it’s time to drop the debt ratio limit


Klaus Regling, director general of the European Stability Mechanism, called the current wording of Europe’s Stability and Growth Pact “economically absurd” in an interview with Der Spiegel this week.

This criticism, from a man who helped then-German Finance Minister Theo Waigel negotiate the terms of the pact in the 1990s, could hardly have come from a more damning source. Surely this should be the last nail in the coffin of outdated austerity measures. But no. Germany does not get the message.

The Stability and Growth Pact is supposed to keep the debt burden of EU member states below 60% of GDP and their deficits below 3% of economic output. Countries with a debt burden exceeding 60% of GDP must reduce their annual deficit by one-twentieth of the amount by which they exceed the limit of 60% debt per year. The reform process was launched this week.

But the man most likely to succeed Angela Merkel as German Chancellor, Olaf Scholz, is a SGP fan, believing that it is already flexible enough for current use. Its alleged finance minister, Christian Lindner, agrees.

But there is no flexibility built into the PGS. The Commission can choose not to apply the corrective clauses or, as it did in response to the Covid-19 pandemic, to deactivate them. Neither action is proof of the flexibility of the PSC, and both operate on the assumption that the only good pile of debt is shrinkage.

Economists across Europe think differently. Most want to see investments in growth-promoting reforms, rather than the kind of quick belt-tightening austerity that a return to the original SGP would mean.

Debt-to-GDP ratios are not an appropriate way to measure a country’s debt sustainability or default risk. Economists have many other ways of measuring it. You can compare interest payments to income, or interest payments to GDP, or interest payments to the country’s annual budget. The key is that the cost of a debt burden is not the same as the size of the debt pile – a simple concept Regling pointed out in his interview.

The business community agrees with Mr. Regling. The risk of not investing heavily in the years to come far outweighs the risk of over-indebtedness. Even with the return of inflation leading to higher rates, the risks of debt sustainability are a distant prospect.

Investors anticipate a rate hike by the end of 2022. ECB chief economist Philip Lane rebuffed this expectation, saying it is “difficult to come to terms with the ECB’s forward guidance.”

But even if the ECB made a rate hike in 2022 and followed more in 2023, borrowing costs are so historically low that even if rates were to rise significantly, borrowers would still be able to lower their service costs. debt. every time you visit the market.

Going back to the punitive wording of the SGP would hurt Europe’s growth prospects once the pandemic is over. The reduction in the supply of government bonds would lower interest rates further. Instead of benefiting governments by allowing them to borrow more, this would simply disadvantage savers seeking income in secure assets.

The debate should be closed. Debt-to-GDP ratios have no place in determining policy.

Of course, there is too much debt, but debt to GDP is the wrong way to measure it, and the next German government will do Germany and Europe a disservice if they insist on hang on to it.

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John A. Bogar