Debt Rule Design in Theory and Practice : The SGP's Debt Benchmark Revisited

This paper is linked to two debates on fiscal policies: first, the implications of low interest-growth differentials for debt sustainability 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 Stability and Growth Pact's 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 the low-growth low-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 objective; 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