Bogdan Căpraru, PhD., Professor of Finance and Banking
Successive crises in recent years have shown us that the sustainability of public finances should become a concern for all stakeholders involved: governments, the general public, financial and banking institutions, companies, supranational institutions, etc. The Stability and Growth Pact, which came into force at the end of the 1990s and has been successively reformed with new rules, aims to ensure the smooth functioning of the Economic and Monetary Union. In 2011, the so-called ‘six-pack reform’ introduced the need to set up bodies to monitor these rules – independent fiscal institutions, also known as fiscal councils. Their mission is to help increase accountability and improve fiscal transparency by providing analysis, evaluation and positive and/or normative recommendations in the area of fiscal policy.
The main tool used by these institutions to fulfil their mission is communication with stakeholders: governments, the general public, financial-banking institutions, companies, supranational institutions, etc. Better informed voters can provide stronger incentives for governments to develop sustainable policies. But for information asymmetry to be reduced as much as possible, the general public needs to have some level of financial literacy, especially „fiscal literacy”. The messages, analyses and opinions of fiscal councils will be better received, understood and interpreted. Thus, fiscal literacy must focus on at least four issues: public debt and deficit; crowding-out effect, fiscal illusion, ageing populations with implications for public pension systems.
Public debt and budget deficit. When government expenditure exceeds budget revenue, a budget deficit occurs. The government borrows from the domestic and foreign markets to support this expenditure. Depending on the public policies promoted, governments provide a range of public goods and services. They can also intervene as „insurer of first resort”, as Gita Gopinath, former chief economist of the International Monetary Fund, calls it, when destabilising events occur, such as the financial crisis and pandemic. This is how “fiscal activism” is put into practice to manage economic cycles. Investments in infrastructure, education, digitalisation, health and because of the ageing population, due to their importance, nature and long-term effect, require public policies supported by increasing public spending. Recent geopolitical tensions have brought back into question the need for increased defence spending at European Union (EU) level.
However, we must not forget that there is no such thing as a „free lunch”! Someone pays sooner or later: the present generation through tax increases and future generations, who will take over the repayment of public debt and part of its costs, as well as less ability to borrow due to the oversized debt stock. The public debt cannot grow to the skies! Markets cannot sustain this growth or/and its „snowballing” effect! The era of cheap money is over, and interest rates are likely to remain high for longer, amplifying the cost of public debt.
That is why we must be aware that there are limits to the provision of public goods and services, large-scale public investment and the capacity to absorb shocks! This triad sometimes involves a trade-off, ideally striking a balance. Beyond this, there are major discrepancies between countries in terms of the „fiscal space” needed to achieve this balance of the triad mentioned above. This fiscal space has depended on the actions of governments to this point.
As mentioned earlier, the establishment of Economic and Monetary Union meant setting fiscal rules to support its smooth functioning: budget deficits should not exceed 3% of GDP and public debt should not exceed 60% of GDP. The new fiscal framework at EU level will continue to build on these two rules, anchoring public spending on a path that reduces public debt levels in the medium and possibly long term, supporting public investment, in particular related to climate change, digitalisation and ageing.
The crowding-out effect refers to an economic theory according to which an increase in public spending leads to a reduction or even elimination of private spending. Thus, financial resources will support the needs of the state, sometimes more or less justified, reducing their availability to the private sector, and thus the growth potential of the economy. Also, the state, in its need to borrow, will offer increasing interest rates on the amounts borrowed, which will lead to a lower appetite for private investment with lower returns. At the same time, the „zero risk” nature of government debt further increases the propensity to invest in government securities, to the detriment of lending to the economy, supporting stock market investments or other forms of investment.
The fiscal illusion, a phenomenon explained by Amilcare Puviani in his work „Financial Theory of Illusion” as early as 1903, involves a poor perception by citizens of the link between public revenue and expenditure. They have the impression that public spending can be expanded in the context of given public budget revenues, a perception sometimes maintained by incumbent governments. The „cost of public policy” is seen as lower than it really is. Thus, while in the short term this phenomenon seems sustainable, in the medium and long term it ends up in large public budget deficits and rising public debt.
The ageing of the population and the long-term unsustainability of public pension systems is another issue. Demographic dynamics show an increase in the number of people receiving a pension (in old age) compared to those in work, mainly due to increased life expectancy and lower birth rates (compared to previous generations). Most pension systems in the EU are based on intergenerational solidarity: the working population – the younger generations, through contributions or taxes paid into public pension budgets, provide for the pensions of the older ones. Thus, the ratio of retired people to the working population in the years to come will no longer be able to ensure the preservation of the living standards of retired people. Also to the detriment of this ratio we should take into account the attitude of the new generations towards intergenerational solidarity and tax payments, as well as the impact of Artificial Intelligence which could replace human labour in certain fields of activity. In this context, the current working population, in order to preserve their standard of living and financial independence, should be aware of these realities and turn to other forms of long-term saving (Pillar II and III, investment funds, accumulation deposits, etc.). Here again, personal finance education blends harmoniously with fiscal education!
Note: The views expressed are the personal views of the author and do not involve the institutions with which he is associated.
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