key: cord-0027323-i97k36uu authors: Breuer, Christian title: A Three Percent Structural Deficit Rule date: 2022-02-12 journal: Inter Econ DOI: 10.1007/s10272-022-1017-x sha: c519ddf6a535800c77cc189d3517666502a22d8b doc_id: 27323 cord_uid: i97k36uu nan Thirty years ago, on 7 February 1992, the Maastricht Treaty was signed. It laid the foundations for the Economic and Monetary Union (EMU). While Germany has been sceptical about a monetary union without a political union, Chancellor Kohl accepted the Delors plan that lead to the EMU in a three-stage process. To compensate for the lack of a political union and to avoid fi scal pressure on the new independent European Central Bank (fi scal dominance), Germany pushed forward strict entry conditions and rules. Particularly the fi scal rules -the 3% defi cit and the 60% debt reference values -have been controversial from the beginning (Priewe, 2020) . They have become even more controversial since the European debt crisis and the introduction of the Fiscal Compact that intended to achieve close to budget balance medium-term budgetary objectives. Since the start of the COVID-19 crisis in 2020, the EU's fi scal rules have been suspended, but they are expected to be reinstated after 2022, which is why researchers and policymakers are discussing whether and how the rules should be renegotiated and modernised. According to policymakers, the reform of the Stability and Growth Pact should maintain debt sustainability and ensure growth-and climate-friendly investment. Moreover, the fi scal rules should become simpler and more transparent (German Federal Government, 2021; Draghi and Macron, 2021; Cuerpo, 2022) . The recent discussion takes place against the background of quite remarkable and exceptional macroeconomic conditions in the major OECD economies. In 2021, the newly elected US administration enacted large-scale spending and investment packages that increased defi cits, GDP, employment as well as infl ation, and will force the Fed to quickly increase the federal funds interest rate this year. These actions will shift the fi scal-monetary policy mix away from expansionary monetary towards fi scal policy. The US has escaped a "Japanese disease". Japan has tried to achieve moderate infl ation with expansionary fi scal policy and increasing levels of public debt for decades; however, the country is stuck at the effective zero lower bound, and recent forecasts see infl ation at 1.1%, well below the infl ation target rate of 2%. The EMU, with its current fi scal framework, would be forced to push defi cits back to close to balanced budgets if no reform takes place next year. Contrary to Japan and the US, the EMU would choose the opposite side of the fi scal-monetary policy mix, i.e. contractionary fi scal policy that the ECB will likely compensate with super expansionary policy, as it has done since the European debt crisis, after the introduction of the Fiscal Compact. The question of whether the recent low interest rates are a temporary phenomenon or refl ect a secular trend is one of the most important macroeconomic controversies today. Von Weizsäcker and Krämer (2021) argue that the natural rate of interest (the risk-free real rate of interest that is compatible with full employment in a closed economy without public debt) can be (and turns out to be) below zero in the OECD countries and China. The theory has important implications for the fi scal framework. To stabilise real interest rates at reasonable levels, von Weizsäcker and Krämer argue that it is necessary to abolish the current fi scal rules, particularly in Germany, and stimulate demand with expansionary fi scal policies. They suggest that countries eliminate their current account surpluses (defi cits) in periods of low (high) real interest rates by increasing (decreasing) government net borrowing. This could be an interesting takeaway in the recent debate given that the EU framework already has rules to avoid excessive current account imbalances. It does not, however, put a great deal of emphasis on the rules regarding current accounts. To fi ll this gap, Mathieu and Sterdyniak (2022) discuss the possibilities of fi scal policy to stabilise current accounts in EMU countries in line with the infl ation target. In line with von Weizsäcker and Krämer (2021), a recent contribution by Blanchard (2022) investigates the determinants of the so-called neutral safe interest rate and argues that the neutral rate decreased since the early 1990s and now turns out to be negative. Blanchard discusses the implications of low safe rates on the sustainability conditions of public debt. If the interest rate r is below the growth rate of the economy g, the government can run a primary budget defi cit (i.e. the budget defi cit excluding interest payments). Blanchard (2021) argues that no simple fi scal rule would work well under r