Reda Simonaitytė-Mikulė. Why is it important to keep the budget deficit below 3%?

Next year’s Lithuanian state budget was adopted on Tuesday. As every year, Members of Parliament have had many proposals on how to distribute the revenue raised and where to increase spending. The government has stressed that the budget is not elastic and that increasing the deficit above 3% is out of the question.

Reda Simonaitytė-Mikulė is an expert at the Lithuanian Free Market Institute

This is not only because of the Maastricht criteria – the requirements ensuring public finance stability of the EU Member States – which are due to return to force in 2024. Discipline in budget formulation and implementation is essential in the upcoming elections when the incentives to increase budget spending are rising. Moreover, government fiscal policy has an impact on the price level – lower spending can help tackle high inflation.

Oriented towards sustainable growth

In 2020, the European Commission lifted fiscal discipline rules to give the economies of the Member States flexibility in responding to the effects of the COVID-19 pandemic. In other words, countries could deviate from the 3% of gross domestic product (GDP) budget deficit and 60% of GDP debt requirements to stimulate their economies. Countries must once again meet these Maastricht criteria from next year, ensuring fiscal discipline. Lithuania has no problem with this so far – the 2024 state budget will have a deficit of 3%, and the state’s debt will reach almost 40%.

As early as the beginning of the COVID-19 pandemic, World Bank experts emphasised that when budget deficits and public debt rise during economic crises, fiscal rules must guarantee greater public savings and debt repayment in periods of economic recovery. They argued that sufficient government reserves in times of crisis reduce pressure on budget deficits and allow for a more flexible response to economic shocks. Lithuania still needs to be committed to this path.

The Constitutional Law on the Implementation of the Fiscal Treaty of the Republic of Lithuania defines the rules of national fiscal discipline, the respect of which ensures the sustainable execution of government budgets. Strict requirements for limiting expenditure growth are foreseen to ensure that public priorities are covered by sustainable revenues, not borrowed funds. Deviations from them are only possible in exceptional circumstances. The Lithuanian government initiated the exceptional circumstances of the need for greater fiscal flexibility to deal with the COVID-19 pandemic, the energy crisis and high inflation.

So far, they have not been suspended, and there is still room for additional spending. This is even though the suspension of the exceptional circumstances is recommended by both the National Audit Office and the Bank of Lithuania. The National Audit Office points out that a further steady increase in expenditure risks breaching the Maastricht criteria by 2025-2026. In that case, the European Commission’s complex excessive deficit procedure would be triggered, with recommendations for correcting the state of public finances and fines in case of non-compliance. The government’s choice to extend the exceptional circumstances to 2024 reflects its reluctance to reform its budgetary planning policy.

Inflation rises with spending

Fiscal measures taken by euro area countries in 2022 to tackle energy challenges and high inflation have contributed to a rise in the price level over the medium term, the European Central Bank has found. Stimulative fiscal policies by Member States are projected to increase the Harmonised Index of Consumer Prices (HICP) in the euro area by 0.7 and 0.4 percentage points in 2024 and 2025, respectively.

The Bank of Lithuania also highlights the impact of the 2024 budget on average annual inflation, with spending decisions projected to increase the annual HICP by 0.32 and 0.41 percentage points in 2024 and 2025, respectively. With the recommendations to lift the exceptional circumstances and the diminishing need for targeted assistance, lower public spending would allow Lithuania to move faster towards the strategic 2% annual inflation target and ensure economic stability. According to the Ministry of Finance’s September economic forecast, the annual change in the price level will only move closest to the 2% target in 2026, reaching 2.3%.

The European Commission’s fiscal policy guidelines promote responsible budgetary planning and sustainable economic growth. The return of the Maastricht criteria means that the days of economic shocks requiring significant fiscal stimulus are over.

Therefore, when implementing the Lithuanian state budget for 2024, adherence to the principles of fiscal discipline must remain a key priority at the national level as well. Sustainable revenues and corresponding expenditures would accelerate the achievement of a balanced budget and price level stability and ensure compliance with fiscal rules in the longer term.

Originally published at