The article below was published in today’s Sunday Business Post.
The Irish electorate will soon be asked to express its opinion on the new EU Fiscal Compact Treaty. Although the treaty document is quite short, its content is quite abstract and addresses issues that have been mainly debated so far within a fairly small technocratic circle of economists. So, what are the economics of the fiscal compact?
The economic logic behind the treaty is that a deep commitment to fiscal sustainability provides a key anchor for macroeconomic policy. If the domestic population and international investors are confident that a government will maintain public debt at a level that does not pose default risk, sovereign debt will be considered a “safe asset’’. In turn, this avoids the incorporation of risk premia into the sovereign bond yield, which is an important saving to the government in terms of its debt-servicing bill. Furthermore, a low sovereign yield lowers the funding costs faced by the banking system, in view of the close financial connections between banks and the government.