Impact of the European MTP implementation on the Portuguese economy growth

CFP has recently published its analysis of the National Medium-Term Fiscal-Structural Plan (MTP). Reading the publication offers a better understanding of the reform of the European fiscal framework. In this new paradigm, the elaboration of a Plan by each Member State within a time horizon of 4 or 5 years, depending on the regular duration of the national legislature, is a central element. 

One of the most relevant points arising from the publication of these Plans of each Member State is the determination of the orientation of the joint fiscal policy – fiscal stance -, which results from their simultaneous implementation. For a small open economy like Portugal, the fiscal stance of its trading partners, and their impact on the aggregate demand of each of these economies, is not indifferent. Failure to account for this contagion channel - spillover - is one of the criticisms already pointed out at the new European fiscal framework. This critique is particularly pressing from a historical perspective, considering the importance that such spillover effects have had in recent episodes of fiscal adjustment, especially in the case of the euro area, a monetary union in which the contagion effects experienced in a given country cannot be counterbalanced by the national monetary policy instruments.

A number of studies describe and assess the main channels for transmitting the stance of national fiscal policies to other euro area countries. For example, Alloza et al. (2019) concludes that, in the context of the Economic and Monetary Union (EMU), national fiscal policy spillovers are relevant for a rigorous assessment of the cyclical outlook in euro area countries. Also, Dabla-Norris et al. (2017) notes that such contagion effects tend to be greater the larger the relative size of the countries undergoing fiscal policy adjustments, and among countries with closer trade and financial relations. 

Based on the information already available, a first estimate of the impact of the scheduled implementation of the Plans on the growth of the Portuguese economy was developed. At the moment, 21 Member States (MS) have their Plan published, including Portugal, and are available for public consultation on a dedicated page created by the European Commission for this purpose. The economic impact was estimated following a 3-step approach: 

(i) From each of the Plans, the estimate of the structural primary balance for the horizon between 2024 and 2028 was extracted, and the implied fiscal effort^[1] was calculated (see Chart 1);

(ii) A multiplier of 0.75 was considered – that is, an improvement in the structural primary balance of 1 p.p. detracts 0.75 p.p. from economic growth in a given year, taking into account the operation of the automatic stabilizers. This choice is based on the fact that it is the same reference used by the European Commission in its debt sustainability analysis (DSA), as described in the Debt Sustainability Monitor (2024);

(iii) The contagion effect is approximated by weighting this result by the share of exports (both goods and services) of each of the Member States in the Portuguese GDP. This methodological option is similar to that used in Heimberger et al. (2024). Although it results in an estimate of static and mechanical impact, omitting other equilibrium effects, namely the impact on prices and monetary policy, such an option offers greater simplicity in interpreting the results.

The Plans result in an episode of fiscal adjustment that is the most synchronized since 2012. In fact, 60% of countries with a published plan commit to an improvement in the structural primary balance by 2028, with nearly all pledging a fiscal adjustment exceeding 1% of GDP. Such a simultaneous adjustment^[2] had not been observed since 2011-2013, a period characterized by a high degree of fiscal policy synchronization, with 80% of the countries considered showing a restrictive fiscal policy stance (improving their structural primary balance). This was substantially higher than the proportion observed between 2015 and 2019 (30%). It is estimated that, between 2011 and 2013, this simultaneous adjustment led to a negative impact on the level of activity of the Portuguese economy of approximately 0.6% of real GDP.

If the fiscal adjustments anticipated in the plans materializes, it is estimated that there will be a cumulative negative impact of 0.3% of the GDP level of the Portuguese economy until 2028. Still, it is possible that these results underestimate the expected impacts through three channels. First, given the existence of a control account, any positive deviations accumulated in the first years of implementation of the Plan reduce the room for maneuver for subsequent periods, potentially leading to adjustments greater than those estimated. Secondly, the 2027-2028 biennium coincides with a period in which the fiscal policy stance in Portugal is also restrictive. Finally, the assumed size of the multiplier may be underestimated, which can result from several factors. 

In fact, the multiplier is not constant – neither in time nor in the policy instrument used. The multiplier effect is typically different, and greater, when it comes to variations in public expenditure, such as public investment or compensation of employees; It is also higher in periods when economic activity is below its potential level. In addition, the effects (negative or positive) on economic activity do not dissipate instantaneously, and there is some persistence over time.^[3]

Six countries have not yet submitted their Plans. Among these are Germany and Belgium, whose inclusion in this analysis, as far as can be inferred from publicly available information, would likely result in a more negative impact to growth. It should be noted that exports to these 2 countries represented, in 2023, 6.4% of the national GDP. The 20 MS included in the analysis represent 23.4%.

^[1] Defined as the annual change in the structural primary balance, which already allows for the correction of the effect of economic cycles. 

^[2] Calculated as the proportion of countries in the sample with an improvement in the structural primary balance of more than 0.1 pps.

^[3] The structural characteristics of the economy are also relevant - among others, the degree of openness of the economy, the rigidity of the labour market, the size of the automatic stabilisers and the government debt ratio. For a recent review of the literature, see Valerie A. Ramey (2019) and Batini, N., Eyraud, L., and Anke Weber (2014).

References

Alloza, M., Burriel, P., and Pérez, J. J. 2019. Fiscal policies in the euro area: Revisiting the size of spillovers, Journal of Macroeconomics, vol. 61, 103132.
 

Batini, N., Eyraud, L., and Weber, A. 2014. A Simple Method to Compute Fiscal Multipliers, IMF Working Paper, no. WP/14/93.
 

Portuguese Public Finance Council. 2024. Analysis of the National Medium-Term Fiscal-Structural Plan (2025-2028), Report, no. 11. 
 

Directorate-General for Economic and Financial Affairs. 2024. Debt Sustainability Monitor 2023, European Economy Institutional Papers, vol. 271.
 

Gechert, S., Guarascio, D., Heimberger, P., Bernhard Schütz, Lennard Welslau, and Zezza, F. 2024. Debt Sustainability Analysis in Reformed EU Fiscal Rules: The Effect of Fiscal Consolidation on Growth and Public Debt Ratios, Intereconomics, vol. 2024, no. 5, 276–83.
 

Poghosyan, T. 2017. Cross-Country Spillovers of Fiscal Consolidations in the Euro Area, IMF Working Papers, vol. 17, no. 140, 1.
 

Ramey, V. A. 2019. Ten Years After the Financial Crisis: What Have We Learned from the Renaissance in Fiscal Research?, Journal of Economic Perspectives, vol. 33, no. 2, 89–114.

Date of last update: 07/11/2024