- - The Fiscal Compact (TSCG), an intergovernmental treaty coming into force 2013, similar to primary law, requires MS to have a structural, i.e., cyclically-adjusted budget balance, in surplus or small deficit. The requirement is considered fulfilled if the structural budget balance stands at-0.5% or higher in MS whose debt is close to 60%. However, if the debt is significantly below 60%, a structural deficit up to 1.0% is allowed. MS with debt above 60% have to reduce 40 50 60 70 80 90 100 110 120 130 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Gross public debt, % of GDP, in the euro area 1999-2022 (weighted with GDP-shares) 7 high-debt countries >> 60% 12 low-debt countries below or close to 60% Euro area the difference to 60 by 1/20 p.a. as a benchmark, which generally implies a significant primary budget surplus or even a structural surplus.
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- (2019), Baldacci et al. (2012), Bernardini et al. (2019) and Eichengreen et al. (2019). Often the methodology of these analyses is unclear. We comment on Bernadine et al. to highlight the shortcomings that also occur in the other studies. The authors analyse 30 episodes of massive debt reduction from 1945 until 2017 in OECD countries. The majority of episodes occurred after World War II via catching up growth with strongly negative r - g differentials, often driven by inflation or “repressed finance”, i.e., regulatory caps on interest rates. Since the 1980s, with financial deregulation, reduced capital controls and strengthening of the independence of central banks, debt reduction occurred via “orthodox fiscal adjustment” as the authors coin it.
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- (5) Despite a big leap in deficits and debt in 2020, spreads in interest rates have been successfully suppressed by asset purchases of the ECB on secondary markets, which has led to significant ownership of sovereign bonds by the central bank. Interest rates on 10 years’ sovereign bonds are contained in the range of-0.6 and +0.5% in the EA (December 2020, worldgovernmentbonds.com 2020).
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- (6) The relationship between interest rates on public debt and nominal growth has fundamentally changed, as the differential became negative for almost all MS, apart from the crisis-year 2020, and will probably remain negative at least for the medium-term. This allows carrying higher debt loads and eases debt reduction.
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- (7) The decisions of the EU Council in July 2020 on the Multi-Year Budgetary Framework of the EU and the Recovery Plan (“Next Generation EU”) have opened the door to a centralised fiscal capacity at the EU-level and loosened the ban on borrowing within the EU budget.
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- 5.3 Empirical evidence on the r - g differential and the interest burden The r - g differential hovers up and down with the business cycle (Graph 2). In the euro area until 2014, g exceeded r only in a few boom years, later continuously. When GDP plummets in recessions or crises, the differential jumps upwards and increases the mean. Italy’s differential is above the euro area mean; Germany’s is below, but only since 2006. Germany reached the regime change a few years before the euro area. The change came predominantly from the interest rate on debt, not from g.
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- A key ingredient of the EU fiscal rules is the methodology for calculating potential output and structural (i.e. non-cyclical) budget balances (EU Commission 2014). The Commission is in charge of selecting the methodology. Over the years the latter has changed several times. Presently the so-called production function approach is used, based on estimating the “non-accelerating-wage-rate of unemployment” (NAWRU), a rate of “structural unemployment” below which nominal wages tend to rise and the inflation pressure increases.
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- All authors reviewed so far prefer some kind of expenditure rule rather than following the structural balances as intermediate goals. The expenditure rule included in the current set of rules of the EU Commission differs somewhat from the proposals, but not very much (see the comparison of Claeys et al. 2016, 10). The idea is to restrict expenditure growth in “good times”, but this likely backfires on aggregate demand and the growth of actual and later on also on potential output, unless there is an inflationary positive output gap in “good times”. Then (and only then) restrictions on aggregate demand make sense. The inclusion of a Golden Rule in two proposals is a point of difference; Feld et al. (2018) intend to leave almost all SGP rules unscathed. Only one proposal (Dullien et al. 2020) really questions the 60% debt ceiling; the EFB (2019) does but without making a clear recommendation. Benassy-Quéré et al. embed
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- Although the interest payments as a share of GDP were 3.3% in 1994, seemingly not extreme, this amounted to a considerable share in total government expenditures.
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- among others, are weak and unconvincing (GCEE 2017, Box 17). Here is not the place to delve deeper into this debate. Lastly, some authors ponder on debt relief to some extent for Italy, Greece or other MS.
