(1) The report does not sufficiently explain how the
scheme would work in practice and how it would
interact with the other governance instruments.
See detailed reply in “Further considerations and
adjustment requirements”. The description of the
main policy option was augmented in Section 5.2.
The interaction with other instruments is discussed
at the end of Section 4.2.
(2) The report does not provide an adequate
baseline. It does not sufficiently explain how the
scheme would be funded, how this relates to the
MFF and whether there is a critical mass of funding
which is needed to make the scheme work
effectively.
See detailed reply in “Further considerations and
adjustment requirements”. The baseline is now
described and justified in more details in Section
4.1. The link with the MFF and other funding
considerations are further described in Section 5.2.
The size of the option is discussed under the new
Section 6.1.3.
(3) The preferred option does not stem logically
from the structure of the analysis and the problem
assessment. The report does not relate the choice of
preferred option to evidence of stakeholders' views.
See detailed reply in “Further considerations and
adjustment requirements”. Analysis of preferred
option was further detailed. Stakeholders' views are
now summarized in the introduction, detailed in the
new Section 3.3 and included in the choice of
options presented in Section 6.5.
Further considerations and adjustment
requirements.
(1) The report should provide more detail
regarding the conditions for activation, the link
with fiscal governance, the degree of
automaticity, and the room to apply judgment
when deciding about disbursing funds. The report
should better explain how the scheme would work,
in particular the procedure to trigger funding. The
The workings of the scheme is now explained in
greater detail, see in particular section 5.2. It
provides additional details on the conditions,
eligibility and timing of activation. Additional
evidence on the correlation of the unemployment
rates and ex post output gaps confirms the
timeliness of triggering. The text discusses the
67
issue of timing of the activation is important
because it determines the point in the business cycle
at which a country becomes eligible. In this vein,
the report should guide the reader through how the
scheme works to prevent bad outcomes, and what
would happen in the event of a large
macroeconomic shock. The report should also
explain any interactions between stabilisation and
fiscal governance. In particular, it should analyse
the extent to which the obligation to respect the
fiscal governance rules could hamper the
stabilisation objective, given that – under the
preferred option – the stabilisation instrument
would not directly shrink the public deficit. The
report should also better explain what kind of
political decision is involved in granting funding
access to a Member State. Who would decide, when
and with what margin of discretion?
decision making for the instrument in more detail,
delineating the degree of automaticity and
discretion more clearly.
The interaction with other instruments is discussed
in more detail now at the end of Section 4.2. It
provides additional elements on the interaction of a
stabilisation function with the European fiscal
framework, more specifically with the fiscal rules
enshrined in the Stability and Growth Pact. The
necessary minimum compliance with the Pact is
designed to support the enforcement of fiscal rules
without generating excessive rigidities in the
functioning of the scheme. The interaction with
financial assistance provided by the ESM is spelled
out in additional detail as well.
(2) The report should elaborate further the
baseline scenario. It should clarify what
continuation of the status quo would mean for the
resilence of the euro area. This should project the
implications of the backstop put in place by the
Single Resolution Fund and of potential support
from the proposed EMF, including to the envisaged
stabilisation function.
Section 5.1 describes in more detail the baseline
scenario. The possible evolution of the ESM/EMF
and its instruments is discussed in more detail, also
in respect to its interaction with the stabilisation
function. The risks associated with not acting
beyond such a baseline are spelled out in more
detail.
(3) The report should more clearly explain the
composition and funding arrangements for the
scheme. In particular, it should better develop the
relation to the MFF and the EU budget. It should
explain whether the scope is Euro Area (with or
without ERM2 participants) or EU-27 and indicate
whether a critical mass of funding would be
necessary to ensure effectiveness of the scheme.
The issue of subsidised loans should also be fully
developed, especially regarding how high the grant
element would be, how it would be funded and by
whom. The report should provide clearer
projections on the possible distribution of funds and
acknowledge which variables are unpredictable and
why. Other elements that need clarifications are
possible caps and backstops that would prevent the
risk of moral hazard and funding arbitrage.
