The Fiscal Framework in the Easter Caribbean Currency Union: Lessons from the Euro Area?

This paper reviews the state of economic policy management in the Euro Area. As the European sovereign debt crisis sadly demonstrates, there is an urgent need for an agreed fiscal framework in replacement of the failed Stability and Growth Pact. We suggest a framework that aims at a better co-ordination between monetary and fiscal policy, where fiscal policy focuses on long run objectives and monetary policy on short run objectives, as an alternative. In such a framework, fiscal policies can be credibly pre-committed without undermining the authority of democratically elected representatives. We therefore argue that the restraints on fiscal policy should focus on structural imbalances – principally the level of public debt – and not on the size of the public sector or the composition of expenditures and revenues. We then review the reasons, theoretical as well as practical, why debt targets are superior to deficit targets or limits, and we propose an excess debt protocol to give enforceable form to those targets. To demonstrate how public sector debt targets provide a practical way to achieve such a set up, we use the idea of “fiscal space” to provide a mechanism for identifying the stable region within which a debt targeting regime should operate. This is especially important at the smaller country level where small scale, economic dependence and the inability to diversify, inevitably make budgets and budget revenues more volatile.