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National debt brakes as a remedy for diverging economies in the European Monetary Union?

Colombier, Carsten (2013): National debt brakes as a remedy for diverging economies in the European Monetary Union? Published in: Political Economy of Eurozone Crisis – Reforms and their Limits (2013): pp. 100-122.

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Due to the ongoing crisis, several reforms have been implemented at the EU-level, which are tilted towards strengthening the budget discipline of EMU member states. These reforms underlie the view that government profligacy is the main culprit of the crisis. Consequently, a fiscal compact that includes national debt brakes at its core has been introduced in the EU. However, several economists emphasise that the EMU is an incomplete currency union. As a result, massive external imbalances have been built up in the pre-crisis years. Therefore, this present paper analyses whether a debt break, which is viewed as supportive for sustainable public finances, can also contribute to a convergent development in the EMU. The back-of-the-envelope simulations run for a typical current-account surplus and -deficit country (Germany and Spain respectively) provide mixed results. It is shown that under a debt brake current-account deficits can be lowered in a boom phase. This is because automatic stabilisers are allowed to work properly. Additionally, it is less probable that the working of automatic stabilisers is counteracted by pro-cyclical fiscal policy. But the impact of the debt brake on current-account balances depends on various factors, i.e. the position of an economy in the business cycle, the sign of the current-account balances and the instruments chosen to adjust the structural budget balance. Consequently, European policy-makers should be aware of the fact that the structural drawbacks of the EMU cannot be resolved by the attempt to balance structural government budgets. For this other measures than a fiscal compact such as a delegation of fiscal powers to the union level are necessary.

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