Is There a Need for a New Fiscal Framework in the Euro Area?

33 Pages Posted: 28 Oct 2010 Last revised: 30 Mar 2011

See all articles by Andrew J. Hughes Hallett

Andrew J. Hughes Hallett

George Mason University - School of Policy, Government, and International Affairs

Svend E. Hougaard Jensen

Copenhagen Business School - Department of Economics

Date Written: October 1, 2010

Abstract

The rules stipulated by the Stability and Growth Pact have proved impossible to enforce. However, to avoid unsustainable fiscal policies reappearing, and to prevent monetary policy from being undermined by self-interested governments, there is still a need for a fiscal framework within the Euro Area. To achieve co-ordination between monetary and fiscal policies, this paper suggests an intertemporal assignment, where fiscal policy focuses on long-term objectives (e.g., social security, public provision of education and research) and monetary policies focus on short run objectives (macroeconomic stabilisation). Specifically, we suggest public debt targets as a practical way to achieve such a set up without compromising the independence of monetary policy. An excessive debt protocol is proposed to give concrete form to this targeting arrangement, and as a mechanism to identify the stable region within which the debt target must operate. Making these factors explicit would both improve the credibility of the Euro Area’s fiscal policies and reduce the risk premia in borrowing costs. However stabilising the stock of debt by fiscal means alone is not always possible.

We therefore examine the role of “internal devaluations” as a means of circumventing those barriers. This framework provides the analytic support to underpin many of the innovations currently under discussion in Brussels.

Suggested Citation

Hughes Hallett, Andrew and Hougaard Jensen, Svend Erik, Is There a Need for a New Fiscal Framework in the Euro Area? (October 1, 2010). GMU School of Public Policy Research Paper No. 2011-09, Netspar Discussion Paper No. 10/2010-057, Available at SSRN: https://ssrn.com/abstract=1698791

Andrew Hughes Hallett

George Mason University - School of Policy, Government, and International Affairs ( email )

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Svend Erik Hougaard Jensen (Contact Author)

Copenhagen Business School - Department of Economics ( email )

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Denmark
(+45) 3815 3478 (Phone)

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