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- Another challenge is the risk of deflation if the pandemic lingers on and the recovery remains weak or is dampened by contractionary fiscal policy. Even worse, when a financial crisis ensues due to the bankruptcies of firms and financial institutions. Then another debt hike is likely. 12 For instance, if Germany has a debt ratio of 71% in 2021 (AMECO forecast August 2020) and faces an r-g differential of-2 ppts (3% growth and 1% interest on debt), the debt level could be reduced with a primary balance of zero by around 1.3 ppts p.a., if maturing debt were rolled over.
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Arnold, N., Barkbu, B., Ture, E., Wang, H., Ya, J. (2018): A Central Fiscal Stabilization Capacity for the euro area. International Monetary Fund, Staff Discussion Note, SDN/18/03.
- At the same time, the initial structural primary deficit of-1.7% was transformed into a small surplus of 0.9%. This was caused mainly by soaring tax revenues (+4.1% p.a.) driven strongly by rising employment (the flip-side of low productivity increases) while total expenditure grew on average not more than 2.6% p.a., significantly less than nominal GDP (3.3% p.a.), but primary spending grew by 3.0% p.a. in nominal terms. Since 2012 rising budget surpluses showed up, which contributed around 25% to the total debt reduction of 22.6 ppt. The contributions to the budget surplus and the falling debt ratio came from four sources: moderate 4
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Baldacci, E., Gupta, S., Mulas-Granados, C. (2012): Reassessing the fiscal mix for successful debt reduction. Economic Policy, 27(71), 1 July, 365–406.
- Bénassy-Quéré, A., Brunnermeier, M., Enderlein, H., Farhi, E., Fratzscher, M. , Fuest, C., Gourinchas, P.-O., Martin, P. , Ferry, J.-P., Rey, H., Schnabel, I. , Veron, N., Weder di Mauro, B., Zettelmeyer, J. (2018): Reconciling risk sharing with market discipline: A constructive approach to EA reform. CEPR Policy Insight No. 91, January.
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Berger, H, Dell’Ariccia, G., Obstfeld, M. (2018): Revisiting the economic case for fiscal union in the Euro area, IMF Research Department Paper.
- Bernardini, S., Cottarelli, C., Galli, G., Valdes, C. (2019): Reducing public debt: the experience of advanced economies over the last 70 years. Policy Brief. LUISS School of European Political Economy, Rome.
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- Besides the eight proposals reviewed here, hints to a few other – contrasting – proposals are necessary. The German Bundesbank (2017) has been concerned about too lax fiscal rules since the flexibility clauses were introduced in 2015 by the European Commission. The authors plea for a return to the pre-2015 rules of SGP and Fiscal Compact and call for stricter enforcement rather than changing the rules. A team of authors from the ECB (Kamps et al. 2019) have a more critical view of the EU fiscal framework. Procyclicality and complexity of the rules are criticised, and the heterogeneity of MS is precisely recognised, yet proposals remain vague. Some authors seem to believe that the shortcomings of the measurement of potential output and structural balances could be solved by technical reforms using different measurement methodology deviating from the production function approach used by the
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Bibow, J. (2018): Unconventional monetary policies and central bank profits IMK Studies 62, Düsseldorf.
- Blanchard, O. J., Leandro, A., Zettelmeyer, J. (2020): Revisiting the EU fiscal framework in an era of low interest rates. March 9. Manuscript.
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- Blanchard, O.J., Chouraqui, J.C., Hagemann, R.P., Sartor, N. (1991): The Sustainability of Fiscal Policy: New Answers to an Old Question (March 1991). NBER Working Paper No. R1547.
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- Buti, M., Carnot N. (2018): The case for a central fiscal capacity in EMU. VOX/CEPR. 7 December.
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Carnot, N., Kizior, M., Mourre, G. (2017): Fiscal Stabilization in the Euro area: A Simulation Exercise, Centre Emile Bernheim Working Paper 17/025.
Chiacchio, F., Claeys, G., Papadia, F. (2018): Should we care about central bank profits? Bruegel, Policy Contribution no. 13.
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Claeys, G., Darvas, Z., Leandro, A. (2016): A Proposal to Revive the European Fiscal Framework. Bruegel Policy Contribution, 2016/07.
