15 December 2022 Fiscal policy: 2023 another exception year; prepare for fiscal consolidation in 2024 Most countries have taken bold steps to cushion the energy prices on real disposable incomes and soften impact of the energy crisis on firms and households. the blow on demand. However, it can also slow down In Europe, most of the current fiscal measures have the reduction in inflation rates overall. We estimate been extended into 2023 for a total of more than 3% that current measures directly reduce inflation rates by of GDP on average in Europe (close to 5% of GDP or lowering energy prices most in the UK (-3.7pps in 2023), more than EUR600bn since September 2021) (Figure 8). followed by more than -2pps in Germany, France, Italy Unsurprisingly, the fiscal response is somewhat higher and Spain. By doing so, however, they “free” 1.7% of in countries with a larger energy-intensive industry and/ GDP of domestic demand on average as the decline or greater gas dependence. In most countries, the total of household disposable incomes in 2023 will be more measures (e.g. price caps, energy tax cuts, liquidity and than halved from -4.3pps to -1.7pps on average (more equity injections, state-guaranteed loans and furlough than EUR1,300 per household). However, coordination schemes) amount to around half of the Covid-19 at the European level is likely to continue to disappoint, packages. With the energy crisis – and in turn the notably as regards the electricity market, which will inflation hit to the private sector – not yet past the peak, raise the potential fiscal cost. we expect EU governments to increase spending further. However, the big fiscal leaps are behind us as the In the US, fiscal policy has decisively shifted towards room for maneuver is much more constrained amid a restrictive stance since the second half of 2021 rising interest rates. Governments need to find a (Figure 9). Because of the lagged effects of fiscal way to enhance energy efficiency and stabilize gas policy, it is expected to weaken the economy in end consumption beyond near-term savings (which currently 2022-early 2023, supporting our call of an upcoming stands at only 10%). Indeed, without demand reduction fall in inflation and a recession. However, we expect (through market prices or fiscal policy), countries could the Democrat-led White House and the Republican-led fall into a vicious cycle of higher prices leading to more House to agree on a modest fiscal easing – to the tune fiscal slippage. Conversely, limited fiscal space and of 0.2% of GDP – around the middle of next year to ineffective energy policy could further slow economic support a flagging economy. In 2024, we expect fiscal growth and raise the odds of a longer and deeper policy to turn restrictive again (to the tune of 1% of recession at a time when rising interest-rate burdens GDP) despite the Presidential election, amid mounting challenge debt sustainability. In particular, diminishing fiscal imbalances. Public deficits should be close to 7% fiscal space could require difficult policy trade-offs as of GDP in 2023 for the general government, pushed governments also tackle important structural challenges up by a rapidly growing interest payment bill (which outside the current energy crisis, such as the green we expect to top USD1,000bn by 2024) amid elevated transition of their economies and the launch of bold borrowing costs. pension reforms, such as in France and Spain. Available fiscal support will reduce the impact of higher 15