European Monetary Union
Fiscal rules

The Maastricht fiscal convergence criteria require general government budget deficits and gross debt to be within 3% and 60% of GDP respectively. In Discussion Paper No. 750, Research Fellows Willem Buiter and Nouriel Roubini, with Giancarlo Corsetti, argue that the debt/GDP ratio must be ignored to avoid massive unnecessary fiscal deflations in Belgium, Greece, Ireland, Italy and the Netherlands. Pursuing the deficit/GDP ratio would hurt Greece and Italy, be moderately painful for Belgium and Portugal and relatively painless elsewhere. Indeed, its adoption might help countries such as Italy which receive some fiscal backbone from international agreements. The authors maintain that countries that have initiated fiscal retrenchment should be allowed to ignore the debt norm and pursue the deficit norm gradually.

The transitional output and unemployment cost of the deficit criterion will depend on EC-wide monetary policy. High nominal and real interest rates reflect the savings-investment imbalances due to the East European transformations and the deficit financing of East German reconstruction, and also the Bundesbank's restrictive monetary stance. The German policy mix increased significantly the real interest burden of public debt and deepened the recession in the non-German ERM member countries, and contributed to cyclical increases in their public sector deficits. Buiter, Corsetti and Roubini conclude that the deficit guideline should be corrected to include cyclical inflation and growth and the effects of capital expenditures on future government revenues. Similarly, the debt criterion should refer to the non-monetary liabilities of the consolidated public sector rather than gross debt. Binding fiscal rules might be useful to combat `excessive deficits' caused by political distortions, but the Maastricht convergence criteria entail a risk of serious overkill.

Excessive Deficits: Sense and Nonsense in the Treaty of Maastricht
Willem H Buiter, Giancarlo Corsetti and Nouriel Roubini

Discussion Paper No. 750, December 1992 (IM)