Figure 2 - Developments in the debt ratio in the main industrialised countries and in the EU over the last 30 years20052000 19951990
19851980
1975
19702005
20001995
1990198519801970200520001995199019851980(^19701975)
0
10
20
30
40
50
60
70
80
15 20 25 30 35 40 45 50 55
General government expenditure as % of GDP
General government debt as% of GDP
0
20
40
60
80
100
120
140
160
180
General government debt as% of GDP (Japan)
EU
US
JP
Source: Commission services.
The role of monetary unions
The incentives for the conduct of unsound fiscal policies may also be stronger in a monetary union
(Weale, 2004). In flexible exchange rate regimes, the negative effects of unsustainable or pro-cyclical
fiscal policies have a direct negative impact on the country concerned (e.g. through higher real interest
rate and lower growth prospects).^9 In a monetary union, the effects of an expansionary fiscal policy on
economic growth may be larger than would be the case in absence of monetary union because there is
little crowding out of private investment and consumption due to the partial interest rate response. In
addition, the adoption of a common currency eliminates the exchange rate risk and the associated interest
rate risk premia among the participant countries, thus weakening the discipline and signalling function
normally exerted by financial markets.^10 In the long term, if excessive borrowing in one country or group
of countries leads to inflationary pressures or even, in the extreme, to a risk of default, the implications in
terms of monetary policy and financial stability may be shared by all the members of the union.
2.4. How can the deficit bias be addressed?
The debate on the ways to address the deficit bias has focused on the need to rebalance the incentives of
policy-makers or / and to impose constraints on the conduct of fiscal policy. A commonly accepted view
is that budgetary governance structures should provide sufficient information and the right incentives for
governments and institutions concerned to interact in a way that favours or ensures sound fiscal policies.
Institutional settings at national level can play an important role in containing spending and deficit
biases. These settings include in particular (i) the procedural rules of the budgetary processes, i.e. the
process laid down in law or constitution governing the elaboration of the annual budget law; (ii) the
numerical fiscal rules which are guiding or imposing constraints on the discretion of policy-makers; and
(iii) the independent bodies or institutions in charge of providing inputs (forecasts, analysis) and
formulating recommendations in the area of fiscal policy.
(^9) Obviously, such policies would also have negative effects in fixed exchange rate regimes.
(^10) This can be seen in developments of euro area government bond yields, which point to a narrowing of spreads across
countries.