Thursday, April 26, 2012

26/4/2012: One interesting point on Fiscal Compact 1/20 rule

One interesting point on Fiscal Compact, folks. The 1/20th adjustment rule has been interpreted widely as the rule requiring states with debt/GDp ratio in excess of 60% to reduce their debt levels by 1/20th of the gap between their existent debt level and the 60% bound. However, the Treaty itself states: "the obligation for those Contracting Parties whose general government debt exceeds the 60 % reference value to reduce it at an average rate of one twentieth per year as a benchmark" (page T/SCG/en5). In other words, there is a big gap between interpretation and reality.

Hat-tip for this discovery goes to Peter Mathews, TD.

Say, Ireland's debt/GDP ratio peaks at 120% GDP (I am rounding up the actual forecasts here). Under 'interpreted' adjustment mechanism, we would be expected to reduce the overall debt by 1/20th of 120% minus 60% or by 3% of GDP in year one. Under the actual Treaty, we are expected to reduce it by 1/20th of 120% or 6% of GDP in year one. Say our GDP is 175 billion in that year. Under interpreted rule, we have to find €5.25 billion to reduce debt levels, under actual Treaty language, we are expected to come up with €10.5 billion. To put this into perspective, the average level of gross investment in the Irish economy is forecast by the IMF to be around 10%pa between 2012 and 2017 or ca €17.5 billion under above assumptions. This means that the Fiscal Compact adjustment path would take out 60 percent of the entire annual investment in the economy. That is hardly a chop-change of a difference.

Updated: Thanks to Prof Karl Whelan for pointing this:

Applying the 1/20th to the full amount is not consistent with the Treaty.

Article 4 ...makes reference to  “as provided for in Article 2 of Council Regulation (EC) No. 1467/97 of 7 July 1997 on speeding up and clarifying the implementation of the excessive deficit procedure, as amended by Council Regulation (EU) No. 1177/2011 of 8 November 2011”

And Regulation 1177/2011 states“When it exceeds the reference value, the ratio of the government debt to gross domestic product (GDP) shall be considered sufficiently diminishing and approaching the reference value at a satisfactory pace in accordance with point (b) of Article 126(2) TFEU if the differential with respect to the reference value has decreased over the previous three years at an average rate of one twentieth per year as a benchmark, based on changes over the last three years for which the data is available.”

So it’s the gap to 60%.
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