g + rb — t = 0
In this case, Eq. (6.19) reduces to
If n > 0, the government budget is sustainable and vice versa. If g + rb — t is fixed at any value, the same argument holds. In such an instance, positive economic growth is necessary to maintain sustainability. Note that even if the fiscal deficit, g + rb — t, is very high, we may attain the sustainability condition as long as the fiscal deficit per GDP is fixed in a growing economy.
Fig. 6.5 The Bohn condition
In the EU, the 28 member states of the European Union have agreed, under the Stability and Growth Pact (SGP), to facilitate and maintain the stability of the Economic and Monetary Union. All member states must respect the following criteria:
- (i) An annual budget deficit no higher than 3 % of GDP; and
- (ii) A national debt lower than 60 % of GDP.
In other words, target b is 0.6 and target g + rb — t is 0.03. These criteria are consistent with dynamic government budget constraint if n = 0.05. Namely, a 5 % growth rate is necessary to attain sustainable fiscal management with the EU criteria.