Abstract: The aim of this article is to demonstrate the development of general government debt and general government balance in two Eurozone countries: Germany and France in order to investigate the extent of fulfilment of the convergence criteria. The article is divided into two periods: from the creation of the Euro currency to the period before the global financial crisis and after it to the time of the pandemic. France and Germany notoriously violated the rules of the Stability and Growth Pact. The beginning of the crisis was a sharp rise in the deficit and debt-to-GDP ratio to over 80% in both countries followed by a fiscal consolidation period. As a result, Germany managed to reduce its debt to 60% of GDP, in line with the SGP requirements, while in France this indi-cator achieved the level close to 100% in 2019. The methodology adopted by the author is based on an analytical approach and a literature review of the subject (see Escolano, 2010). Based on this methodology, the debt sustainability analysis of the general government sector was carried out. The analysis illustrates the changes to be implemented to the primary balance to allow both countries to grow out of debt. According to the author, France should have car-ried out the necessary structural reforms, but above all, reduce the ratio of pub-lic expenditure and revenues to GDP, which is the highest in Europe. Other-wise, if interest rates of ECB continue to rise, France may face a critical situation.
<a href="https://dx.doi.org/10.15611/fins.2022.2.06">DOI: 10.15611/fins.2022.2.06</a>
<p>JEL Classification: H62, H63, H68</p>
<p>Keywords: fiscal balance, primary balance, fiscalsustainability, the Stability and Growth Pact</p>
<h2>1. Introduction </h2>
<p>Budget deficits are a common phenomenon in modern economies. They
appear and deepen not only in special situations such as wars or crises,
but also in normal times, most often as a result of state intervention
and the implementation of state functions in the area of the economy. In
addition to the economic and social prerequisites of a deficit such as a
decrease in tax revenues during periods of slowdown or an increase in
spending on social benefits, in modern democratic countries there are
also specific political mechanisms that make governments tend to
generate significant budget deficits (a phenomenon called deficit bias).
It often happens that this leads to mounting indebtedness and can
endanger the long-term sustainability of public finance (see Reinhart,
Reinhart, & Rogoff, 2012; Reinhart & Rogoff, 2009; Reinhart
& Rogoff, 2010). The inclination to the deficit and, consequently,
the tendency to indebtedness itself, is caused both by reasons related
to the functioning of the representative democracy system as well as by
reasons specific to the monetary union in the case of the euro area. It
is precisely the awareness of the threats related to the deficit
propensity that has contributed to monetary integration in Europe.
Budgetary equilibrium was considered a prerequisite for maintaining the
high credibility of the single currency. Therefore, before the entry
into force of the monetary union, the mechanisms of coordination and
fiscal control were introduced into the EU legal order. The main
mechanism was the Stability and Growth Pact, containing a set of fiscal
rules and preventive and corrective procedures to ensure fiscal
discipline. The Stability and Growth Pact, in its assumption, was to be
the most far-reaching instrument of community intervention in fiscal
policy. Although it has been in force since 1999, the pact failed to
ensure fiscal discipline in the euro area.</p>
<p>Among the countries which notoriously were breaking the rules of the
Pact there were primarily France and Germany – the leading architects of
European integration and later the creators of the common currency. Two
things united these countries: on the one hand, they have provided
constant political support for the Euro project both before and after
the outbreak of the global financial crisis, and on the other , those
countries failed to comply with the Pact's rules on fiscal policy and
were even trying to soften its provisions in the period before the
outbreak of the global crisis. Definitely one thing significantly set
apart the two countries in the period after the outbreak of the crisis,
namely establishing and maintaining fiscal discipline. While Germany in
2019 met all the provisions of the modified Stability and Growth Pact as
well as the provisions of the Fiscal Compact<a href="#fn1">1</a>
(maintaining even a general government surplus for several years and
reaching the debt criterion of 60% of GDP), France's fiscal position
deteriorated further and the debt-to-GDP ratio was close to 100%. Above
all, Germany and France are two striking examples of countries that –
despite expressing ongoing political support for the European currency –
conduct two different fiscal policies: one that is exemplary and should
be still followed by many other Member States and the second one that