- Commission (representative for several authors cp. Heimberger/Kapeller 2017, Heimberger et al. 2020). Via realistic changes in assumptions, the cyclical deficits in recessions would be more significant, and they would fade away later in upswings. This way, structural balances are, in essence, lower and cyclical balances are as well. Thus, the scope for countercyclical action is bigger than calculated by the Commission. Even if this critique is correct and alternative measurement superior, the level of debt would not be addressed and neither would the primary balances. Moreover, the expenditure rule was precisely proposed to overcome such shortcomings of measurement, but it incorporates the problems mentioned above in the review of the proposals.
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Cordes, T., et al. (2018): Expenditure Rules: Effective Tools for Sound Fiscal Policy? International Monetary Fund, Working Paper WP/15/29 Darvas, Z., Martin, P., Ragot, X. (2018a): European Fiscal Rules Require a Major Overhaul. Notes du conseil d’analyse économique, No. 47.
- Darvas, Z., Martin, Ph., Ragot, X. (2018): The economic case for an expenditure rule in Europe. VOX 12 September. https://voxeu.org/article/economic-case-expenditure-rule-europe De Grauwe (2015): Design failures of the Eurozone. VOX/CEPR, 7 December.
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De Grauwe, P., Ji, Y. (2013): Self-Fulfilling Crises in the Eurozone: An Empirical Test. Journal of International Money & Finance, Vol. 34, 15-36.
- Despite several cross-country studies on successful episodes of debt reduction in recent years, there are only a few on EMU members, apart from small ones. There were only 4 MS which could reduce their debt ratios remarkably since the inception of the Euro in 1999 until the eve of the financial crisis 2007: Belgium, Ireland, Spain and Netherlands. Especially the latter three experienced above EMU-average growth due to country-specific structural features which allowed them to have primary surpluses and a very favourable r – g differential, particularly in Ireland and Spain, to a lesser extent in Netherlands and Belgium. For an overview of studies on successful debt reduction episodes, see Nickel et al.
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- Despite the hike in gross debt as a share of GDP in the Corona crisis, the average interest burden in the euro area reached a record low with 1.7% in 2020. In a few countries, it was above the alarm-line of 3% (Italy 3.4% in 2019), while in Germany the burden came down to 0.8% in 2019.11 In all four large EU MS, the average term-to-maturity lengthened in recent years to 78 years, similar to the trend in all OECD countries (OECD 2019). Graph 4 shows that despite the record-high debt due to the Corona-shock, costs of interest payments have reached an alltime low. The capacity to carry debt has never been so favourable. This judgement applies to all MS and corroborates the view that the gross debt to GDP ratio is a misleading indicator of debt sustainability.
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- Deutsche Bundesbank (2017): Design and implementation of the European fiscal Rules, Monthly Review, 29-43.
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- Dullien. S., Paetz, Ch., Watt, A., Watzka, S. (2020): Proposals for a Reform of the EU’s Fiscal Rules and Economic Governance. IMK Report 159e. Düsseldorf.
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- EFB 2019: European Fiscal Board (2019): Assessment of EU fiscal rules with a focus on the six- and two-pack legislation. August. Brussels.
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Eichengreen, B., El-Ganainy, A., Esteves, R.P., Mitchener, K.J. (2019): Public Debt through the Ages. International Monetary Fund, Working Paper, WP/19/06.
Eichengreen, B., Panizza, U. (2014): A surplus of ambition: Can Europe rely on large primary surpluses to solve its debt problems? NBER Working Paper 20316.
- EP 2020: EU Parliament, Economic Governance Unit (2020): Implementation of the Stability and Growth Pact - January 2020. Brussels. January.
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- Estimates for 2020 show Italy, Greece and Portugal with the highest burden of gross interest payments, in % of GDP (Graph 4). When the euro was launched in 1999, 4 MS had a burden above 6% and 12 above 3%. Also, Italy, Greece and Portugal improved enormously. 11 Of course, the burden of interest payments should be calculated in real terms. Since z = rD/Y, nominal values, increased by inflation, show up in the numerator and the denominator. So, z indicates the burden of real debt service. 0 20 40 60 80 100 120 1 1,5 2 2,5 3 3,5 4 4,5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Euro area: gross public debt and interest payments on public debt, % of GDP Euro area interest payments Euro area public debt 60% debt, rhs 3% alarm line, lhs
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- EU Commission (2014): The Production Function Methodology for Calculating Potential Growth Rates & Output Gaps. European Economy, Economic Papers 535.
