Fiscal Sustainability using Growth-Maximising Debt Targets

30 Pages Posted: 24 Sep 2012

See all articles by Cristina D. Checherita-Westphal

Cristina D. Checherita-Westphal

European Central Bank (ECB)

Andrew J. Hughes Hallett

George Mason University - School of Policy, Government, and International Affairs

Philipp Rother

European Central Bank (ECB)

Date Written: September 12, 2012

Abstract

This paper highlights the importance of debt-related fiscal rules and derives growth-maximizing public debt ratios from a simple theoretical model. On the basis of evidence on the productivity of public capital, we estimate public debt targets that governments should try to maintain if they wish to maximize growth for panels of OECD, EU and euro area countries, respectively. These are not arbitrary numbers, as many of the fiscal rules in the literature suggest, but are founded on long-run optimizing behavior, assuming that governments implement the so-called golden rule over the cycle; that is, they contract debt only to finance public investment. Our estimates suggest that the euro area should target debt levels of around 50% of GDP if member states are to have common targets. That is about 15 percentage points lower than the estimate for the growth-maximizing debt ratio in our OECD sample and comfortably within the Stability and Growth Pact’s debt ceiling of 60% of GDP. We also indicate how forward looking budget reaction functions fit into a debt targeting framework.

Keywords: public debt, public capital, economic growth

JEL Classification: H63, E22, O40

Suggested Citation

Checherita-Westphal, Cristina D. and Hughes Hallett, Andrew and Rother, Philipp, Fiscal Sustainability using Growth-Maximising Debt Targets (September 12, 2012). ECB Working Paper No. 1472, Available at SSRN: https://ssrn.com/abstract=2145281

Cristina D. Checherita-Westphal (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Andrew Hughes Hallett

George Mason University - School of Policy, Government, and International Affairs ( email )

Founders Hall
3351 Fairfax Dr.
Arlington, VA 22201
United States

Philipp Rother

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 0 (Phone)
+49 16 1344 6398 (Fax)

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