When German officials pushed in the 1990’s for the Stability and Growth Pact as a prerequisite for giving up the Deutschmark, they did not anticipate that Germany would be the first country to violate the pact. While the pact says that a government cannot borrow more than 3% of its GDP, Germany’s public-finance deficit reached 3.7% of GDP and more from 2002 to 2004.
There have been more sinners, though. France also violated the pact’s fiscal criterion in these three years. Portugal did so in 2001 and the Netherlands in 2003. Greece cheated by manipulating its statistics: while the reported deficits were below the limit, the country had to admit that the true deficit from 2000 to 2004 was 4.3% on average and never below 3.7%.
Other countries have been more successful due to fortunate circumstances. Italy, for example, not only benefited from its government’s creative accounting, but also from the fact the euro led to interest-rate convergence in Europe. Long-term interest rates for Italian government bonds declined from about 12% to about 4% in the ten years from 1994-95 to 2004-05. With the Italian debt/GDP ratio currently at roughly 106%, lower borrowing costs reduced the public debt ratio by more than eight percentage points.
Indeed, other things being equal, had the interest rate not declined, Italy would have had a public-finance deficit of 11% of GDP in 2004 rather than the reported 3%, and its debt/GDP ratio would, of course, have been much higher. It was the euro, not the Italian government, that helped Italy satisfy the Stability and Growth Pact. But now Italy seems to have run into trouble again and also wants to weaken the pact.
The reform proposals that are currently being debated are adventurous to say the least, because they all seem to center around the question of which government expenses should be exempt from the calculation of the deficit. The list of exemptions includes a country’s net payments to the EU, education expenses, public investment in general, or exceptional expenses. The pact would become meaningless under such circumstances.
The idea of the pact was, after all, to impose firm borrowing constraints on European governments to prevent them from saddling future generations with today’s liabilities or from one day adopting the Italian strategy: borrow without limits and print more money to inflate away the debt. While constraints are a good idea, it is understandable that EU governments do not like them. Sinners do not like rules.
Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
Subscribe Now
Future generations already bear an excessive pension burden in all European countries. In Germany, for example, the Council of Economic Advisors calculated the implicit pension debt to be more than 270% of GDP. Add the open public debt of 67% of GDP to this total, and the result is an overall German debt/GDP ratio of about 340%.
Other European countries are in a similar situation, which is exacerbated by the fact that Europeans are having fewer children. The future generations that are to foot the bill may simply not be there.
Europe is, moreover, the continent with the slowest rate of economic growth in the world. Average EU growth in 2004, when the world economy recorded the strongest growth in more than a quarter-century, was only 2.2% while inflation was 1.9%. This is about 4% in nominal terms, and faster growth will hardly be possible in the longer run.
With such low growth, the 3%-of-GDP ceiling for annual fiscal deficits is no longer compatible with the 60% limit on the debt-GDP ratio that the Maastricht Treaty stipulates for the euro countries. Countries that borrow 3% and grow at a rate of 4% will converge towards a debt/GDP ratio of 75%. A country like Germany, which has a real growth trend of only 1% per year and may continue to have only 1% inflation in the medium term, is heading towards a debt/GDP ratio of 150%.
But the right response is to make the Stability and Growth Pact tougher, not weaker. The easiest way to keep the debt/GDP ratio under control would be to implement a staggered deficit criterion that reduces the permitted public-finance deficit to less than 3% for countries whose debt/GDP ratio exceeds 60% and raises the deficit ceiling above 3% for countries whose debt/GDP ratio is below this level.
This approach would automatically take account of different growth rates and give countries a powerful incentive to run surpluses in good times in order to increase the scope for maneuver in bad times. Unfortunately, however, it is the sinners themselves who will determine the conditions under which they are punished.
To have unlimited access to our content including in-depth commentaries, book reviews, exclusive interviews, PS OnPoint and PS The Big Picture, please subscribe
For the last several years, world leaders have made big promises and laid out bold plans to mitigate the climate crisis and help the neediest countries adapt. At this year's World Bank/IMF Spring Meetings, they must demonstrate that they can fulfill these promises, rather than simply touting new ones.
think policymakers need to get four things right to shore up the credibility of the international system.
