Reducing sovereign debt levels in the post-Covid Eurozone with a simple deficit rule

Research Area: Fiscal Policy
Researcher: Thomas Jost,
Karl-Heinz Tödter
Date: 1.12.2021

Debt levels in the eurozone have reached new record highs. The member countries have tried to cushion the economic consequences of the corona pandemic with a massive increase in government spending. There are various calls to abolish or soften the Maastricht rules of limiting sovereign debt. The authors see the risk of a new sovereign debt crisis in this decade if it is not possible to bring public debt down to an acceptable level.
The authors propose a new fiscal rule that would be suitable and appropriate for this purpose. In contrast to the rigid 3% Maastricht-criterion, the rule is flexible and it addresses the main problem: excessively high public debt ratios. The authors argue that it lowers the existing incentives for highly indebted governments to exert expansionary pressure on monetary policy. If obeyed strictly, the rule reinforces the snowball effect and reduces the excessively high debt ratios within a manageable period, even if nominal growth is weak. This is confirmed by simulations with different scenarios as well as with the hypothetical application of the new fiscal rule to eurozone economies from 2022 to 2026. Finally, the authors take up the proposal by ESM economists to increase the permissible debt ratio from 60 to 100% of GDP in the eurozone.

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