should be avoided as otherwise it might even endanger the euro project
itself<a href="#fn2">2</a>. The main aim of this article is to
present the development of general government debt and general
government balance in two Eurozone countries, Germany and France, in
order to investigate the extent of fulfilment of the convergence
criteria. Secondly, the article points out the relevant factors that
were responsible for the given course and pace of fiscal consolidation
aimed at growing out of debt by both countries. Finally, an analysis of
sustainability of general government debt in Germany and France is
presented that includes three sensitivity scenarios. The article refers
to two periods: since the creation of the single currency until the
period of the global crisis and up to the pandemic. The methodology
adopted by the author is based on an analytical approach and a
literature review of the subject (see Escolano, 2010). Based on this
methodology, the debt sustainability analysis of the general government
sector was carried out. The analysis demonstrates the changes to be
implemented to the primary balance to allow countries to grow out of
debt. The conclusions constitute the final part of the article.</p>
<h2>2. Deficit bias
phenomenon – why does it happen? </h2>
<p>Empirical research shows unambiguously that in modern democratic
countries there are specific political mechanisms that make governments
tend to generate significant budget deficits (a phenomenon called
deficit bias). It often happens that this leads to mounting
indebtedness, and can endanger the long-term sustainability of the
public finance. In the subject literature there are several hypotheses
that try to provide an explanation of deficit bias. According to the
first one, the propensity of politicians to increase debt is determined
by the political cycle (Nordhaus, 1975). In order for politicians to
maximise their chances to be reelected, they simply ‘buy’ voters by
raising spending or lowering taxation. Moreover, a hypothesis of fiscal
illusion can take place that explains with clarity why voters favour
wasteful governments (Wagner, 1977). There is a tendency for society to
re-evaluate the current expenditure, and in parallel underestimate the
future taxation burden resulting from the earlier growth in public
spending. Furthermore, the fiscal deficit constitutes a result of the
strategic use of indebtedness (Rubini & Sachs, 1988) – a government
still in power but uncertain about its reelection, starts to conduct an
expansive fiscal policy to decrease the room for manoeuvre for their
successors. According to the next hypothesis, a permanent fiscal deficit
occurs as a result of passing the costs on to the next generations
(Tabellini, 1991). Finally, mounting public debt can be reflected by the
problem of common resources (von Hagen, 1998). The government tends to
prefer public expenditures concentrated on specific electorate groups or
regions, whilst the advantages of such expenditure are internalized by
certain groups, then costs of the spending are redistributed to all
taxpayers (Ptak, 2016, pp. 608-609).</p>
<p>Furthermore, in the framework of the Monetary Union, the tendency for
budget deficit intensifies due to the occurrence of two peculiar
phenomena, namely free riding and moral hazard. The first problem refers
to a situation when any EMU country breaks the established and reference
value of fiscal deficit through an increase in public spending, while
being aware that any additional costs related to that (an increase in
interest rates as a result of an increase in aggregate demand with a
constant supply of money) will be incurred by all EMU countries. In
turn, the second phenomenon, namely moral hazard, appears when an EMU
country increases its indebtedness over an acceptable threshold while
being aware that in the case of potential insolvency, other countries
will be compelled to assist it with financial aid because the losses
connected with bankruptcy (impairment of banking sector assets) could
outweigh the cost of the aid itself (Greece as an example) (Rosati,
2013, p. 15).</p>
<h2>3. Fiscal
rules and fiscal performance in the European Monetary Union</h2>
<p>The main mechanism of coordination and fiscal control introduced into
the EU legal order prior to the entry into force of the Monetary Union
was the Stability and Growth Pact, containing a set of fiscal rules both
preventive and corrective procedures to ensure fiscal discipline. The
creators of the EMU were aware that fiscal discipline will constitute a
prerequisite for maintaining the high credibility of the single
currency. Under the Treaty on the Functioning of the European Union
(TFUE) and the Stability and Growth Pact, three fiscal rules were
introduced into the EU economic governance system: the 3% deficit rule,
the 60%<a href="#fn3">3</a> debt rule and the rule of
maintaining budget balance in the medium term after taking into account
the impact of the business cycle (MTO rule i.e. Medium Term Objective).
