Debt Regulation in the European Union

This study will analyse to what extent the European debt regulation as outlined in the Stability and Growth Pact contributes towards sustainable economic growth. The primary focus of this paper is to see whether the deficit-debt ceilings as described in the SGP are in fact critical levels (they are not). The value of this thesis lies in the fact that it combines an extensive literature review of recent literature on the topic with an empirical study, both aimed for EU debt regulation analysis. For the empirical study, 19 OECD countries were taken in the period 1983 to 2010. The literature study yields the following results: first, debt affects economic growth only at high levels of approximately 75-80% or higher. Second, spending cuts are preferred to tax based corrections for their efficiency and their trait to have a smaller effect on output. Third, the timing of fiscal consolidation is of immeasurable importance: the state of the economy seriously influences both output and the structural deficit. Fourth, when considering spending reductions, the right mix of government expenditures targeted could in fact lead to stable debt, and a level that is allowed by EU fiscal regulation. The following can be concluded from the own empirical research: First, effects of debt on economic growth for different debt levels are not always significant but are never negative. Second, the effect of debt on the whole dataset is negligible, indicating a non-linear trend. Third, debt levels do not seem to matter much for debt levels lower than 30% of GDP. Fourth, debt levels produce a strong positive effect on economic growth starting somewhere between 30-50%, peak around 70%, and become weaker again after this. Fifth, and last, no significant effect of debt on growth exists above levels of 100%, but, if results were in fact significant, the sign of the effect is likely to be positive. All in all, there is no evidence that debt harms economic growth for levels below 70%, and debt rules do not contribute towards sustainable economic growth but tend to have a negative effect on growth instead.