Why 3% for budget deficit?

  • Thread starter Charles123
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In summary: Can you please explain your thought?Thank you for your question. I believe that the number is arbitrary and that it originated from when the EU zone was formed as a requirement. Now, this value is merely reinforced.
  • #1
Charles123
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Why does the EU Stability and Growth Pact sets the specific value of 3% of GDP for maximum budget deficit. Where does the number come from? Why specifically 3% instead of 2.5% or 3.5%?
Thank you
regards
 
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  • #2
I don't have an actual reference, but it is probably tied to the average historical inflation rate. A deficit equal to the inflation rate is doesn't result in a growing debt over time.
 
  • #3
Can you please explain your thought?
Thank you
Regards
 
  • #4
I'd say it's 3% and not something near it because it's nicely rounded number. For real reason: if you have inflation 3% (i.e. 3% higher prices and wages) you get more taxes (since tax is % of wages etc.) and therefore can pay for more debt. So inflation increases your nominal revenue.

Another factor in sustainable deficit is GDP growt, so when you add inflation and GDP growth you get about 5% sustainable deficit.
 
  • #5
Thank you for your reply.
I wasn’t thinking about wages being adjusted to inflation and therefore inflation adding in tax revenue (wages tax + VAT), and therefore the value of dept you can pay is constant, assuming no GDP growth.
About GDP growth, what you are saying is that the 3% instead of 5% is a safeguard against no growth?
regards
 
  • #6
Alesak said:
Another factor in sustainable deficit is GDP growt, so when you add inflation and GDP growth you get about 5% sustainable deficit.

Actually, you and Russ are thinking about this slightly wrong. If you match debt growth to GDP growth, your debt levels will rise, if they are less then 100% of GDP. If they are over 100% they will actually shrink. The obvious way of thinking about this is take a country with no debt and a 3% deficit for the year and 3% inflation, obviously their debt levels would have to rise from 0.

p.s. in Russ's case he actually did say specifically for inflation, which depending on the case, may or may not lead to an increase in debt levels.
 
  • #7
Charles123 said:
Why does the EU Stability and Growth Pact sets the specific value of 3% of GDP for maximum budget deficit. Where does the number come from? Why specifically 3% instead of 2.5% or 3.5%?
Thank you
regards

Purely arbitrary number. Origin: it was already selected earlier when the EU zone was formed as requirement, now this value is merely reinforced.
 

1. Why is a budget deficit of 3% considered ideal?

The 3% budget deficit target is considered ideal because it strikes a balance between stimulating economic growth and maintaining fiscal responsibility. A budget deficit of 3% allows for necessary government spending on programs and services without causing excessive inflation or debt.

2. How does a budget deficit of 3% affect the economy?

A budget deficit of 3% can have both positive and negative effects on the economy. On one hand, it can stimulate economic growth by allowing for government spending on infrastructure, education, and social programs. On the other hand, it can lead to inflation and debt if not managed properly.

3. What happens if a country exceeds the 3% budget deficit target?

If a country exceeds the 3% budget deficit target, it may face consequences such as higher interest rates, reduced investor confidence, and decreased economic growth. This can also lead to a cycle of borrowing and debt that becomes increasingly difficult to manage.

4. How is the 3% budget deficit target determined?

The 3% budget deficit target is determined by analyzing economic factors such as inflation, GDP, and debt levels. It is also influenced by political factors and the goals of the government. The target may vary slightly between countries depending on their unique economic situations.

5. Is the 3% budget deficit target applicable to all countries?

No, the 3% budget deficit target is not applicable to all countries. It is a general guideline that is often used by developed countries with stable economies. Developing countries or countries with volatile economies may have different budget deficit targets based on their specific needs and circumstances.

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