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- EU Fiscal Board (2019) The EU Fiscal Board (EFB 2019) was commissioned by Jean-Claude Juncker, the former President of the EU Commission, to assess the EU fiscal rules with a focus on the Two- and Six-Pack legislation and the revised SGP from 2011. The EFB comes up with four major proposals. - The first one is to simplify the current set of rules (“unnecessary complexity”) and instead concentrate on a medium-term goal for debt sustainability and a short-term operational target.
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- EU-Commission (2015): Making the best use of the flexibility within the existing rules of the Stability and Growth Pact. 13.01.2015. COM(2015) 12 final EU-Commission (2019): Vade Mecum on the Stability and Growth Pact – 2019 Edition, Institutional Paper 101. Brussels.
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- EU-Commission (2020): Economic Governance Review. 05.02.2020. COM(2020) 55 final EU-Commission (2020a): Debt Sustainability Monitor 2019. Institutional Paper 120. Brussels.
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Eyraud, L, Debrun, X., Hodge, A., Lledo, V.D., Pattillo, C.A. (2018): “Second-Generation Fiscal Rules: Balancing Simplicity, Flexibility, and Enforceability, IMF Staff Discussion Notes No. 18/04.
Eyraud, L., Wu, T. (2015): Playing by the Rules: Reforming Fiscal Governance in Europe.
- Feld, L., Schmidt, Ch., Schnabel, I., Wieland, V. (2018a): Refocusing the European fiscal framework. 12 September. VOX/CEPR https://voxeu.org/article/refocusing-european-fiscalframework Furman, J., Summers, L. (2020): A Reconsideration of Fiscal Policy in the Era of Low Interest Rates. Discussion Draft. 30 November. https://www.brookings.edu/wpcontent /uploads/2020/11/furman-summers-fiscal-reconsideration-discussion-draft.pdf Gaspar, V. (2020): Future of Fiscal Rules in the Euro area. Speech 28 January. Brussels.
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- Fifth, overcoming procyclical fiscal policy and turning to decisive countercyclicality, improves the r - g differential. This requires not only expansionary fiscal impulses in all MS in recessions, that could partly be complemented by a central fiscal capacity, but also prolonged upswings and prevention of negative shocks, especially from global financial markets. The average positive r - g differential in the euro area prior to the financial crisis, compared to the U.S. with a decade-long trend of a negative differential, was partly due to a flawed or at least unfavourable macroeconomic policy regime (cp. Priewe 2020a, 2020b).
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- Fourth, there is a long global trend towards lower real interest rates, as shown in Graph 6, which is unlikely to be reversed to the level prevailing in the 1990s when the rule-book for the euro was designed.
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- Furthermore, many authors call for a central fiscal capacity as central bank monetary policy runs out of steam. Also, the Director of the Fiscal Affairs Department of the IMF calls for establishing a centralised fiscal policy in the EMU (cp. Gaspar 2020) as one of three major reforms (besides completing the banking and the capital market union). Similar quests for a central stabilisation capacity in the EA come from other IMF-authors (Arnold et al. 2018, Buti/Carnot 2018, Carnot et al. 2017, Sims 2019, De Grauwe 2015, Berger et al. 2018, Carnot/Kizior/Mourre 2017). Before we turn to our proposals, we analyse the key pillars of the expenditure rule proposals. 3. Critique of the expenditure rule proposals 3.1 The “deficit bias” hypothesis Although there seems to be broad consensus that expenditure rules will likely perform better than the SGP with its focus on structural balance targets, there are several shortcomings with both concepts. so the focus here is on expenditure rules.
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- GCEE (German Council of Economic Experts) (2019): Jahresgutachten 2019/2020. Wiesbaden.
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- GCEE (German Council of Economic Experts) (2020): Jahresgutachten 2020/2021. Wiesbaden.
