Optimal Debt Under a Deficit Constraint

Abstract

It has been consistently argued by many that European Union member states, in the context of significant demographic change in coming years, should pursue a more rigorous course of accelerated debt abatement in order to reduce the burden on future taxpayers. In this vein, these observers point to the need for a new fiscal paradigm more solidly based on the principles of sustainability and intergener- ational responsibility. One tool to help in generating this outcome is the adoption of a rule-rather than discretion-based fiscal policy, given the success of this approach in the conduct of monetary policy. In order to produce a more credible and predictable path for future fiscal policy, there would be a need to curtail systematic discretionary policy and resuscitate the role of automatic stabilisers in government policy. In the past, the effectiveness of shock absorbers has been often severely reduced as the result of discretionary action, leading to a need for high interest spending and accompanied by recurrent spells of deficit and debt crises.