Under present conditions, therefore, the only elements of government expenditure which are susceptible to a measure of discretionary control are capital outlays, operational expenditures and other programmes, mainly consisting of Malta’s contribution to EU-funded projects. Indeed, the Convergence Programme indicates that around one half of the required cost savings during the next three years will come from a reduction in capital expenditure. This, however, still leaves the need for expenditure cuts by 2007 of around Lm70 million. This is more than one third of what the Government spends on operational expenditures and programmes. And while economies should be sought in these areas too, it is unrealistic to expect that these can produce all the required savings. Unpalatable as it may sound, the truth is that difficult but crucial decisions must be made without delay regarding the size and the cost of both the public sector and the welfare state. In this context, I propose to examine government expenditures from the perspective of what they are achieving as a guide to understanding whether the allocation of resources resulting from choices made in the past is optimal in today’s circumstances. Let us first look at how recurrent expenditure, which this year amounts to almost Lm740 million when the interest on the public debt is excluded, is distributed. Education, health and activities related to the promotion of economic growth, such as co-financing of EU projects and expenditure on tourism, information technology, infrastructure and communications account for some 39%.

The crisis has also shown that monetary policy cannot be the only euro area stabilisation mechanism. We must equip ourselves with a permanent fiscal stabilisation mechanism that allows us to face future crises without the need for ad hoc political agreements. The European funds approved during this crisis may be a good precursor of this mechanism. And we must also debate the reform of the Stability Pact. It should be simplified and tailored to the current circumstances, namely the low interest rate environment. Further, its scant capacity to successfully steer countries to build up fiscal buffers in boom periods for use in crises must be resolved. The medium-term challenges also affect monetary policy.8 These challenges arise from the progressive reduction in the so-called natural interest rate in recent decades. It is attributed to demographic factors, such as population ageing, or technological factors, such as lower productivity growth, which have altered the balance between the supply of saving and the demand for investment. The upshot is that, to stabilise inflation, real interest rates must now be lower. The problem lies in the fact that there is a lower bound on nominal interest rates, meaning that monetary policy is more effective in combating inflation than deflation or, even, persistently low inflation. 8  See Hernández de Cos (2021): "The European Central Bank’s monetary policy: response to the pandemic crisis and future challenges", speech at the Universidad Autónoma de Madrid. 8  Against this background, the main central banks have deemed it necessary to review their monetary policy strategies.