The funding arrangements of option 2 areare now
described further in Section 5.2. The “budgetary
technique” with respect to the MFF is explained
thoroughly. The geographical scope was clarified
and different considerations explained. The size
necessary for the scheme to provide important
stabilisation was discussed further along different
stylised options, see Section 6.1.3. The text now
provides further detail on the operation and design
(options) of the interest rate subsidy. The
presentation of the distribution of support, which is
covered throughout Sections 6.1 and 6.3, was
reworked. Section 6.1.3 explains how past crisis
periods are used to calibrate the loan support to the
available funds. Specific dispositions on caps and
backstops to avoid cost overruns are also described
in Box 1.
(4) The report should better elaborate how the
choice of the preferred option was made and
based on which criteria. In this context, it should
discuss Member States' likely diverging views for
the various options and the proposed solution. It
should justify the selection of preferred policy
option taking into account political feasibility and
proportionality. Under the preferred option, it
should clarify the degree of commitment for an
insurance mechanism as a longer-term solution.
The conclusions on the different options and the
choice of the preferred options were detailed
further, see Section 6.5. It now includes more detail
about political feasibility and proportionality. The
position of different stakeholders is also covered in
much detail in a new subsection 3.3 and in a revised
Annex 2.The possibility of a phased-in approach,
allowing for the creation of an insurance
mechanism in the longer term is presented in more
detail.
(5) The report should explain what success of
this initiative would look like. It should clarify
what arrangements would be put in place to monitor
the performance of the scheme, and to collect
evidence that this delivers improved outcomes
relative to the baseline. The report should also
The description of the monitoring of the scheme has
been extended in Section 7. It provides a more
thorough link with the objectives pursued and
provides additional detail on the frequency of
monitoring.An indicative list of macroeconomic
indicators to be used for monitoring purposes is
68
clearly explain how the evaluation of the initiative
would take place.
provided in Box 3.
(6) The report should present its arguments in
the logic of an impact assessment. It should not
base its analysis on the resulting Commission
proposal. Rather, the analysis in the impact
assessment should support the proposal.
References to the upcoming Commission proposal
were removed. Text now provides a more inductive
sequence of arguments, deriving policy options and
considerations more directly from the problem
definition.
The Board notes that this impact assessment will
eventually be complemented with specific
budgetary arrangements and may be substantially
amended in line with the final policy choices of the
Commission’s MFF proposal.
Some more technical comments have been
transmitted directly to the author DG.
69
Annex 2: Stakeholder consultation
Due to the compressed timeline for the preparation of the legal draft and the impact
assessment, there was no public consultation in the traditional sense and no public
inception impact assessment.
The discussion on creating a stabilisation function for the euro area is not new; it has
been an important part of the overall process towards deepening the economic and
monetary union (EMU) over the past years. During this period, the Commission has put
forward several ideas for discussion, which have indeed steered the public debate.
Public discussion
A number of reports have been produced over the past few years emphasizing the need
for a macroeconomic stabilisation function: the Four Presidents report in 2012, the
Five Presidents Report in 2015, as well as the Reflection Paper on Deepening the
EMU in May 2017.
In December 2017, then, the Commission published a Communication on new
budgetary instruments for a stable Euro Area, explaining the concept and design
features of a stabilisation function with increasing level of detail, in the run-up to the
proposal for a new Multiannual Financial Framework (MFF).
The political declarations from Member States in this debate have been mixed, with some
expressing strong support in principle for a stabilisation instrument while others have
shown scepticism. France has been amongst the most ambitious advocates for central
fiscal capacity, with President Macron (2017) proposing a permanent, fully-fledged euro
area budget that would finance common public goods include migration, defence and
disruptive innovation. The national ministries of economy or finance from Italy and
Spain have issued papers lining out proposals for specific funds providing
macroeconomic stabilisation (see below). While views floated in the German government
appear mixed, the coalition agreement includes a reference to "devoting specific budget
funds to economic stabilization, social convergence and structural reform in euro zone.
Those funds could form the basis for a future ‘investment budget’ for the euro zone." In
contrast, other Member States have been more sceptical of the need for an instrument for
the absorption of large economic shocks, as reflected in recent speech by Dutch Prime
Minister Rutte (2018). This was mirrored when the finance ministers of six euro area
Member States (Estonia, Finland, Ireland, Latvia, Lithuania, the Netherlands) plus
Denmark and Sweden did not mention a central fiscal capacity in their priorities for
EMU reform.
