2023-12-29 19:48:09
European and national debt rules have a difficult time in the current discourse. Given the challenges posed by climate change, demographics and defense, it seems difficult to explain why politicians are shackling themselves. So why don’t we finally break the chains of the debt brake and the European Stability Pact in order to shape the future financed by debt?
As plausible as this way of thinking of the critics of fiscal rules seems, it is ultimately not very convincing. Because it is based on the fundamental misjudgment that a debt limit sets an artificial limit where there would otherwise be no limit. But that is wrong, because no country has unlimited scope for debt. An essential task of a debt rule is not to allow a country to move too close to the maximum debt limit that can be financed, because it would then lose all room for maneuver or end up in an extremely costly debt crisis.
The maximum scope for debt is largely determined by the ratio of the real growth that can be achieved in the future (“g”) and the long-term real interest rate (“r”). g is important because it provides information about how the ability to collect taxes develops. r is relevant because it determines the interest burden on national debt. Two regimes can be distinguished here. If the interest rate is below the growth rate (“r less than g”), then a country can let time work for itself and grow out of any debt ratio, no matter how high.
In this constellation, the growth in economic output and tax revenue relieves the state more than the burden of interest on old debt. In this case, it is even possible to have a permanently high deficit without the debt level in relation to economic output increasing. The situation is completely different if the interest rate is above the growth rate (“r greater than g”). Then there is no permanent scope for deficits if the debt is not to get out of control. The existing debt level with its interest burdens would constantly grow in relation to economic output if budget policy did not constantly generate surpluses in the current budget.
Mountains of old debts can have a disastrous effect
This distinction is highly relevant for today’s discussion on the debt brake and the EU Stability Pact. For Germany and most EU countries, the last years before Corona were a time when interest rates were far below the growth rate. These fiscally favorable times are over today, and there is much evidence that they will not return for decades to come. The yields (r) on euro government bonds have increased not only in nominal terms, but also in real terms, assuming realistic inflation expectations.
At the same time, the prospects for potential growth (g) are falling. Demographics, but also transformation and a loss of European competitiveness are further reducing growth opportunities in Germany and other EU economies. So it’s not surprising that MIT macroeconomist Olivier Blanchard recently backpedaled. In 2019, in a highly acclaimed lecture, he pointed out the unused scope in national debt with the argument that r was smaller than g. Now he warned of exploding debt in the USA and Europe.
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