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The IEB Report 4/2021 reflects on fiscal sustainability in the post-Covid-19 era

The Barcelona Institute of Economics has presented its IEB Report 4/2021 ‘Fiscal sustainability in the post-Covid-19 era’ coordinated by Alejandro Esteller-Moré, Professor of Economics at the University of Barcelona. The report stresses the need for structural reforms that increase GDP and thus reduce debt pressure. The impact of the pandemic in Spain has seen the public debt/GDP ratio rise to 125%, well above the expected pre-pandemic levels.

The academics and experts who have contributed to the report expect the situation to remain financially sustainable in the short term due to the low interest rates, and do not think that the debt/GDP ratio will continue to grow. However, they warn of the risk of rising interest rates if inflation becomes permanent, and therefore advocate the adoption of fiscal consolidation policies as soon as possible so as not to harm economic growth, and the design of monetary policies that do not generate inflationary expectations.

The report analyses the extent to which the public finances of all countries have been affected by the shock caused by COVID-19, which led to an abnormal increase in the volume of public debt. There is no doubt that the public sector’s response has borne witness to its key role as an insurer, and as Esteller-Moré points out, “the alternative would have been an unprecedented disaster for the Spanish economy.” The fact is that even with public intervention, the Spanish GDP fell almost 11% in real terms. In other words: there was a deviation from the initial forecasts of economic growth for 2020 of almost 13 percentage points.

According to the experts, the key issue is whether this situation can affect the sustainability of public finances. For Esteller-Moré “in the short term, low interest rates and renewed growth have not put the public system under stress, so the debt is sustainable. However, in the medium term, there are various risks looming, such as a possible rise in interest rates that must be considered and which our public managers will have to face”.

For 2020, the deficit target established by the Stability Program (2019-2022) for all public administrations was 1.1% of GDP, mainly as a result of the negative balance of the Social Security budget. These forecasts, which the European Commission (EC) has already shown were biased upwards (that is, the EC predicted a higher deficit of 2%), have been transformed into a deficit of 10.1% of GDP. The Stability Program (2021-2024) foresees that this deficit will gradually fall to 3.2% in 2024.

In any case, the IEB report notes that “in the Spanish case, it never rains but it pours” and that “part of the deficit in its public finances is structural”. Given this situation, the experts conclude that “the need for structural reforms that, by way of increasing the GDP, reduce the pressure of the debt is clear again” – all this in the knowledge that “with the progressive aging of the population, increasing productivity becomes an unavoidable challenge”.