FISCAL VULNERABILITY vs. FISCAL
SUSTAINABILITY: THEORETICAL
BACKGROUND
Andreea Stoian, PhD
Postdoc Fellow
Bucharest Academy of Economic Studies
FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY:
THEORETICAL BACKGROUND
Acknowledgments
This work was cofinaced from the European Social Fund
through Sectoral Operational Programme Human
Resources Development 2007-2013, project number
POSDRU/89/1.5/S/59184 „Performance and excellence
in postdoctoral research in Romanian economic science
domain”.
FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY:
THEORETICAL BACKGROUND


Abstract.
The aim of this study is to present the theoretical background for the
concepts of fiscal vulnerability and fiscal sustainability. The
distinction between them is very thin and accounts for the time
horizon. For assessing the state (vulnerable/sustainable) of fiscal
policy, it can be used few indicators. Applying them for the case of
European Union members, it was shown that Belgium and Italy
confronts with a vulnerable fiscal policy. In such situation, it is
imperative for the governments to take fiscal adjustment measures
to avoid an unsustainable fiscal policy in the long run.
FISCAL VULNERABILITY vs. FISCAL SUSTAINABILITY:
THEORETICAL BACKGROUND





Introduction
Theoretical background of fiscal
sustainability and fiscal vulnerability
Interrelations between fiscal sustainability
and fiscal vulnerability
Assessing the state of fiscal
vulnerability/sustainability within EU
Concluding remarks
1.Introduction

Fatas and Mihov, 2009; Afonso, Agnello, Furceri and Sousa, 2009


Afonso (2000), Afonso and Rault, 2008


fiscal sustainability issues for EU
Corsetti and Roubini, 1996; Alesina, 2000; Kotlikoff and Hagist, 2005


over the period 1970-2007, fiscal policy in the euro area has been mildly procyclical, and the adoption of the common currency and the constraints imposed
by the SGP have not had a large impact on the cyclical behavior of the structural
balance
current fiscal policies of most EU countries based on growing social spending will
become unsustainable in the future
Balassone et al (2009)

countries currently recording high fiscal surpluses (Finland) or have undertaken
more important structural reforms to their pensions systems (Germany, Austria
and Italy) tend to experience lower sustainability risks
1.Introduction

Recent financial crisis
 Fiscal
policy is vulnerable
 Fiscal policy could become unsustainable in
the long run
2. Theoretical background of fiscal
sustainability and fiscal vulnerability

Fiscal sustainability – ‘good management’ of financial resources from
public budget

Blanchard (1990), and Blanchard, Chouraqui, Hageman, and Sartor (1990)


Zee (1987), Horne (1991), Buiter (1995), Chalk and Hemming (2000), de
Castro Fernandez and Hernandez de Cos (2000)


solvability criterion
Artis, 2000; Croce and Juan-Ramon, 2003


i) public debt does not explode, nor governments are forced to increase taxes, decrease
spending, monetize fiscal deficit or repudiate public debt, or (ii) public debt, as ratio of
GDP, converges to its initial level
a solvent government implies public debt reimbursement in the long run by not
changing the current fiscal policy
Hamilton and Flavin (1986), Chouraqui, Hagemann and Sartor (1990),
Blanchard (1990), Gramlich (1990), Horne (1991), Buiter (1995)

public debt as ratio to GDP does not increase faster than the gap between real interest
rate and real growth rate
2. Theoretical background of fiscal
sustainability and fiscal vulnerability

Fiscal vulnerability

Furman and Stiglitz (1999)


Allen et al (2002), Rial and Vicente (2004)


the economy is vulnerable when there is a liquidity or solvency risk
Brixi et al (2000)


define a vulnerable economy based on the increased probability that the
economic system is not able to absorb all the shocks (speculative attacks on
national currency) and to transform them into systemic risk
fiscal risk related with the government’s ability to meet all its payments
Hemming and Petrie (2000), and Hemming et al (2003)

(i) avoiding excessive fiscal deficits and publics debt stocks that can threaten
macroeconomic stability in the short run and fiscal sustainability in the long
run; (ii) designing a flexible fiscal policy that assures the immediate reaction
to domestic and external disequilibrium; (iii) assuring stable and proper
taxation rate that allows for collecting sufficient fiscal revenues for the public
budget.
3.Interrelations between fiscal sustainability
and fiscal vulnerability
government’s ability o generate primary
surpluses as to meet its financial needs
 the difference between fiscal sustainability
and fiscal vulnerability is very thin

3.Interrelations between fiscal
sustainability and fiscal vulnerability

Fiscal sustainability – forward-looking concept

Fiscal vulnerability – backward-looking concept
3.Interrelations between fiscal
sustainability and fiscal vulnerability
governments ability to generate primary
surpluses as to meet its financial needs
 the distinction is made by the time horizon
considered

4.Assessing the state of fiscal
vulnerability/sustainability within EU




budgetary balance as ratio to GDP (d),
public debt as ratio to GDP (b),
primary balance as ratio to GDP (p),
the gap between the real interest rate and the
real growth rate (gap)
 Database
 EU-27
 Annual data from AMECO
 End year 2008
4.Assessing the state of fiscal
vulnerability/sustainability within EU

Budgetary balance as
ratio to GDP
3.0
LU
2.0
FI
EE
1.0
15%
DK
0.0
-1.0
DE
ES
-2.0
CY
FR
-5.0
PL
CZ
PT
BE
MT
-6.0
-7.0
-8.0
GR
IT
HU
SK
>-3
RO
AT
-4.0
[-3,0)
UK
LT
SI
>=0
SE
BG
NL
IE
-3.0
37%
LV
48%
4.Assessing the state of fiscal
vulnerability/sustainability within EU

Public debt as ratio to
GDP
120.0
100.0
BE
22%
IT
19%
<=20
80.0
IE
20-40
CY
GR
60.0
PT
MT
40.0
DE
FR
ES
HU
SK
SI FI
LU
PL
CZ
19%
UK
DK
AT
20.0
0.0
BG
NL
SE
LT
RO
LV
EE
40-60
60-100
40%
4.Assessing the state of fiscal
vulnerability/sustainability within EU

Balassone and Franco (2000)
 3%
of GDP
 60% of GDP
4.Assessing the state of fiscal
vulnerability/sustainability within EU

Primary balance as
ratio to GDP
6.0
BG
FI
4.0
IE
2.0
0.0
BE
DK
LU
ES IT
DE
SE
NL
UK
LV
PT
SI
RO
LT
-2.0
MT
CZ
-4.0
-6.0
>=0
AT
CY
FR
GR
41%
EE
SK
PL
HU
<0
59%
4.Assessing the state of fiscal
vulnerability/sustainability within EU

The gap between the
real interest rate and
the real growth rate
(gap)
40.00
30.00
20.00
37%
10.00
0.00
-10.00
-20.00
FR
DK
NLAT
BEDE
FI
ES
CY
SI
GR
IE
PT SK CZ HU
IT MT
LU
CZ
PL
LV
<0
63%
LT
-30.00
-40.00
>=0
SE
UK
-RO
4.Assessing the state of fiscal
vulnerability/sustainability within EU
Tabel 1 European states with a vulnerable fiscal policy
Indicator/Countr
y
BE
GR
IT
HU
d
-5,2
-7,2
-7,1
-6,3
b
97,3
62,4
85,9
63,6
p
1,7
0,3
0,7
-0,6
gap
0,8
-2,5
0,2
-5,9
Concluding remarks