Overall, the Stability and Growth Pact of 1997 provided the fiscal
criteria to which all Member States are supposed to conform.</p>
<p>Although these rules had been in force since 1999, they failed to
ensure fiscal discipline in the EU. Figure 1 demonstrates the evolution
of the budgetary situation in EMU states since the creation of the
Monetary Union. In the period 1999-2008, EMU countries as a whole did
not manage to generate a budget surplus even once, but instead showed a
persistent deficit .</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image1.png" />
</p>
<p>Figure 1. General Government Debt and General Government Balance
(right axis) in the euro area in % of GDP in 1999-2008</p>
<p>Source: AMECO database, European Commission.</p>
<p>As a result, public debt remained above 60% of GDP all the time
within the period. In total, in 1999-2008, EMU countries violated the
deficit rule 42 times and the debt rule 61 times [calculation based on
statistical data from AMECO database, European Commission]. Overall, one
can conclude that the system of maintaining fiscal discipline in the EU
failed to work properly.</p>
<h2>4. Fiscal
policy of Germany and France before the outbreak of the financial
crisis</h2>
<p>Meeting the deficit criterion was not a great challenge when adopting
the single currency. In practice, often one-off budget operations
(including raising taxes or sale of state assets) and changes on the
expenditure side allowed candidate countries (except Greece) to reduce
the budget deficit below 3% of GDP, and even to achieve a budget surplus
in the designated time. During the implementation of budgetary reforms,
the main problem turned out to achieve the level of general government
debt (60% of GDP)<a href="#fn4">4</a>. In the year of entry into the EMU
(1999), both Germany and France managed practically to meet the criteria
from the Maastricht Treaty (60% and 60.5% of GDP in terms of general
government debt, and -1.7% and -1.6% of GDP in terms of general
government balance, respectively). However, the original principles set
out in the Stability and Growth Pact seemed sufficient until the first
economic recession in 2002, as a result of which, among others, Germany
and France showed an excessive deficit of the general government sector
(over 3% of GDP), persisting over the following years. Budget
difficulties in this period also affected other EMU countries
(Marchewka-Bartkowiak, 2011, p. 2).</p>
<p>In the period 1999-2008 there were frequent cases of the violation of
fiscal rules adopted in the Stability and Growth Pact (specifying the
acceptable limits of debt and budget deficit), which led to a systematic
increase in public indebtedness. In this period, both Germany and France
broke the deficit rule five times and as a result the general government
deficit was significantly higher than in the euro area as a whole (see
Figure 2).</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image3.png" />
</p>
<p>Figure 2. General Government Balance in Germany and France against
the euro area in % of GDP in 1999-2008</p>
<p>Source: AMECO database, European Commission.</p>
<p>In turn, public debt in 2003-2008 in those countries was persistently
above the threshold of 60% of GDP (see Figure 3). Furthermore, both
Germany and France were trying to soften the provisions of the Stability
and Growth Pact and thus avoid penalties<a href="#fn5">5</a>. In
2005, under pressure from Germany and France, the European Commission
agreed that countries would not automatically be subject to the
excessive deficit procedure – which could theoretically lead to
financial penalties for wasteful governments – if the infringement has
economic justification or contributes to improving the efficiency of the
economy. Since they are the largest eurozone countries, France and
Germany thus avoided any consequences of violating the Maastricht
criteria; this practice has become widespread (Forbes, 2011).</p>
<p>Figure 3. General Government Debt in Germany and France against the
euro area in % of GDP in 1999-2008.</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image5.png" />
</p>
<p>Source: AMECO database, European Commission.</p>
<p>Summing up, one can say that in the case of Germany and France their
fiscal policies were neither sustainable nor counter-cyclical<a href="#fn6">6</a>. The fiscal policies conducted by
those countries led to a steady increase in public debt and even in the
periods of high economic growth (e.g. years 2006-2007) they failed to
balance their budgets. Simply put, the Stability and Growth Pact did not
work.</p>
<h2>5. The
outbreak of financial crisis and institutional reforms</h2>
<p>The global financial and economic crisis revealed numerous weaknesses
and gaps in the fiscal governance system based on the Stability and
Growth Pact, such as the actual lack of incentives to maintain fiscal
discipline, excessive and politicized nature of preventive and
corrective procedures, lack of sanctioning mechanism for the debt rule
and the MTO rules, lack of appropriate EU fiscal rules in domestic law
and the possibility of statistical manipulation to lower the actual
amounts of debt and deficit. As a result, the indebtedness of many EMU
countries increased instead of falling, and when the crisis came those
countries were on the brink of insolvency (Greece, Ireland, Spain,
Portugal).</p>
<p>The primary fiscal balance is the best available variable for
presenting the overall fiscal picture within governmental control. The
primary balance is the overall fiscal balance excluding net interest
payments on public debt. This is of a particular importance in terms of
short-run sustainability, as it demonstrates to what extent a government
can honour its obligations without incurring additional indebtedness.
