Implications of the New Public Debt Rule in the ‘Fiscal Compact’ for the Economic and Monetary Union

Abstract

This paper proposes a simple modeling of the dynamic evolution of the interest rate, budgetary deficit and public debt of a member country of a monetary union, if a representative investor has the choice between bonds from this country a benchmark bond. In this framework, we can analyze the consequences of the most recent measure included in the ‘Fiscal Compact'. After the financial Crisis, the coordination of public finances still mainly relies in Europe on rules of fiscal discipline. However, beyond the threshold on the budgetary deficit, a new stress is put on the reduction of the public debt at a ‘satisfactory pace': its distance with respect to the reference value must decrease at a rate of the order of one-twentieth per year. Then, we show that such a measure is fully reachable for Luxembourg, Finland, Germany, Austria or the Netherlands. However, the public debt target of 60% of GDP would necessitate sizeable fiscal consolidation efforts for Ireland, France and Belgium. Moreover, such a target would not even be stable for Italy, Portugal or Spain; and the Greek situation is explosive. Therefore, the new European fiscal framework appears as quite ambitious for some member countries of the Economic and Monetary Union.