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- Germany managed to reduce its debt level from 82.4% 2010, a record high, to 59.6% in 2019, i.e., by 22.8 ppt in ten years (the data used in this paragraph are from AMECO, 9 February 2021, “government” is general government including social security institutions). This reduction came along with an average r - g differential of-1.1%, with a moderate growth rate of real output of 1.7% with a mean inflation rate of 1.6% (GDP-deflator). The favourable r–g differential was mainly driven by the fall of the interest payments on debt from 3.5% to 1.3% of GDP, so that the interest burden fell by 2.2 ppt. The structural balance improved by 3 pts, from-2.1 to +0.9%, similarly the structural primary balance. Also, the countercyclical fiscal policy right after the financial crisis in 2009-2010, which stimulated domestic growth and net exports, contributed to a relatively quick recovery (in 2011 the pre-crises GDP was surpassed).
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- Gestrich, H. (1944): Kredit und Sparen. Jena 1944.
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Giavazzi, F., Pagano, M. (1990): Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries). NBER Macroeconomics Annual. 5: 75–111 Guajardo, J., Leigh, D., Pescatori, A. (2014): Expansionary Austerity? International Evidence. Journal of the European Economic Association, 12(4), 949-968.
- Graph 2 Source: AMECO: lines AYIGD and UVGD, December 6, 2020. Note: data for 2020 and 2021 are estimates of the European Commission.
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- Graph 3 Source: AMECO, lines AYIGD and ILN, December 6, 2020. Note: Estimates for 2020-2022 by the European Commission. -8 -6 -4 -2 0 2 4 6 8 10 12 14 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Interest-growth differential (r-g) in the Euro area, Germany and Italy r-g Eurozone r-g DE r-g IT 0 1 2 3 4 5 6 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Euro area: implicit interest rates on government debt and nominal long-term interest rates, % implicit interest rate nominal long-term interest rate
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- Graph 4 Source: AMECO, lines UYIG, UVGD, UDGG. 28 January, 2021. Note: Estimates for 2020 and 2021 by the EU Commission.
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- Graph 6 AMECO: lines ILN, ILRV, PVGD, December 7, 2020. Note: real rates deflated with GDP deflator.
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- Graph 7 Source: Federal Reserve Bank Economic Data (FRED), 7 December 2020. Note: Annual values refer to data for January in each year. Now we turn to a brief discussion of potential objections against our fiscal policy reform proposal with the primary structural deficit as the operational target, rather than the structural balance as in the SGP and the TSCG – and the interest service ratio as the fiscal anchor instead of the debt ratio. -2 -1 0 1 2 3 4 5 6
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- growth of GDP, buoyant tax revenues without tax increases, strong relief in interest payments and from moderately subdued spending over a long upswing period of 9 years. Without the expansionary monetary policy of the ECB, which reduced r in Germany, the debt reduction would not have worked (cp. Rietzler/Truger 2020). Both episodes, the U.S. and the German one, demonstrate that postulating the simple solution of raising primary balances via less expenditure growth as a universal success formula is only a small part of the real story.
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Heimberger P., Kapeller J. (2017):The performativity of potential output: Pro-cyclicality and path dependency in coordinating European fiscal policies. Review of International Political Economy, Vol. 24(5), 904-928.
- Heimberger, Ph., Huber, J., Kapeller, J. (2020): The power of economic models: the case of the EU’s fiscal regulation framework. Socio-Economic Review, 18(2)17 December, 337-366.
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Holtfrerich, C.-L., L. P. Feld, W. Heun, G. Illing, G. Kirchgässner, J.Kocka and C.Ch. von Weizsäcker (2015): Staatsschulden: Ursachen, Wirkungen und Grenzen, Berlin.
- However, the planned health reforms were cancelled. In two years, 2000 and 2001, a small budget surplus contributed marginally to the debt reduction. The main political reason for Clinton debt policy was the aversion of the balanced budget legislation propagated by the Republicans, which led to a political compromise of debt reduction, tax increases and sacrificed welfare reforms (cp. Priewe 2001). Clinton’s austerity came on the back of the growth dynamic of the “Roaring 1990s” (Stiglitz) and would not have been possible without it, driven in part by expansionary monetary policy. Clinton did not follow the idea of curbing solely expenditure as advocated by the expenditure rule, but intended to combine decisions on spending with decisions on taxes (PAYGO approach).
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http://www.oecd.org/finance/Sovereign-Borrowing-Outlook-in-OECD-Countries-2019.pdf Ostry, J., et al. (2010): Ostry, J.D., Ghosh, A.R., Kim, J.J., Qureshi, M.S. (2010): Fiscal Space. IMF Staff Position Note 10/11, International Monetary Fund, Washington Ostry, J.D., Gosh, A.R., Espinoza, R. (2015): When Should Public Debt be Reduced? IMF Staff Discussion Note, SDN/15/10.