With the exception of the extreme right, no one in Israel wants to be stuck in Gaza, responsible for 2.4 million Palestinians, and facing a likely insurgency. Israel can end this war soon and save those hostages who are still alive, having demilitarized Gaza and set the stage for an alternative to Hamas.
thinks the only strategic objective that matters is close – or close enough – to being met.
China’s authorities have powerful economic-policy levers at their disposal to achieve their 5% growth target this year and put the economy on a more sustainable long-term growth path. But several trends – from the shift toward state capitalism to population aging to the loss of goodwill between Chinese and Americans – could thwart China’s ambition to join the ranks of high-income countries by mid-century.
When German officials pushed in the 1990’s for the Stability and Growth Pact as a prerequisite for giving up the Deutschmark, they did not anticipate that Germany would be the first country to violate the pact. While the pact says that a government cannot borrow more than 3% of its GDP, Germany’s public-finance deficit reached 3.7% of GDP and more from 2002 to 2004.
There have been more sinners, though. France also violated the pact’s fiscal criterion in these three years. Portugal did so in 2001 and the Netherlands in 2003. Greece cheated by manipulating its statistics: while the reported deficits were below the limit, the country had to admit that the true deficit from 2000 to 2004 was 4.3% on average and never below 3.7%.
Other countries have been more successful due to fortunate circumstances. Italy, for example, not only benefited from its government’s creative accounting, but also from the fact the euro led to interest-rate convergence in Europe. Long-term interest rates for Italian government bonds declined from about 12% to about 4% in the ten years from 1994-95 to 2004-05. With the Italian debt/GDP ratio currently at roughly 106%, lower borrowing costs reduced the public debt ratio by more than eight percentage points.
Indeed, other things being equal, had the interest rate not declined, Italy would have had a public-finance deficit of 11% of GDP in 2004 rather than the reported 3%, and its debt/GDP ratio would, of course, have been much higher. It was the euro, not the Italian government, that helped Italy satisfy the Stability and Growth Pact. But now Italy seems to have run into trouble again and also wants to weaken the pact.
The reform proposals that are currently being debated are adventurous to say the least, because they all seem to center around the question of which government expenses should be exempt from the calculation of the deficit. The list of exemptions includes a country’s net payments to the EU, education expenses, public investment in general, or exceptional expenses. The pact would become meaningless under such circumstances.
The idea of the pact was, after all, to impose firm borrowing constraints on European governments to prevent them from saddling future generations with today’s liabilities or from one day adopting the Italian strategy: borrow without limits and print more money to inflate away the debt. While constraints are a good idea, it is understandable that EU governments do not like them. Sinners do not like rules.
Subscribe to PS Digital
Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
Subscribe Now
Future generations already bear an excessive pension burden in all European countries. In Germany, for example, the Council of Economic Advisors calculated the implicit pension debt to be more than 270% of GDP. Add the open public debt of 67% of GDP to this total, and the result is an overall German debt/GDP ratio of about 340%.
Other European countries are in a similar situation, which is exacerbated by the fact that Europeans are having fewer children. The future generations that are to foot the bill may simply not be there.
Europe is, moreover, the continent with the slowest rate of economic growth in the world. Average EU growth in 2004, when the world economy recorded the strongest growth in more than a quarter-century, was only 2.2% while inflation was 1.9%. This is about 4% in nominal terms, and faster growth will hardly be possible in the longer run.
With such low growth, the 3%-of-GDP ceiling for annual fiscal deficits is no longer compatible with the 60% limit on the debt-GDP ratio that the Maastricht Treaty stipulates for the euro countries. Countries that borrow 3% and grow at a rate of 4% will converge towards a debt/GDP ratio of 75%. A country like Germany, which has a real growth trend of only 1% per year and may continue to have only 1% inflation in the medium term, is heading towards a debt/GDP ratio of 150%.
But the right response is to make the Stability and Growth Pact tougher, not weaker. The easiest way to keep the debt/GDP ratio under control would be to implement a staggered deficit criterion that reduces the permitted public-finance deficit to less than 3% for countries whose debt/GDP ratio exceeds 60% and raises the deficit ceiling above 3% for countries whose debt/GDP ratio is below this level.
This approach would automatically take account of different growth rates and give countries a powerful incentive to run surpluses in good times in order to increase the scope for maneuver in bad times. Unfortunately, however, it is the sinners themselves who will determine the conditions under which they are punished.