The widely known reference values for the budget deficit and for the public debt of 3% and 60% of GDP, respectively, are set in a protocol annexed to the Maastricht Treaty of 1992. The two figures are consistent with each other when nominal GDP growth is 5%, when for example real (or volume) growth is 3% and inflation 2%. In such economic circumstances, if the starting point is a debt ratio of 60%, reaching a deficit of 3% of GDP the following year keeps the debt unchanged at 60% of GDP.

This calculation derives from the identity which indicates that in absolute terms the debt at the end of the current year is equal to the debt at the end of the previous year added to the budget deficit generated in the year itself and the deficit-debt adjustment. Ignoring this latter component and making use of a simplification valid for low GDP growth rates, the change in the debt ratio in GDP in the year t (ΔD_t) is given by:

where g_t is the nominal GDP growth rate, d_t the deficit of the year t, expressed as a percentage of GDP, and b_t-1 the debt ratio in the previous year (t-1).

Considering 3% deficit, 5% nominal growth and 60% debt in year t-1, a null change to the debt ratio in the t-period is achieved, meaning the two reference values are consistent with each other under such growth scenario.

However, such reference values are no longer consistent with each other today because the growth of European economies is now much lower than it was in 1992. The nominal growth in 2010’s decade is not expected to reach even 3% in the euro area at 12 (2.5% according to the European Commission), given the decrease in the pace of real growth and inflation.

Average annual GDP growth (%)

Source: European Commission, Autumn Forecast, November 2019.

Looking into the future, GDP growth is not expected to return to the values observed in the 1990s given the expected reduction in the working-age population resulting from the ageing of the European population. The Ageing Report 2018 assumes that between 2021 and 2030 the potential GDP growth rate in the euro area and in Portugal will be 1.1%. Further assuming that inflation will be the usual 2%, a nominal growth of 3% is to be expected for such decade.

Let's be a little more optimistic and add 1/4 p.p. to this projection.  Thus, considering an average nominal annual growth of 3.25%, to keep debt in the reference value of 60% of GDP, we reached a new reference value for the deficit that is necessarily lower than the Maastricht’s 3%. In these circumstances, the value of the deficit compatible with the 60% of debt is 1.95% of GDP and not the current 3%, so it can be said that 2% are the new 3%. Alternatively, we can keep the reference value for the deficit unchanged at 3%, which would lead to a necessarily higher debt ratio: 92.3% of GDP, which leads to the conclusion that 90% are the new 60%.

In short, with lower economic growth either the deficit limit should be lowered or the limit for the debt should be increased to maintain the consistency of the two Maastricht reference values.

Footnote remark: This exercise does not consider the deficit-debt adjustments (stock-flow adjustments), but in practice they cannot be ignored. These adjustments arise because the deficit definition excludes financial transactions, while the concept of gross debt includes them, reflecting the way they are financed. In technical language, this means that the above derived reference value for the deficit may not guarantee a constant debt ratio if significant financial transactions do occur. It's a technical detail, most of the time ignored, but that recent history proves to be relevant, and which calls for more fiscal prudence.