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- in this paragraph are from Priewe 2020a, based on U.S. sources). The average r - g differential was-1.7 ppt, due to reduced interest rates and buoyant real GDP growth of 3.4% p.a. in this 8year episode with 1.8% average inflation. Although a stable debt ratio had not required a primary surplus, the average surplus in these years was 1.8%, with restrictions on expenditures and rising taxes. Strongly reduced interest payments on debt from 3.3 to 1.4% enlarged fiscal space 4 ; the growth of spending was moderately limited besides cuts in military spending.
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- Instead, we propose some fundamental changes. The proposal emanates from the following critique of the SGP. Since 2005, the SGP defines “medium-term objectives” for fiscal policy in terms of structural balances. The TSCG has engraved the targets of-0.5 and-1.0% as caps for structural deficits. This is meant as a debt brake once countries are close to or significantly below 60%, and the 1/20th rule is designed in the SGP and TSCG to reduce excessive debt above 60%. The notion of balanced structural balances with a maximum tolerance of 1.0 ppt would require significant permanent primary surpluses in the order of 23 % on average in the euro area if the interest burden has the same magnitude as in years prior to the financial crisis. This has continuous contractionary consequences. The implicit logic is that interest rates on public debt r tend to be higher than output growth g. Implicitly the debt brake has a debt anchor goal way below 60% as a point of convergence (under a 3%-growth
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- International Monetary Fund, Working Paper, WP/15/67 Fatás, A., Summers, L.H. (2018): The permanent effects of fiscal consolidations. Centre for Economic Policy Research. Discussion Paper 10902. London.
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- ISSN 1861-2180 This publication is licensed under the Creative commons license: Attribution 4.0 International (CC BY). Provided that the author's name is acknowledged, this license permits the editing, reproduction and distribution of the material in any format or medium for any purpose, including commercial use. The complete license text can be found here: https://creativecommons.org/licenses/by/4.0/legalcode The terms of the Creative Commons License apply to original material only. The re-use of material from other sources (marked with source) such as graphs, tables, photos and texts may require further permission from the copyright holder.
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- Priewe, J. (2020a): Die Staatsverschuldung in Deutschland und den USA 1960-2018 im Vergleich. In: Junkernheinrich, M., Korioth, St., Lenk, Th., Scheller, H., Woisin, M. (eds.): Jahrbuch für öffentliche Finanzen 1-2020. Berliner Wissenschaftsverlag, Berlin 2020, 405428.
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- Rietzler, K., Truger, A. (2019): Is the “Debt Brake” behind Germany’s successful fiscal consolidation?. Revue de l’OFCE, Special Issue, Hors-série (2019), 11-30.
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- Said bluntly, if there are so many adverse shocks, good times are rare and short. Times that were good enough to constrain expenditures, even though inflation was unambiguously below target, triggered strong monetary easing. In other words, the imperative to save in good times ignores history (shocks, legacy debt), and it ignores inflation below target, hence monetary policy. Similar narratives could be told regarding European high-debt countries like Italy. Key for understanding Italy’s debt is understanding its historical legacy. Attempting to reverse historical developments by fiscal frugality can lead, under certain circumstances, to self-defeating fiscal constraint. This is a phenomenon ignored by almost all authors following the deficit-bias hypothesis (cp. Fatás/Summers 2018).
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- Second, if “good times” are considered as “relatively good” compared to the recession times, irrespective of the inflation rate, the term “output gap” is inappropriate. Then the only goal might be to reduce the debt level, even at the expense of real growth in an upswing. If this dampens growth or shortens the upswing, the task would be calibrating fiscal retrenchment and growth in a way that sacrifices some growth (probably also employment) without jeopardising the debt-reduction attempt. Such a calibration would require fiscal fine-tuning and is not a very promising endeavour. It could turn out that in presumably “good times” target inflation and debt reduction are conflicting goals (2012-2019 in the EA as a whole) or that both goals remain unachieved, as in most high-debt countries in the same period.