Other stakeholders than Member States as well as academia have generally been
supportive of the idea overall. The European Parliament's Committees on Budgets and
Economic and Monetary Affairs issued a report on a budgetary capacity for the Eurozone
in 2015 and the European Parliament adopted a resolution outlining a roadmap for the
creation of a budgetary capacity for the Eurozone in 2017. The European Central Bank
70
has seen a fiscal capacity as an important part of EMU deepening (Coeuré, 2016). Other
European actors such as the European Economic and Social Committee have emphasized
the need for a fiscal union while the European Stability Mechanism has offered to
support financially a macroeconomic stabilisation function if one is created. In the more
academic literature, there is a wide array of papers supporting the case for a stabilisation
function for Europe. Broad studies on fiscal union have put forward the notion of a
common stabilisation capacity for coping with large shocks and share risks. This is in
particular the case of surveys from international organisations such as the IMF and the
OECD (e.g. Allard et al. (2013); Berger et al., 2018; OECD, 2018). These international
institutions have made detailed proposals for a central fiscal stabilization capacity, with
variants of an insurance mechanism and a common unemployment scheme. A non-
exhaustive list of specific proposals from economic papers includes Dullien (2009,
2013), Enderlein et al. (2013), Pisani-Ferry et al. (2013), Delbecque (2013), Dolls et al.
(2014), Drèze and Durré (2014), Lellouch and Sode (2014), Beblavy and Maselli (2014,
2015), Carnot et al. (2015, 2017), Benassy-Quéré et al. (2018), Arnold et al. (2018),
Dullien et al. (2018) and Claveres and Stratsky (2018). Some academics have however
also warned against the notion of a stabilisation function, or at least drawn attention to its
risks (Feld and Osterloh, 2013; Hebous and Weichenrieder, 2015).
Discussions among Member States and the European institutions
First discussions at the Economic Financial Committee and among their alternates
confirm varied views. Notably, besides some supportive and some sceptical Member
States, there is a sizeable group of Member States who acknowledge the merit of in-depth
discussions but do not yet hold a firm view. The proposal to be presented by the
Commission in May could seek to bridge these gaps among Member States, although it is
likely that extensive subsequent discussions will be needed in order to create a consensus
on both the necessity and operational characteristics of such an instrument.
After the December Communication, the Commission organised several outreach
missions in Member States to consult the main institutional stakeholders on the process
of deepening the EMU. These missions consisted of targeted meetings during the visits
with: Sherpas, high level representatives of Ministries of Economy and Finance and
Ministries responsible for cohesion policy, national parliaments' committees, think tanks
and other stakeholders.
These are the missions that took place:
 Belgium: 14 March and 21 March, meetings with Federal Parliament and Finance
Ministry, Budget Ministry.
 Bulgaria: 13th / 14th February, meetings with Ministry of Finance, Cohesion
policy, Central bank, National parliaments' committees, Social partners, Think
tanks.
 Germany: 1st February, meetings with Ministry of Finance, Chancellery,
Members of Parliament, Ministry for Economic Affairs.
71
 Spain: March 15, meetings with Economic experts on EMU, Secretary General of
Treasury and Financial Policy, Secretary of State for the Budget.
 France: 6th February, meetings with Treasury, European affairs, Foreign affairs,
central bank, think tanks.
 Italy: 5 February, meetings with Treasury, central bank, Academics.
 Netherlands: 5-6 February, meetings with Symposium Raad van State (Council of
State conference) - Conference on EMU deepening and Meeting with Dutch
Central Bank, Treasury, Bureau for Economic Policy Analysis (CPB), employers'
organisation, MPs of Finance Committee.
 Austria: 23 February, meetings with Sherpa, Minister for EU affairs in the
Federal Chancellery, Foreign Ministry, ministry of finance, Ministry of
Sustainability and Tourism, Central Bank, Think Tanks and Social Partners.
 Poland: 9th February, meetings with Ministry of Finance , National Bank of
Poland, Committee on the European Union in the Parliament, Ministry of Foreign
Affairs, Ministry of Investment and Economic Development.
 Finland: 30th January, meetings with Prime minister Office, Finance Ministry,
Ministry of Energy and Climate, Ministry of Innovation, researchers.
