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Sustainability of Public Finances

  • Perotti, Roberto
  • Strauch, Rolf
  • von Hagen, Jürgen

A central tenet of the Maastricht Treaty is that a successful European Monetary Union requires sustainable public finances of its member states. Yet there is no clear definition of sustainability. The economist’s common use of the term builds on the concept of an intertemporal budget constraint over an infinite time horizon, which is of little practical use. In this study, we develop a concept of sustainability focusing on the controllability of public finances. In so doing, we adopt the approach of the Maastricht Treaty, to assume sustainability as long as a country does not violate the double standards of the deficit (3%) and the debt (60% of GDP) criterion. When the benign assumption does not hold, we distinguish between the symptoms of non-sustainability of public finances, which can be determined in a relatively straightforward way, and the underlying institutional causes, which are more difficult to identify. Correcting the symptoms requires a disaggregate view of the government budget. Successful consolidation requires the fiscal policy problem to be addressed ‘at the source’, i.e. the adjustment of those items of the government budget that produced the build-up of a non-sustainable deficit in the first place. Lasting consolidation also requires a correction of the institutional weaknesses that are the ultimate causes of a non-sustainable deficit. After reviewing the theoretical and empirical arguments for a disaggregate and institutions-oriented approach to correcting non-sustainable deficits, we propose a practical procedure to assess the sustainability of a country’s public finances.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1781.

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Date of creation: Nov 1997
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Handle: RePEc:cpr:ceprdp:1781
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