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- spreads explode. The model chosen is one of many, resting on concepts of intertemporal budget constraints and the highly controversial Laffer curves. There are many such models with quite different results. These models assume that r > g, that bondholders behave uniformly and follow a specific rationality that is well known beforehand and in which the role of central banks is ignored (cp. Ostry et al. 2010 and the review in Priewe 2020, 29-34). In general, spreads on interest rates are very small when debt levels rise in countries with stand-alone currency, even in case of high debt (Priewe 2020 with a brief overview on studies, 36).
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- Stanley, T. D. (1998): New Wine in Old Bottles: A Meta-Analysis of Ricardian Equivalence. Southern Economic Journal, 64, 713-727.
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- The authors plea for a simple hierarchy of rules. The debt rule should be a long-term “debt anchor”. Without reasoning, the 60% target is implicitly accepted, but it is mentioned that having only one debt target for all EU MS lacks an economic basis (Eyraud/Wu 2015, 30). Furthermore, there should only be one operational rule, preferably a medium-term expenditure rule linked to the debt target. It is not clear which expenditures should be focussed on; from an analytical point of view, it could only be primary structural spending which excludes interest payments which cannot be influenced by governments. They are fixed costs for the MS.
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- The German Council of Economic Experts (GCEE) has attempted to show that sudden interest hikes can occur which make rollover of debt at maturity impossible and lead to illiquidity and insolvency, similar to what happened in Greece in 2011 (GCEE 2020, #295, based on GCEE 2017, Box 16). The underlying model estimates “fiscal limits” beyond which
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- The implicit interest rate (r) on public debt differs from the yield of long-term bonds, as shown in Graph 3. Until 2012, r was above the yield for bonds, which fluctuates with demand and supply, while the gap widened afterwards to more than 100 basis points. For Germany, the yield turned negative, and it became the world champion in negative interest rates, similar to Switzerland.
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- The measurement is highly sensitive to changes of assumptions and is rooted in a predominantly neoclassical conceptual framework (cp. Heimberger et al. 2020). - EU secondary law, such as the SGP and regulations by EU institutions, defines many detailed requirements for MS, among them: - a Medium-Term Budgetary Objective (MTO) for the structural budget balance (calculated by the methodology mentioned above). The calculation of the MTO include several criteria such as the 60% debt cap, implicit future liabilities, debts from ageing and numerical goals defining minimum efforts for reducing debt; - if the MTO is not yet reached, a matrix of adjustment requirements is prescribed, which defines goals for normal, good, and bad times in terms of the Commission’s output gap.
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- their ideas in a broader scenario of reforms, some call for a combined reform of the MIP and the SGP, such as Dullien et al. (2020). The “deficit bias” is an idea that most authors follow, more or less explicitly. Since this is a crucial analytical part of most proposals, its validity needs to be examined. If this concept does not hold, many proposals likely fail to tackle the challenges mentioned above.
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- This method relies primarily on raising the primary balance. The authors ignore the fact that in most cases after 1980 g exceeded r and that among the successful countries, small open economies predominate. Indeed, the primary balances turned positive – but the authors did not even try to analyse whether this was driven by contractionary fiscal policy or by the private sector. Causality regarding the change of the primary balance is not analysed at all. As is well known, in a number of cases, the key factors were soaring net exports, devaluation, prolonged upswings, increased propensity to consume or other fortuitous factors.
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- Turrini, A. (2008): Fiscal policy and the cycle in the EA: the role of government revenue and expenditure, European Economic Papers 323, DG ECFIN, European Commission.
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- Vihriälä, V. (2020): Make room for fiscal action through debt conversion. VOX/CEPR 15 April.
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- We briefly review two strong episodes of successful debt reduction here, namely the U.S. 1994-2002 (not covered by Bernardini et al.) and Germany 2010-2019. In the U.S., the debt ratio fell by 16 ppt from 60.8% to 44.9%, mainly under both Clinton administrations (data
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Wyplosz, C. (2012): Fiscal Rules: Theoretical Issues and Historical Experiences. NBER Working Paper 17884, March. Imprint Publisher Macroeconomic Policy Institute (IMK) of Hans-Böckler-Foundation, Georg-Glock-Str. 18, 40474 Düsseldorf, Germany, phone +49 211 7778-312, email imk-publikationen@boeckler.de IMK Study is an irregular online publication series available at: https://www.imk-boeckler.de/de/imk-studies-15380.htm The views expressed in this paper do not necessarily reflect those of the IMK or the Hans-Böckler-Foundation.