In addition, several discussions took place on this topic among Ministers of Finance in
the Ecofin and Eurogroup, preceded by discussions in EFC/EWG and EFC-A/EWG-
A.
These are the meetings in which this topic was discussed:
 Economic and Financial Committee, of 4-5 September 2017
 Informal ECOFIN - Tallinn, of 15-16 September 2017
 Eurogroup Working Group + on Fiscal framework: fiscal capacity, fiscal rules
and institutions, of 27 October 2017
 Eurogroup in inclusive format of 6 November 2017
 Eurogroup in inclusive format of 4 December 2017
 Economic and Financial Committee, of 11-12 January 2018
 Eurogroup meeting of 22 January 2018
 ECOFIN Council of 23 January 2018
 Eurogroup Working Group, of 1-2 March 2018
 Eurogroup Working Group + Dinner seminar - The future of the European fiscal
architecture, of 8 March 2018
 Eurogroup meeting of 12 March 2018
72
Annex 3: Analytical methods
This impact assessment uses various types of quantitative tools.
The problem definition relies on a retrospective analysis of the unfolding of the
recent crisis and an econometric analysis of business cycles in the euro area. This
analysis is based on standard macroeconomic indicators (GDP growth, output gap, public
deficit and debt, sovereign spreads). The analysis also builds on more advanced tools and
metrics, such as a principal component analysis to identify the common fluctuations in
the business cycles of the EA Member States, the revenue windfalls/shortfalls and the
fiscal stance to analyse the reaction of the governments to the crisis or the income
stabilisation coefficients of the various tax systems.
To assess the potential activity and the calibration according to the financial
envelope of the stabilisation function or the insurance mechanism, simulations are
run based on past data (1985 to 2017). These simulations apply the proposed rules for
the functioning of these mechanisms to past fluctuations in the euro area. Doing so, it is
possible to compare the different options (trigger, calibrations), estimate the frequency of
activation of the schemes, isolate the periods when the schemes would have been active
and identify the beneficiaries. These simulations also allow calibrating the budget for
both the loans support and the insurance mechanism and exemplifying their non-
permanent transfer properties. The analysis was performed on data mostly from Eurostat,
using the software R. The approach and the applicable caveats, including data
availability, are described in the text.
An econometric analysis in panel is also mobilised to assess the positive effect of
preferential interest rates provided by the stabilisation function on public
investment. This analysis builds on and simplifies other works conducted by the
Commission (European Commission, 2017 E) to estimate the impact of various factors
on public investment dynamics. The analysis was performed using Stata, the approach
and the applicable caveats are described in box 2.
The stabilisation impact of both the stabilisation function and the insurance
mechanism is assessed through simulations of a macroeconomic model
(QUEST).QUEST is the global macroeconomic model that the Directorate General for
Economic and Financial Affairs (DG ECFIN) uses for macroeconomic policy analysis
and research. It is a structural macro-model in the New-Keynesian tradition with rigorous
microeconomic foundations derived from utility and profit optimisation and including
frictions in goods, labour and financial markets. Models of this class are used for shock
analyses and shock decompositions, for example to assess the main drivers of growth and
imbalances. Many applications deal with fiscal and monetary policy. This model is also
used to analyse the impact of structural reforms in the EU. The main caveat of such a
model in the context of the simulations presented here are the modelling assumptions
which constrain the stabilisation channels and the sensitivity of the results to the
calibration.
73
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Annex 5: Glossary and acronyms
Acronyms
EA: Euro area
EC: European Commission
ECB: European Central Bank
EDP: Excessive deficit procedure
EFSM: European financial stabilisation
mechanism
EMF: European Monetary fund
EMU: Economic and monetary Union
ESM: European stability mechanism
EU: European Union
GDP: Gross domestic product
GFCF: Gross fixed capital formation
IMF: International monetary fund
MFF: Multiannual financial framework
MIP: Macroeconomic imbalances
procedure
OECD: Organisation for economic eo-
operation and development
OMT: Outright Monetary Transactions
SRF: Single resolution fund
TFEU: Treaty on the functioning of the
European Union
ZLB: zero lower bound
Glossary
Activity rate: The activity rate of the
loan mechanism proposed as part of the
stabilisation function measures the
support which is provided by the
scheme as a fraction of the theoretical
maximum. At each point in time, not
all countries receive support (see
trigger) and not all support are equal to
the maximum (see severe shock),
therefore the activity rate will remain
below 100% and increases as the
economic downturn becomes more
severe or widespread.
