December 09, 2011
The Washington Post reported on the new agreement among euro zone countries on fiscal policy and noted the difficulty that many countries would face in reaching their debt targets. It would have been worth mentioning that the polices of the European Central Bank (ECB) are making it more difficult for these countries to reach debt targets.
The ECB has remained committed to keeping a very low inflation rate even in a context where the euro zone countries have a huge amount of excess capacity and unemployed workers. If the ECB adopted more expansionary policies it would both allow more growth and help to reduce the burden of the debt through inflation.
If a country can sustain 3.0 percent real growth for 5 years and there is 4.0 percent inflation, then a debt burden that is equal to 100 percent of GDP can be reduced to 84 percent of GDP even if the country runs annual deficits equal to 3 percent of GDP ($450 billion in the United States). After 10 years the debt to GDP would be down to 73 percent of GDP. More rapid growth will also make it easier to run lower deficits since it will increase tax revenues and reduce payments for unemployment benefits and other transfers.
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