On the Potential Pitfalls of the EU Fiscal Pact: A Simulation Study of the International Dimensions of Fiscal Austerity

Abstract

A SP E C T E R IS H A U N TIN G EU R O PE— THE SPEC T ER OF FISC A L austerity. As it is widely known, the Fiscal Pact1 (officially the Treaty on Stability, Coordination, and Governance in the Economic and Monetary Union) attem pted to introduce a new legally enforced era o f fiscal austerity in the European Union.2 The EU Fiscal Pact puts forward two criteria intended to restrain fiscal policy am ong the signing EU m em ber states: the deficit criterion and the debt criterion. According to the deficit criterion, governm ent budget deficits are to be nearly balanced, with the cyclically adjusted budget deficit allowed to be at m ost 0.5 percent o f GDP if the current debt-to-GDP ratio is above 60 percent, and a budget deficit perm itted up to 1 percent if the debt-to-GDP ratio is below this threshold. According to the budget criterion, the level o f governm ent debt is to be brought down by an am ount equivalent to 5 percent o f the difference between the current debt ratio and the target debt ratio o f 60 percent o f GDP every year until the target debt-to-GDP ratio is reached.3 The intention is to reduce public debt, which in turn is supposed to foster econom ic grow th by allow ing private sector investm ent and consum ption to expand.