Fiscal policy and public debt sustainability in the EMU

Abstract

Monetary Union (EMU) over the last few years. Several EU members, including the three largest Euro Area countries, have repeatedly failed to fulfill the public deficit criterion of a general government (Maastricht) deficit of less than 3 percent of GDP. Moreover, although politically less spectacular, the central government debt of several countries remains not only considerably higher than the 60 percent of GDP mark prescribed by the Maastricht criteria but has also been rising during the last few years. Although generally the transition to the new common EMU currency was remarkably smooth and the euro is now generally accepted within its area of circulation, failure to meet the self-imposed fiscal policy restrictions may undermine the credibility of macroeconomic policies in Europe. In principle, there are two possible reactions to the gap between targeted and actual government deficits and debt. Either policy makers may intensify their efforts to reach the original goals in spite of increasing difficulties, like low growth and high unemployment, or the targets have to be revised downwards. In the EMU, the latter course of action was pursued in 2005 by (moderately) weakening the Stability and Growth Pact. It is clear that in no way can this amendment alleviate the problems resulting from the discrepancy between the need for fiscal prudence and the day-today pressures of partisan and interest-led politics. In particular, the long-run detrimental effects of high and increasing public debt threaten the stability of the fiscal and monetary policy arrangements in the EMU. To deal with these problems, the Ludwig Boltzmann Institute for Economic Analyses (now succeeded by the Robert Holzmann Institute for Economic