Along with net interest payments for debt servicing, which constitute an
inflexible part of public budgeting, the primary balance provides the
most accurate reflection of the state of fiscal management in a country
(OECD, 2017). According to
the International Monetary Fund, the global financial crisis resulted in
the greatest ever worsening of the primary fiscal balance, with the
average primary fiscal deficits in 2008-2009 larger than at any other
period in history aside from the two World Wars (see IMF, 2013). In the
euro area, the fiscal position was similar. Figure 4 presents the
government debt and primary fiscal balance in the EMU, both prior to the
crisis and during the crisis years (the right axis corresponds to the
fiscal primary balance).</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image7.png" />
</p>
<p>Figure 4. General Government Debt and Primary balance (right axis) in
the euro area in % of GDP in years 2008-2018</p>
<p>Source: AMECO database, European Commission.</p>
<p>A considerable worsening in the primary balance was accompanied by a
rapid rise in the debt-to-GDP ratio, and as a result of fiscal
consolidation carried out by countries, the ratio was put to a gradual
halt in the years to come. In 2015 the debt-to-GDP ratio started to
decline, whereas the primary balance started to record positive values
which meant that the start of the process of moving out of debt in the
euro area came into effect.</p>
<p>The experience of financial and economic crisis led European leaders
to address measures aimed at restoring fiscal discipline in the Member
States<a href="#fn7">7</a>. One of the solutions signed by
Member States was the Treaty on Stability, Coordination and Governance
(TSCG), the so-called Fiscal Compact which specifies requirements for
fiscal rules in the countries that are subject to the provisions of the
Treaty. It strengthens the reformed Stability and Growth Pact, under
which:</p>
<p>- national deficits must not exceed 3% of gross domestic product
(GDP),</p>
<p>- national public debt must remain below 60% of GDP.</p>
<p>The signatory countries are to commit themselves to implementing in
their legislation fiscal rules which require that the general government
budget be balanced or show a surplus. The two major components of the
Fiscal Compact are the mandatory balanced budget rule and the benchmark
for government debt reduction. The fiscal rule is considered to be met
if the annual structural balance achieves the country-specific
medium-term budgetary objective and does not violate a deficit (in
structural terms) of 0.5% of GDP. In cases when the government
debt-to-GDP ratio is considerably below 60% of GDP and risks to
long-term fiscal sustainability in general are low, the target can be
placed higher to the level of 1% of GDP. If the structural balance of a
country deviates significantly from the medium-term budgetary objective,
corrective measures are taken automatically.</p>
<p>The requirements of the Treaty also include a numerical benchmark for
debt reduction for Member States with government indebtedness exceeding
60% of the GDP reference value. Countries with a general government debt
above 60% of GDP are supposed to reduce the ‘surplus of debt’ (i.e. the
percentage above 60% of GDP) by one-twentieth annually. Countries that
do not conform to those rules may be subject to financial fines of up to
0.1% of GDP.</p>
<p>The Treaty entered into force on 1 January 2013 and its solutions
adopted strengthened supervision and imposed on politicians restoration
and maintenance of fiscal discipline in public finance of Member
States.</p>
<h2>6. Arithmetic of deficit-debt
dynamic</h2>
<p>The following formula allows to make a decomposition of changes in
the debt ratio into the most underlying factors, such as interest rates,
inflation, fiscal adjustment, etc. (see e.g. Escolano, 2010):</p>
<p><span>\(d_{t}\)</span> - <span>\(d_{t - 1}\)</span> = <span>\(\frac{i_{t}}{1 + \ y_{t}}\)</span> <span>\(d_{t - 1}\)</span> - <span>\(\frac{y_{t}}{1 + \ y_{t}}\)</span> <span>\(d_{t - 1}\)</span>+ <span>\(p_{t}\)</span> (1)</p>
<p><span>\(d_{t}\)</span> <em>=</em> debt at the end
of period <em>t</em>, as a ratio to GDP at <em>t</em>.</p>
<p><span>\(d_{t - 1}\)</span><em>=</em> debt at the
end of period <em>t-1</em>, as a ratio to GDP at <em>t-1</em>.</p>
<p><span>\(i_{t}\)</span> <em>=</em> nominal
interest rate in period <em>t</em>; paid in period <em>t</em> on the
debt stock outstanding at the end of <em>t –</em> 1.</p>
<p><span>\(c_{t}\)</span> = nominal GDP growth rate
between t – 1and t.</p>
<p><span>\(p_{t}\)</span> <em>=</em> primary fiscal
deficit in <em>t</em>, as a ratio to GDP at <em>t</em>.</p>
<p>This equation demonstrates that the change in the debt-to-GDP ratio
equals the impact of interest (positive) and nominal GDP growth
(negative), along with the contribution of the primary deficit:</p>
<p><span>\(d_{t}\)</span> - <span>\(d_{t - 1}\)</span> =<span>\({\
p}_{t} +\)</span> <span>\(d_{t - 1}(\frac{i_{t} -
y_{t}}{1 + \ y_{t}}\)</span>) (2)</p>
<p>Equation (2) shows that the change in debt-to-GDP ratio constitutes
the sum of primary fiscal deficit and the snowball effect which is the
combined effect of the interest rate of government bonds and the growth
rate of nominal GDP on the debt-to-GDP ratio. A constant debt-to-GDP
ratio will be maintained if the left side of equation (2) equals zero.
