Goldman Sachs Sees More Fiscal Tightening For Europe

Goldman Sachs issued a European Economics Analyst paper Thursday with expectations on fiscal policy in Europe.

Analysts led by Huw Pill observed that “Euro area fiscal policy [has been] highly contractionary in recent years. Area-wide fiscal policy tightened sharply in 2011-13 in response to the European debt crisis."

“Governments’ fiscal efforts have demonstrated commitment to long-term fiscal solvency. But the fiscal adjustment has exacerbated the contraction of aggregate demand stemming from the European debt crisis. The area-wide fiscal drag, on our estimates, was close to 1pp of GDP growth in 2012 and 2013.

“By contrast, the area-wide fiscal impulse has been essentially neutral this year. From here, we expect only a marginal fiscal tightening over the medium term, including next year. The bargaining process over fiscal adjustment, in which national governments initially propose less adjustment, while the EU Commission sets more ambitious targets, is likely to continue and ensure an (albeit moderate) adjustment,” according to Pill.

Because Euro area debt remains high, the report concluded that to ensure “public debt ratios gradually fall towards 60 percent of GDP at a reasonable pace [over a 20-year period], further fiscal tightening is needed – of the order of 2 percent of GDP in Spain/Italy and 3 percent of GDP in France. Germany can ease fiscal policy and still see its long-run debt ratio decline. On our medium-term assumptions for the fiscal impulse, Italy closes about a quarter and France a half of the remaining fiscal gap, while Spain completes its fiscal adjustment in full.”

The paper assumed average long-term nominal growth of 2.5 percent in Italy, 3 percent in Spain, 3.5 percent in Germany and 4 percent in France.