Fiscal Targets, Automatic Stabilisers and Their Effects on Output

We investigate the risk that the Stability and Growth Pact may act as a constraint on the fiscal policy of EMU Member States in three respects: a) discretionary counter-cyclical policy which finds a limit in the 3 per cent of GDP threshold set for nominal deficit; b) automatic stabilisers whose extent may have to be limited both during the transition to the medium term objective of a budgetary position of close to balance or in surplus, and in the steady state, for countries with strong stabilisers where a high structural surplus may be needed to comply with the 3 per cent threshold; c) public investment, given that there is no provision for a golden rule within the EMU fiscal framework. We argue in favour of a revision of the fiscal target set in the Pact of a medium-term position of close to balance or in surplus. They stress the benefits in terms of growth from public borrowing to finance public investment and they point out that a one per cent of GDP deficit over the cycle should still be compatible with the 3 per cent threshold for the annual nominal deficit