26 Mar 2017 What’s behind the EU-Cyprus budget spat?

On Tuesday, Finance Minister, Harris Georgiades told state radio that the Eurogroup meeting for eurozone finance ministers had accepted his position on the government’s budgetary policy.

While there was no specific reference to Cyprus in the official Eurogroup statement by the president, Jeroen Dijsselbloem, he did say that during the meeting they had “followed up on the implementation of the budgetary plans” (of all member states). Dijsselbloem added they would “take stock again on the implementation of the budgetary plans” in May, on the basis of the European Commission’s Spring forecast.

We can assume from this and Georgiades’ statements that Cyprus was not asked to take any additional measures.

This seems to mark a victory for the finance minister in what has been a fairly long battle with the European Commission about the 2017 budget. In sum, the European Commission said there were risks to the government’s 2017 budget plans and wanted the government either to raise taxes or cut spending further. The government rejected the Commission’s assessment, and since it is no longer in a bailout programme, simply ignored the demands.


Measuring structural balances

The battle has been quite a technical one, focused on differing forecasts for the ‘structural balance’.

Measuring a country’s structural balance is tricky. Zsolt Darvas of the respected Bruegel think-tank says a structural balance “aims to measure the ‘underlying’ position of the budget by excluding the impacts of temporary effects: the economic cycle and one-off measures”.

Temporary factors can include a boom that raises tax revenue or a bust that depresses revenue.

The estimate for the structural balance is based on another estimate, namely the ‘output gap’. When the output gap is small, the economy is close to full capacity and the government should not inflate a potential bubble by spending too much money of its own.

By contrast, when the output gap is large, government spending can act as a useful buffer to replace spending by consumers and businesses.

However, measuring the output gap is also contentious. Darvas says it is a “key source of error” in estimating the structural balance.

One sign that a statistic is difficult to measure is how often it is revised.

In six charts Darvas shows the large revisions made each year by the European Commission, the IMF and the OECD to their initial estimates of the structural balances of 15 EU countries. Revisions typically range from 0.5% to 1% of GDP, but are even higher in crisis years.

This touches on the dispute between Georgiades and the Commission: late last year the government forecast a structural deficit of 1% of GDP in 2017, but the Commission forecast a structural deficit of 1.9%.

The Commission’s forecast implies the economy is running close to full capacity. Yet those long-empty commercial buildings and shops suggest that is not the case.

This does not mean that the government should be splashing money about. But it does suggest that its own forecast is closer to reality than that of the Commission.