In order to stabilise the debt-to-GDP ratio at a specified debt level,
one has to meet the following condition:</p>
<p><span>\({- p}_{t}\)</span> = <span>\(d_{t - 1}(\frac{i_{t} - y_{t}}{1 + \
y_{t}}\)</span>) (3)</p>
<p>Equation (3) shows that the condition for stability of the
debt-to-GDP ratio requires that the primary deficit equals the snowball
effect. The public debt will not grow if the primary deficit is
compensated by the surplus of growth of nominal GDP above the level of
nominal interest of government bonds. One can conclude that the
debt-to-GDP ratio will grow indefinitely if the nominal interest rates
of government bonds exceed the growth rate of nominal GDP, unless the
primary budget is in a sufficient surplus in order to compensate for
that. Based on the experiences of many countries, to stop the process of
growing debt, not only a primary balance but also a primary surplus is
required to be achieved. Therefore, the sign of formula <span>\(i_{t} - y_{t}\)</span> is essential for the
debt-to-GDP dynamic. In the case of high and positive value of formula
<span>\(i_{t} - y_{t}\)</span>, stabilising the
debt-to-GDP ratio requires maintaining a sufficient primary surplus
(Ptak, 2017, pp. 45-46).</p>
<h2>7. Fiscal
policy during and after the financial crisis </h2>
<p>At the beginning of the crisis the fiscal situation in Germany and
France did not differ greatly from most of the euro-zone countries. The
lack of balanced budgets and, consequently, maintaining budget deficits
over the years even in times of fast economic growth had to lead to
their deepening and rapid increase in the debt-to-GDP ratio. Fiscal
Consolidation packages were launched, however, with very different
results. The fiscal picture after the crisis indicated a significant gap
between Germany and France in terms of achieving primary balance as
clearly illustrated in Figure 5.</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image9.png" />
</p>
<p>Figure 5. Primary balance in Germany, France and in the euro area in
% of GDP in 2009-2019</p>
<p>Source: AMECO database, European Commission.</p>
<p>In this respect, while Germany achieved a significant primary surplus
– much greater than the average value of the euro area as a whole –
France still did not manage to achieve even a primary balance, which
clearly illustrates the strikingly differentiated fiscal effort both
countries undertook. As a result, in 2019 the debt-to-GDP ratio in
Germany fell even below the value of 60% of GDP as required by the
Stability and Growth Pact of 1997, while in France the ratio shaped
close to 100% (97.5%). Note that after the outbreak of the global
financial crisis, the debt-to-GDP ratio in 2010 in both countries was
running at a relatively similar level (80%-85% of GDP). However, the gap
between Germany and France rose to almost 40% in 2019 (Figure 6).</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image11.png" />
</p>
<p>Figure 6. General Government Debt in Germany, France and in the Eeuro
area in % of GDP in 2009-2019</p>
<p>Source: AMECO database, European Commission.</p>
<p>Furthermore, Table 1 demonstrates the sustainability of general
government debt in Germany and France, including three sensitivity
scenarios, to better illustrate the changes in relation to the required
level of primary balance to be in accordance with equation (3).</p>
<p>Table 1. Sustainability of General Government Debt in Germany and
France</p>
<table class="table table-bordered">
<colgroup>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
</colgroup>
<thead>
<tr><th><strong> </strong></th>
<th><strong>Primary balance as % of GDP</strong></th>
<th><strong>Threshold of primary balance beyond which the
government debt starts to fall</strong></th>
</tr>
<tr><th><strong>2020</strong></th>
<th><strong>2021*</strong></th>
<th><strong>Forecast 2021*</strong></th>
<th><strong>Scenario 1**</strong></th>
<th><strong>Scenario 2***</strong></th>
<th><strong>Scenario 3***</strong></th>
</tr>
</thead>
<tr><td><strong>France</strong></td>
<td>-7.8</td>
<td>-6.9</td>
<td>-6.7</td>
<td>-4.6</td>
<td>-8.8</td>
<td>-5.6</td>
</tr>
<tr><td><strong>Germany</strong></td>
<td>-3.7</td>
<td>-5.9</td>
<td>-3.7</td>
<td>-2.5</td>
<td>-5.0</td>
<td>-3.1</td>
</tr>
</table>
<p>* Based on European Economic Forecast, Winter Autumn, Institutional
Paper 160, European Commission 2021.</p>
<p>** Scenario 1 assumes lower inflation and real GDP rates by 1.0 pp.
compared to Forecast 2021.</p>
<p>*** Scenario 2 assumes higher inflation and real GDP rates by 1.0 pp.
