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

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.