Fiscal Policy in Economic and Monetary Union

Fiscal Policy in Economic and Monetary Union

Theory, Evidence and Institutions

Marco Buti and Daniele Franco

This book explores the origins, rationale, problems and prospects of the European fiscal policy framework. It provides the reader with a roadmap to EMU’s budgetary framework by exploring its theoretical and empirical foundations, uncovering its historical roots and emphasising its supranational nature.

Chapter 7: Long-term Sustainability

Marco Buti and Daniele Franco

Subjects: economics and finance, money and banking, public finance


* INTRODUCTION While the intuition is clear (a sustainable policy must ultimately avoid bankruptcy), the analytical and operational definition of sustainability is not straightforward. The theory has proposed different conditions for sustainability (from a non ever-rising tax rate to an intertemporal discounted budget constraint);144 furthermore, the problem has always been dealt with in a partial equilibrium framework where the interactions between the budget and the economy are not fully taken into account. In practice difficulties arise with regard to the statistical definition of the main variables to be used for the assessment of sustainability (is it gross or net debt to be relevant, how should the deficit be measured?); moreover, as sustainability is a forward-looking concept, long-term projections are needed and these are necessarily subject to wide margins of error. Yet sustainability is a central tenet of the Maastricht Treaty. Article 109(1) makes a sound government financial position an explicit criterion for a country’s eligibility to join EMU. The fiscal rules set out in the Treaty and subsequently integrated by the Stability and Growth Pact require budget positions close to balance or in surplus in the medium term, deficits lower than 3 per cent of GDP and the reduction of debt to GDP ratios below 60 per cent. Compliance with these rules, which aims at combining fiscal discipline and flexibility, clearly excludes divergent and unsustainable fiscal dynamics.145 Although the choice of the actual parameters is somewhat arbitrary,146 the pragmatic approach taken by...

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