compared to Forecast 2021.</p>
<p>**** Scenario 3 assumes higher government long term interest rates by
1.0 pp. compared to data (Reuters).</p>
<p>Source: own calculations based on AMECO database, European
Commission.</p>
<p>Up to the pandemic, Germany managed to build and maintain a large
primary surplus which facilitates the fast reduction of debt-to-GDP
ratio. In turn, France not only did achieve primary balance but also
recorded primary deficit all the time. The outbreak of the pandemic,
along with the support provided by governments, led to a significant
worsening of the primary balance, however in the case of France this was
twice as much as for Germany.</p>
<p>Scenario 1 reflects lower inflation and real GDP rates by 1.0%
compared to the 2021 forecast. In this particular case, the value of the
primary balance beyond which the debt starts to fall increases for
France and more so for Germany, however both countries can maintain a
primary deficit which will be sufficient to start to reduce its
indebtedness. Due to the high dynamic of nominal GDP and interest rates
close to zero for France and negative for Germany, both countries have
to moderately tighten their fiscal policies.</p>
<p>Scenario 2 considers higher inflation and higher real GDP rates by
1.0% compared to the 2021 forecast. The value of the primary balance
beyond which the debt starts to fall decreases significantly for France
and increases slightly for Germany. In turn, in scenario 3 which assumes
higher government long-term interest rates by 1.0 pp. compared to the
data for 2021, the value of primary balance beyond which the debt-to-GDP
ratio starts to fall will require higher fiscal adjustment for Germany
and almost an for France.</p>
<p>The analysis carried out only confirms that the sign and value of
primary balance in accordance with equation (3) is highly sensitive
about the sign and value of formula <span>\(i_{t} -
y_{t}\)</span>. At present, the high nominal GDP growth ( <span>\(y_{t})\)</span> supports the debt reduction,
notably for France. Furthermore, the highly expansionary monetary policy
of the European Central Bank enables to keep very low interest rates
<span>\({(i}_{t})\ \)</span>(close to 0%), hence
keeping low the cost of servicing debt as well. Overall, France is the
country that primarily benefits from the favourable development of the
sign of formula <span>\(i_{t} - y_{t}\)</span>. In
the opposite case, given France's highly insufficient efforts to improve
the primary balance, the debt-to-GDP ratio would deteriorate further and
faster. In both countries, the public debt increased significantly
during the pandemic. Nevertheless, toward the end of the forecast’s
horizon (2023), Germany is much closer than France to form a primary
surplus and start to lower its debt-to-GDP ratio, which is projected to
be lower by 45 pp. than in France. Under such circumstances, France will
be required to implement appropriate measures and tackle the fiscal
deficit.</p>
<p>Comparing the outcome of the analysis with the progress toward the
second main component of the Treaty on Stability, Coordination and
Governance in the EMU, in the case of France, the benchmark for
government debt reduction could have also not been in line with the
Treaty’s provision. The difference between the government debt-to-GDP
ratio and the TFUE threshold of 60% of GDP has had to be decreased at an
average rate of one-twentieth annually. Table 2 presents two paths of
the debt-to-GDP ratio: the actual one and the one required by the Fiscal
Compact.</p>
<p>Table 2. Changes of Debt-to-GDP ratio in Germany and France in the
years 2014-2019</p>
<table class="table table-bordered">
<colgroup>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
<col></col>
</colgroup>
<thead>
<tr><th>In % of GDP</th>
<th><p><strong>Path of debt-to-GDP ratio</strong></p>
<p><strong>required by Fiscal Compact</strong></p></th>
<th><strong>Actual path of debt-to-GDP ratio</strong></th>
</tr>
</thead>
<tr><td> </td>
<td>2013</td>
<td>2014</td>
<td>2015</td>
<td>2016</td>
<td>2017</td>
<td>2018</td>
<td><strong>2019</strong></td>
<td>2014</td>
<td>2015</td>
<td>2016</td>
<td>2017</td>
<td>2018</td>
<td><strong>2019</strong></td>
</tr>
<tr><td><strong>Germany</strong></td>
<td>77.4</td>
<td>76.5</td>
<td>75.7</td>
<td>74.9</td>
<td>74.2</td>
<td>73.5</td>
<td><strong>72.8</strong></td>
<td>74.5</td>
<td>70.8</td>
<td>67.9</td>
<td>63.9</td>
<td>61.3</td>
<td><strong>58.9</strong></td>
</tr>
<tr><td><strong>France</strong></td>
<td>93.4</td>
<td>91.7</td>
<td>90.1</td>
<td>88.6</td>
<td>87.2</td>
<td>85.8</td>
<td><strong>84.6</strong></td>
<td>94.9</td>
<td>95.6</td>
<td>98.2</td>
<td>98.5</td>
<td>97.8</td>
<td><strong>97.5</strong></td>
</tr>
</table>
<p>Source: the author’s own calculation based on AMECO database.</p>
<p>Since the adoption of the Fiscal Compact, Germany managed to reduce
its debt-to-GDP ratio considerably more than required by the provisions
of the Fiscal Compact, while France let it continue to rise. If France
had respected the provisions of the Treaty, the debt ratio would have
been, on average, 13 percentage points lower than before the
pandemic.</p>
