Written by Alessandro D’Alfonso, Martin Höflmayr, Karoline Kowald, Sidonia Mazur, Marin Mileusnic and Marianna Pari.
The economic outlook for 2023 is marked by a large degree of uncertainty, the prospect of a shallow and likely short-lived recession at the start of the year, inflation at elevated levels, and a remarkably robust labour market. However, forward-looking economic data such as production and sentiment indicators give reason for hope that a recession can be fended off despite the gloomy prospects. While at the beginning of last year, the economic momentum for a recovery from the COVID-19 pandemic was strong, supported by decisive fiscal and monetary policies, the Russian invasion of Ukraine in February 2022 put a premature brake on the economic recovery. Alongside the humanitarian tragedy of the war, Europe was hit by a substantial shock in import prices that severely dented the economic outlook and aggravated price increases. In particular, soaring energy prices pushed EU inflation to unprecedented levels not reached since the advent of the economic and monetary union. In 2022, average annual inflation reached a record of 9.2 %. With fading pressures from energy prices, and monetary policy measures taken by the European Central Bank (ECB) achieving their desired results, overall inflation is expected to fall significantly in 2023. However, it will then remain above the 2 % target, as projections assume that wages will pick up and fiscal measures, which are currently curbing energy prices, will be withdrawn later, pushing inflation up, with a carry-over effect until 2025. The latter effect prompted the ECB to revise its latest inflation projections upwards (Chapter 2). That illustrates the growing divide between fiscal and monetary policy objectives, as monetary authorities are fighting inflation while fiscal policy tries to cushion the impact of high energy prices on households and firms.
While economic growth and inflation trajectories are going in opposite directions – unlike the oil price shocks of the 1970s, which led to a period of stagflation – labour markets have proven particularly resilient. Unemployment rates are at record low levels as demand for labour remains high. In an environment of slowing growth, high inflation, elevated post-pandemic debt levels and eroding real incomes, the economic outlook is heavily influenced by the development of the geopolitical situation and its reverberations in commodity markets; forecasts are thus surrounded by a significant degree of uncertainty. In such an environment, policy responses need careful calibration, as policy coordination in the EU remains limited.
To ensure budgetary discipline and financial planning in an orderly manner, the EU’s finances are established around a medium-term structure, lasting for seven years. The current multiannual financial framework (MFF) – the sixth since the 1980s – was decided at the end of 2020 (Chapter 3). The pandemic has had a major impact on its design. It resulted in the adoption of an unprecedented budgetary package that combines the €1 210.9 billion MFF for the years 2021 to 2027 with the €806.9 billion Next Generation EU (NGEU) temporary recovery instrument. In that new financial architecture, the EU budget and NGEU play a major role in the EU’s strategy to relaunch the economy. Beyond supporting the recovery from the pandemic, the 2023 EU budget (Chapter 4), set at €186.6 billion in commitments, is providing additional funding for several programmes and policies designed to help face the consequences of Russia’s war of aggression against Ukraine, including the energy crisis, while backing the green and digital transition and biodiversity.
However, in the face of multiple challenges, notably the war on Ukraine and its repercussions, the European Commission will examine, in the second quarter of 2023, whether EU finances are sufficient to cope with the evolving context. The European Parliament has repeatedly voiced its concern that the EU’s long-term budget (Chapter 5) may already have reached its limits, and calls for an ambitious revision to increase the EU budget and make it more flexible. Parliament supports the EU budget being subject to respect of the rule of law, an essential precondition for sound financial management and effective use of EU funding. Moreover, Parliament is a proponent of strengthening parliamentary scrutiny and transparency over EU expenditure, including through NGEU and other EU financing tools, in particular off-budget instruments. Some of these issues will be examined in connection with the forthcoming modification of the EU’s financial rules.
NGEU (Chapter 6) is a major but temporary innovation in EU finances. Overall, it reinforces significantly the resources channelled through EU budgetary instruments up until 2026, supporting ambitious packages of investment and reform measures designed to make the EU economy more sustainable, innovative and inclusive. In 2023, NGEU is projected to finance additional grants worth €113.9 billion in commitments and €130.7 billion in payments, while its main expenditure tool, the Recovery and Resilience Facility (RRF), enters a crucial stage in its lifecycle following its first year of full deployment. The national recovery and resilience plans financed by the RRF focus their action on six priority areas of European relevance that have been identified as vital for strengthening the EU’s resilience, including the green transition (at least 37 % of each national plan) and the digital transformation (at least 20 %).
In addition, the RRF is expected to become the main funding tool of the REPowerEU plan, which seeks to end the EU’s dependence on Russian fossil fuels and accelerate the green transition. That development is meant to further reinforce the recovery plan’s already strong energy dimension. The European Parliament has repeatedly underlined the importance of NGEU and RRF implementation and monitoring, given the size and strategic nature of their expenditure. Lessons learnt from the RRF are feeding into the debate on the revision of the EU’s economic governance framework.
The economic focus of this year’s edition of the Economic and Budgetary Outlook is the EU economic governance framework and its forthcoming revision (Chapter 7). The chapter consists of two parts. The first examines the current design of the EU fiscal framework and its effectiveness, in particular by tracking public finance indicators and national compliance with the EU fiscal rules. The forward-looking part takes stock of the main orientations for a revised fiscal framework the European Commission has put forward. That section touches on the question of how greater investment levels across the EU could be sustained – whether through well-designed fiscal rules, an EU fiscal capacity, or by combining the two.
Policymakers and academics commonly agree that the EU economic governance framework is complex, rigid and prone to boosting domestic fiscal policies’ pro-cyclicality. Moreover, the rules have not contributed to the debt sustainability of Member States with particularly high debt-to-gross domestic product ratios, all the more so since the start of the pandemic crisis. In particular, the activation of the general escape clause by temporarily suspending the application of common fiscal rules has signalled the need for a revision of the EU fiscal framework to strengthen growth and investment prospects. The European Commission is expected to table legislative proposals in 2023with the aim of reforming the economic governance framework. Main elements of the forthcoming reforms include improved debt sustainability, stricter fiscal surveillance by the Commission within the European Semester exercise, the development of national fiscal plans (while evoking analogies with the national recovery and resilience plans under the RRF), and increased national ownership through empowered independent national fiscal institutions.
Read the complete study on ‘Economic and Budgetary Outlook for the European Union 2023‘ in the Think Tank pages of the European Parliament.