This column argues that many EU countries have the fiscal space to stimulate their economies, which could help in preventing a recession.
With the spectre of a recession looming in the euro area, and elsewhere, the policy question that arises is how much leeway the fiscal authorities in the euro area have to follow counter-cyclical fiscal policies aimed at providing some stimulus. This question is important because it appears that the ECB’s capacity to provide for such a stimulus is limited. The ECB has flooded the markets with liquidity to the tune of trillions of euros since 2015. It is difficult to see how adding a couple of hundred billion of money base, most of which is likely to be hoarded or put to use for speculative activities, will provide for a significant stimulus of economic activity in the euro area.
The conclusion must be that the burden of business cycle stabilisation in the euro area will have to come from the fiscal authorities. This was also recognised by Mario Draghi when he announced a new dose of quantitative easing for the euro area (Hüther and Südekum 2019.).
Two questions arise about the use of fiscal policies. The first one is how effective these policies are in stimulating the economy. This is the question of the size of the fiscal multipliers. The second one is how much leeway the fiscal authorities have to perform their stabilisation responsibilities, taking into account that these authorities have significant levels of outstanding debt. There is considerable reluctance among policymakers these days to use fiscal policies for stabilisation purposes. This reluctance is mainly driven by the fear that these policies may lead to a surge in government debt and in so doing quickly become unsustainable. [...]
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