<p>Note again that for the development of formula <span>\(i_{t} - y_{t}\)</span>, was strongly impacted by
the highly expansive monetary policy of the European Central Bank. Up to
the pandemic, the average interest of long-term government bonds <span>\({(i}_{t})\)</span> was much lower than prior to
the crisis. It was surprising to see that in both countries but
especially in France, despite the large growth of debt-to-GDP ratio, the
cost of debt servicing in relation to GDP fell (Figure 8).</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image13.png" />
</p>
<p>Figure 8. General Government Debt and its service (right axis) in
Germany and France as % of GDP in 2010-2019</p>
<p>Source: AMECO database, European Commission.</p>
<p>In the case of Germany this situation is not surprising. Germany
undertook a significant fiscal effort to tackle the growing debt and
managed to reduce it to even a lower level than prior to the crisis,
whereas France was not able to stop the growing debt-to-GDP ratio, which
before the pandemic ran close to 100% of GDP, and afterwards to 118%.
The low interest of government debt means that France could afford to
service its debt. However, the monetary policy conducted by the European
Central Bank weakens the need to carry out the necessary structural
reforms that would improve the competitiveness of the French economy and
this argument cannot be ignored (The Economist, 2012). International
organizations like the Organization for Economic Co-operation and
Development (OECD) has recommended to France a long-term strategy to
reduce public expenditure without endangering social protection so as to
allow lower taxes with sustainable public finances. Such a combination
would generate faster growth and lower unemployment (see e.g. OECD,
2017, p. 10).</p>
<p>At present, the ratio of both public expenditure and revenues to GDP
in France has been the highest in the whole EU. It is not surprising,
therefore, that with such high taxes the French economy is
uncompetitive, and the high share of expenditures to GDP makes it
impossible to reduce the deficit faster and thus to slow down the growth
of debt (OECD, 2018, p. 114). In 2019, the general government deficit in
France was the highest in the Euro Area (Figure 9) and it is worth
adding that France has failed to balance its budget since 1974, so it is
not surprising that the indebtedness has been on the upward trend. In
contrast, Germany built the third highest general government surplus and
hence the debt-to-GDP ratio was on the downward path. In fact, this
chart shows almost a mirror reflection between Germany and France in
terms of fiscal performance.</p>
<p>
<img src="/articles/2022/ptak-2022-2/media/image15.png" />
</p>
<p>Figure 9. General Government Balance in the euro area as % of GDP in
2019</p>
<p>Source: AMECO database, European Commission.</p>
<p>Therefore, France should have used the conditions of faster economic
growth recorded for the last few years to carry out the necessary
reforms. Due to the outbreak of the pandemic and the response of the
government to it, general government debt in France grew in years
2019-2021 by 20% reaching the level of 118%, whereas in Germany
substantially less – by 10%, and reached 68%. This only proves the need
to focus on developing and maintaining a primary surplus to reduce the
debt-to-GDP ratio to be in line with the provisions of the Fiscal
Compact and in accordance with equitation (3).</p>
<h2>8. Conclusion</h2>
<p>Fiscal discipline was to form the basis and prerequisite for building
credibility of the single currency. The main mechanism to ensure that
was the Stability and Growth Pact of 1997 which included admissible
limits on general government deficit and debt. Although it was in force
since 1999, the Pact failed to ensure fiscal discipline in the Euro
Area. Among the countries which were notoriously breaking the rules of
the Pact were primarily France and Germany, the leading architects of
European integration and later the creators of the common currency. Even
though they provided constant political support for the euro project
both Germany and France were trying to soften the provisions of the
Stability and Growth Pact and thus avoid penalties.</p>
<p>The fiscal policies conducted by those countries led to a steady
increase in public debt and even in the periods of high economic growth
(e.g. 2006-2007), they failed to balance their budgets. Simply put, the
Stability and Growth Pact did not work. The recent crisis clearly
exposed any dysfunctionalities in the construction of the euro area. The
experience of the financial and economic crisis led European leaders to
address measures aimed at restoring fiscal discipline in the Member
States. The reformed Stability and Growth Pact and the Fiscal Compact
constitute the foundations of a new European economic governance
system.</p>
<p>During the outbreak of the financial crisis the fiscal situation in
Germany and France did not differ much from most of the euro rea
countries. The lack of balanced budgets and, consequently, maintaining
budget deficits over the years even in times of fast economic growth had
to lead to their deepening and rapid increase in the debt-to-GDP ratio.
