Thursday, 21 February 2013

Structural versus nominal deficits

Fiscal sustainability is a necessary condition for economies to function.
The conditions for sustainability are objective. For example, the difference between the rate of income growth and the interest rate on sovereign debt, and/or the path of fiscal deficits/surpluses, determine if the fiscal stance is sustainable (meaning that the inter-temporal budget constraint of the government holds).
These conditions are objective but linked and linked in an uncertain way. They are linked because a change in the path of deficits or surpluses affects both the growth rate of income and the interest rate on sovereign. They are linked in an uncertain way because the size of the effects appears to depend on the state of the economy.
The conditions for sustainability are also subjective. Conditional on the uncertainty, the path of deficits and surpluses must be credible. The capacity of a government to control tax revenues and expenditure is key.
The focus on structural deficits and surpluses in the new fiscal treaty allows governments to have fiscal plans conditional on uncertainty. This is most welcomed as it increases the probability of success of the plans and therefore their credibility.


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