Debt policies in the aftermath of COVID-19 — The SGP’s debt benchmark revisited

• Published in: European Journal of Political Economy 2022-12, Vol.75, p.102187-102187, Article 102187
• Main Authors: Hauptmeier, Sebastian, Kamps, Christophe
• Format: Article
• Language: English
• Subjects: Adjustment; Banking; Central banks; Coronaviruses; COVID-19; Debates; Debt; Debt overhang; Fiscal governance; Fiscal policy; Fiscal rules; Governance; Inflation; Interest rates; Macroeconomics; Political economy; Public debt; Public debt sustainability; Sustainability; Treaties
• ISSN: 0176-2680; 1873-5703
• DOI: 10.1016/j.ejpoleco.2022.102187

The post-COVID-19 period is likely to be characterised by an intensified stabilisation-sustainability trade-off. This paper revisits the design of the Stability and Growth Pact’s debt rule in the context of two debates on fiscal policies: first, the implications of the low interest environment for debt sustainability and the appropriate interaction of fiscal and monetary policies and, second, the reform of the EU fiscal governance framework. In both debates the choice of government debt anchor and the speed of adjustment take centre stage. The debt rule appears predestined to fulfil the role of debt anchor. However, our analysis shows that its existing design gives rise to a pro-cyclical bias that has hampered its implementation in a low-growth and inflation environment. We propose two parametric changes to better balance the objectives of macroeconomic stabilisation and debt sustainability: first, accounting for persistent deviations of inflation from the central bank’s target; and, second, a reduced speed of adjustment. Putting a reformed debt rule at the centre of the EU fiscal governance framework would allow reducing the latter’s complexity without the need to revise the EU Treaties. •The design of the European Stability and Growth Pact’s debt rule gives rise to a pro-cyclical bias.•Two parametric changes could help to balance the objectives stabilisation and sustainability.•Accounting for deviations from the ECB’s inflation target would enhance the policy mix.•A reduced speed of adjustment would reduce pro-cyclicality and support political implementability.