The impact of fiscal rules on public finances in the Euro Area

Abstract

Due to the 2008–09 financial crisis and ensuing economic downturn, budgetary problems are on the policymakers’ agenda once again. Fiscal deficits incurred as a result of the financial crisis and economic downturn have caused public debt to rise steeply once again. Moreover, the public debt of some EU countries was already at a high level before the crisis. At a high level of public debt, public finances become susceptible to adverse interest rate and economic growth fluctuations. If interest rates increase, advantageous government programs may be postponed, a debt trap may arise, and crowding out may reduce private investments. Interest rates may increase due to the growing risk aversion and the emergence of risk premiums on sovereign debt. Greece, Ireland and Portugal, which have been the hardest hit by the European debt crisis, have received support from the IMF, and the new EU and the euro area’s Financial Stabilization Mechanism and Financial Stability Facility.