13 September 2012

Aart De Geus: Maastricht 2.0 - Proposed reform of EU sovereign debt rules

A credible strategy for the consolidation of public budgets is now more important than ever, writes De Geus in this E!Sharp article. Europe urgently needs long-term fiscal policies designed to reduce government debt to manageable levels and promote a stable kind of economic development.

However, the Fiscal Compact concluded in March of this year is no more than a half-hearted attempt to stabilise European government finances. I believe that the measures that have been adopted, which are part of the Compact’s European debt brake, are seriously flawed in three ways. They are too restrictive in the long term, and too lax in the short term, and they take no notice of country-specific peculiarities. That is why I am in favour of a flexible debt reduction strategy which does not have these shortcomings. I have decided to call it “Maastricht 2.0”.

This alternative has the following core elements. There will be a sustainable level of government debt if it amounts to no more than 60 per cent of nominal gross domestic product (GDP). This figure has become generally accepted in political debates on the subject. It is basically not necessary to regulate government borrowing below this debt ceiling. However, it is still a good idea to have binding targets, since they make it possible to do something at an early stage if things start to go wrong. However, since the idea is to promote growth, this ceiling should be higher than in the case of the European debt brake. “Maastricht 2.0” envisages an admissible annual public deficit limit of a maximum of three percent of GDP.

As soon as public debt amounts to more than 60 per cent of GDP, “Maastricht 2.0” works out the maximum permitted deficit level on the basis of the expected long-term economic growth of a particular country. We estimate that these deficit levels will amount to about one per cent, and will thus be above the permissible 0.5 per cent of the European debt brake. Countries in which weaker economic growth is predicted in the long term will have slightly less room for manoeuvre. They include Ireland and Italy, which will have deficit levels amounting to about 0.75 or 0.8 per cent.

In the medium and long term, “Maastricht 2.0” gives highly indebted states more room for manoeuvre than the European debt brake. However, if these states wish to reach a sustainable level of debt, they will have to make a determined effort to cut spending in the first few years. Both the European debt brake and “Maastricht 2.0” give states a transitional phase of six years within which they must reach the permissible long-term deficit levels. However, in contrast to the European debt brake, “Maastricht 2.0” calls for a greater reduction in deficit levels during the first few years.

By the year 2025, and possibly ever earlier, the real gross domestic product in all of the EU countries will be greater than it would have been under the European debt brake. Moreover, by the year 2030 the accumulated gains in terms of real growth for the whole of the EU that are the result of “Maastricht 2.0” will amount to slightly more than €450 billion. This needs to be compared with the fact that on 1 April 2012 Portugal’s government debt had reached €190 billion. In July Greek government debt in the wake of the “haircut” once again rose above the €300 billion line.

This op-ed was first published in German in the Süddeutsche Zeitung on August 24, 2012. It is based on a larger study “Maastricht 2.0 - Proposed reform of EU sovereign debt rules” which can be downloaded here.

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