Summary: KEY ISSUES Prudent fiscal policies with near-balanced budgets over the cycle have reduced gross public debt to about 10 percent of GDP. These policies have also led to a pro-cyclical fiscal stance, with unsustainable increases in spending during the boom and a sharp contraction during the crisis. However, the new budget framework with a target of a structural fiscal balance or surplus should prevent excess spending in upturns and allow full operation of automatic stabilizer in downturns. Legislation in parliament would establish the Eesti Pank (the central bank) as the macroprudential authority and provide it with a full toolkit of macroprudential instruments. However, Nordic banks dominate the system and membership in the Banking Union, limiting Estonia’s scope for unilateral action. In this context, the authorities need to strengthen the Nordic-Baltic cross-border supervisory collaboration and integrate the ECB into them. Labor costs have been rising since 2012, and recent large increases in minimum wages and wages in education and health may be putting additional upward pressure on economy-wide wages and competitiveness. The authorities should refrain from further large wage increases until it is clear that they aren’t undercutting competitiveness. Structural unemployment remains high, and the authorities should continue to implement education, training, and other initiatives to encourage foreign and domestic investment. Consideration should also be given to policies that reduce the tax wedge, particularly for lower-wage workers.

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