Fiscal consolidation packages were launched, however, with very
different results. In this respect, while Germany achieved a significant
primary surplus much greater than the average value of the euro area as
a whole, France did not manage to achieve even a primary balance – which
clearly illustrates the strikingly differentiated fiscal effort both
countries undertook. This is confirmed by the sustainability analysis
conducted in the article.</p>
<p>In 2019 the debt-to-GDP ratio in Germany achieved lower value than
60% of GDP as required by the Stability and Growth Pact of 1997, while
in France the ratio ran close to 100%. Note that after the outbreak of
the global financial crisis the debt-to-GDP ratio in 2010 in both
countries was running at a relatively similar level (80-85% of GDP).
However, the gap between Germany and France rose to almost 40% in 2019,
hence before the pandemic and after it in 2023, according to the latest
forecast of the European Commission. That is why it is not surprising
that the general government deficit in France was one of the highest in
the Euro Area.</p>
<p>It is necessary to mention the expansive monetary policy of the
European Central Bank. Up to and during the pandemic, the average
interest of long-term government bonds <span>\({(i}_{t})\)</span> was much lower than prior to
the crisis, therefore France could afford to service its debt
effortlessly, and should have taken advantage of this time and carried
out the necessary reforms in order to improve the competitiveness of its
economy and increase production capacity, and above all, to reduce the
ratio of both public expenditure and revenue to GDP which are the
highest in the whole EU. Otherwise, if current ECB interest rates
continue to rise, France might finally find itself facing a critical
situation.</p>
<p>Nevertheless, due to extraordinary circumstances, the fiscal policy
stance can deviate from the domestic fiscal rules, as the European
Commission allowed their members to activate the escape clauses.
However, in the foreseeable future actions taken by France will be
closely monitored. France as the main architect of the single currency
should set an example to mobilize other countries to conduct reforms,
like Germany does, otherwise in the event of another economic slowdown
domestic fiscal problems will only gain in importance. Political support
for the single currency is not enough, the real strength of the European
currency should be the good condition of its economies and to ensure
this, fiscal discipline is fundamental. Therefore, France should finally
prove its capacity to maintain a continued fiscal discipline.</p>
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<ol><li><p>The Treaty on Stability, Coordination and Governance
(TSCG).<a href="#fnref1">↩︎</a></p></li>
<li>
<p>In terms of the size of GDP, France is the second largest euro area
economy whereas the Italian economy, which faces significant problems
connected with the poor condition of its banking system and high
debt-to-GDP ratio, third.</p>
<a href="#fnref2">↩︎</a></li>
<li><p>Based on empirical studies, a certain level of
indebtedness beyond a given threshold starts to have negative
repercussions on the economy and policy making. The relationship between
public debt and economic growth is insignificant for debt-to-GDP ratios
below a given threshold, but above it the average economic growth rate
starts to decrease rapidly (Reinhart & Rogoff, 2010). For instance,
Reinhart and Rogoff (2009) put the threshold at which public debt is
associated with lower contemporaneous growth at about 90% of GDP for
both advanced and emerging economies. Other studies (Reinhart, Reinhart
& Rogoff 2012) with alternative methodologies and samples
demonstrate similar estimates.<a href="#fnref3">↩︎</a></p></li>
<li><p>In 1999 half of the countries that adopted the single
currency did not meet the required level of debt.<a href="#fnref4">↩︎</a></p></li>
<li><p>Even if it was found that the budget deficit of a given
country is excessive, when determining the appropriate time to correct
it, the circumstances surrounding the occurrence of an excessive deficit
were taken into account, consciously increasing the time needed to
offset this indicator. Sanctions as the last resort were never used
(Nowak-Far, 2007, pp. 45-52).<a href="#fnref5">↩︎</a></p></li>
<li><p>Economic theory recommends that the optimal fiscal
policy must fulfil two basic conditions: it must be sustainable and it
must be counter-cyclical. Fiscal policy is sustainable if the public
debt-to-GDP ratio converges toward a constant value in the long run. In
turn, a counter-cyclical policy is a policy that reduces the amplitude
of the business cycle fluctuations, meaning is expansionary during
economic slowdowns and contractionary during economic expansions
(Janikowski, 2018, p. 8).<a href="#fnref6">↩︎</a></p></li>
<li><p>A complex description of the relevant reforms can be
found e.g. in (Rosati, 2013).<a href="#fnref7">↩︎</a></p></li>
</ol>