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Journal of Economic Integration 2000 September;15(3) :397-417.
Does the Maastricht Public Debt Criterion Call for Fiscal Expansion or Contraction?

Pekka Ahtiala 

University of Tampere
Copyright ©2000 Journal of Economic Integration
The Maastricht convergence criteria of the Economic and Monetary Union of Europe stipulate that the public debt of a member country maybe at most 60 percent, and the fiscal deficit at most 3 percent of the GNP, which has led member governments to contract their expenditures. A simple two-country flow equilibrium model demonstrates that if the central banks target the interestrate, the contraction is likely to increase the public debt ratio in many member countries. A contraction by one country unambiguously increases the debt ratio of the other. If the foreign central bank targets the money supply, the contraction is less likely to increase the ratio. The ratio can also be lowered with monetary policy, and the appropriate policy is expansion in both regimes. Simulation with an econometric model shows that, with interest rate targeting, fiscal contraction increases the debt ratios of 3 out of 14 EU countries if the country contracts alone. If all the member countries contract simultaneously with money supply targeting by Germany, the ratios of 7 countries increase. These effects persist for four to eleven quarters, whereafter the ratios begin to decline in all the countries except Belgium.
Keywords: Public Debt Ratio | Fiscal Correction | Maastricht Convergence Criteria
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