Arestis on the EU’s New Fiscal Compact

Michael Stephens | December 20, 2011

Philip Arestis and Malcolm Sawyer have a guest post at Triple Crisis that critiques the latest proposal for a new fiscal compact in the EU (essentially an SGP with more automatic sanctions for those who surpass the 3 percent of GDP budget deficit limit and the annual structural deficit limit of 0.5 percent of GDP).  Arestis and Malcom note the asymmetrical restrictions of the compact (there are limits on deficits, but not surpluses) and demonstrate that the deficit limits are entirely too stringent:

The ‘fiscal compact’ assumes that an upper limit of 3 per cent of GDP is consistent with a near balanced structural budget despite the swings in economic activity and associated swings in budget deficits as the automatic stabilisers take effect. As a rule of thumb a 1 per cent fall in GDP below trend leads to around a 0.7 per cent rise in the budget deficit – hence a more than 3 per cent drop in GDP before trend with a structural deficit of 0.5 per cent would lead to a country breaching the limit. Note that this is a drop in GDP below trend – and could come from an actual drop of more like 1 per cent (with a 2 per cent trend growth rate).

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