Automatic stabilisers: Features of the
tax and spending regime, which react
automatically to the economic cycle
and reduce its fluctuations. As a result,
the budget balance in per cent of GDP
tends to improve in years of high
growth, and deteriorate during
economic slowdowns.
Banking Union The European
Banking Union regroups activities of
supervision of banks, resolution of
bank failures and insurance of deposits
at the EU level, through the single
supervisory mechanism (SSM), the
single resolution mechanism (SRM)
and European deposit insurance
scheme.
Cyclically-adjusted budget balance:
See structural budget balance.
Eligibility In order to be eligible to
support under the stabilisation function,
Member States must meet certain
criteria (regarding the conduct of the
economic policies). Eligibility is a
precondition to receive support if and
when the economic conditions justify it
(see trigger).
Excessive Deficit Procedure (EDP):
A procedure according to which the
Commission and the Council monitor
the development of national budget
balances and public debt in order to
assess and/or correct the risk of an
excessive deficit in each Member State.
80
Its application has been further
clarified in the Stability and Growth
Pact.
Fiscal consolidation: An improvement
in the budget balance through measures
of discretionary fiscal policy, either
specified by the amount of the
improvement or the period over which
the improvement continues.
Fiscal policy Fiscal policy refers to the
decisions influencing the level and
composition of government
expenditure and revenue, budget
deficits and government debt. Fiscal
policy is a pivotal element of
macroeconomic stability. In a monetary
union, such as the euro area, sovereign
states retain responsibility for their
fiscal policies. Fiscal discipline and
coordination are nevertheless needed to
have a significant impact on economic
growth, macroeconomic stability and
inflation.
Medium-term budgetary objective
(MTO): According to the reformed
Stability and Growth Pact, stability
programmes and convergence
programmes present a medium-term
objective for the budgetary position. It
is country-specific to take into account
the diversity of economic and
budgetary positions and developments
as well as of fiscal risks to the
sustainability of public finances, and is
defined in structural terms (see
structural balance).
Multiannual Financial Framework
(MFF) The MFF lays down the
maximum annual amounts (ceilings)
which the EU may spend in 5 different
categories of expenditure (headings)
over a period of at least five years. The
current MFF covers 2014-2020 for a
total amount of EUR 1 trillion. It
provides a framework for financial
programming and budgetary discipline
by ensuring that EU spending is
predictable and stays within the agreed
limits.
Output gap: The difference between
actual output and estimated potential
output at any particular point in time.
Own resources Own resources are the
EU's revenue. The different types of
own resources and the method for
calculating them are set out in a
Council Decision on own resources. It
also limits the maximum annual
amounts of own resources that the EU
may raise during a year to 1.20 % of
the EU gross national income (GNI).
EU expenditure must be completely
covered by such revenue. Revenues in
excess of expenditures can be refered
to as the margin.
Pro-cyclical fiscal policy: A fiscal
stance which amplifies the economic
cycle by increasing the structural
primary deficit during an economic
upturn, or by decreasing it in a
downturn. A neutral fiscal policy keeps
the cyclically-adjusted budget balance
unchanged over the economic cycle but
lets the automatic stabilisers work.
Public investment: The component of
total public expenditure through which
governments increase and improve the
stock of capital employed in the
production of the goods and services
they provide.
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Severe shock: In the context of the
loan support, severe shock refers to the
annual increase in unemployment
beyond which the maximum support is
made available to the Member State.
Below this magnitude, the support is
proportionate to the increase in
unemployment.
Structural budget balance: The
actual budget balance net of the
cyclical component and one-off and
other temporary measures. The
structural balance gives a measure of
the underlying trend in the budget
balance.
Stabilisation function: The concept of
stabilisation function is also referred to
as stabilisation capacity, fiscal capacity
or central (or common) fiscal
stabilisation capacity (CFC).It consists
of a pooling of public resource which
would be used to reinforce fiscal
policies coordination in the union (see
fiscal policy).
Trigger The trigger of the stabilisation
function identifies thanks to economic
indicators when support should be
provided to Member States who are
eligible.