I. Summary of the paper.

This paper is about the fiscal rules that govern countries in the European Union (EU) and their implications for the countries whitch are candidates for early EU accession. There are likely to be persistent and significant differences among EU members in the growth rates of real GDP and in the rates of inflation, because enlargement will substantially increase the structural diversity of the economies inside the European Union. In this paper is argued that the existing fiscal rules are ill equipped to deal with the increasing economic diversity of EU member countries.

All new EU members will automatically, upon entry in the EU, be bound by the rules of the Stability and Growth Pact (the Pact) and the Broad Economic Policy Guidelines (BEPGs)..

Each EU member state draws up a Stability Programme or a Convergence Programme, which is updated yearly. These programmes are considered by the Commission and Council through a system of ‘multilateral surveillance' designed to ensure consistency with the guidelines and the proper functioning of EMU. This surveillance process provides an early warning system under which the Council can issue a recommendation for actions by the member state to remedy the difficulties identified. In principle, this multilateral surveillance system, required by the Treaty, has a very wide scope.

In this paper are suggested ways of amending and improving the fiscal-financial rules of the Stability and Growth Pact so as to enhance fiscal-financial sustainability and macroeconomic stability.

The likely early addition to the EU membership roll of eight EBRD countries of operation, and a-fortiori the later accession of Bulgaria and Romania and the eventual accession of the remaining South East European countries will, however, increase the importance of addressing the problems that will be encountered when the one-size-fits-all fiscal-financial criteria of the Stability and Growth Pact and the Maastricht Treaty are confronted with the heterogeneous real economic structures of an enlarged EU.

We do not argue that countries with markedly distinct real economic structures cannot all prosper in the European Union. They will prosper, provided proper allowance is made in the design of fiscal-financial rules for marked differences in economic structure. We also do not argue that countries with very difference real economic structures should not join together in a monetary union or that there should be any protracted delay between EU accession and EMU membership for the leading cohort of current accession candidates.

II. Fiscal Sustainability and Macroeconomic Stability in EU.

1.Fiscal-Financial Constraints of SGPand Maastricht Treaty

European Union has settled on an original framework to manage public finances, called the Stability and Growth Pact (SGP). It defines two sets of fiscal rules: (1) the Excessive Deficit Procedure (EDP) according to article 104 of the Treaty, which sets a hard ceiling for actual deficits at 3 percent of GDP, to be exceeded only in exceptional circumstances; it also formulates the softer constraint of a debt/GDP ratio below 60 percent, which may be overshot, provided it subsequently is “sufficiently diminishing and approaching the reference value at a satisfactory pace” Violating theses rules obligatorily triggers off a sequence of corrective measures with the purpose of returning to positions below the ceilings. (2) The Stability and Growth Pact, agreed at the Amsterdam European Council in 1997, specifies the application rules for the EDP aiming to prevent the obligatory need for corrections. Other than procedural regulations and requesting member states to present medium-term Stability Programs for their public finances, it stipulates maintaining cyclically adjusted budget positions “close to balance or in surplus”. Following this second set of rules would provide sufficient space for the working of the automatic stabilizers and would ultimately reduce debt/GDP levels to zero.

In recent years policy makers have become increasingly concerned with the consequences of aging and the issue of long-term fiscal. A low debt ratio should provide the European Union with a sufficient “buffer” against the pressures that population aging will put on government budgets. The Stability and Growth Pact was revised in 2005 to include sustainability concerns into the definition of medium-term budget objectives. The questions, whether the SGP contributes to fiscal sustainability is, therefore, not only of academic interest. With respect to the stipulated fiscal rules, the actual implementation of the SGP has been doubtfully successful.

After signing the Maastricht treaty and the ERM crisis in 1993, significant efforts of fiscal consolidation eliminated the aggregate deficit in the following seven years and slowly lowered the debt ratio. Yet, after the boom year 2000, deficits returned and stabilised just below three percent. It looks as if the Excessive Deficit Procedure has shifted the aggregate deficit ratio of the Eurozone to a permanently lower, but not to a balanced level.

Are the movements after 1996 oscillations on the way to a stable equilibrium or do they reflect random shocks around or on the way to equilibrium? One may argue that in sub-optimal currency area, fiscal policy needs more flexibility across countries. Yet, since the Maastricht Treaty was signed, fiscal policy has become more homogenous. The standard deviation of budget deficits across the Eurozone has had a tendency to fall, although income from mobile telephone licenses sold in 2000 had some asymmetric effects. The debt ratios in individual countries do not reflect a homogenous implementation of the SGP. Portugal, Germany and France have had rising debt/GDP ratios, while in all other countries they have fallen. In 2005, the European Spring Council has relaxed the balanced structural budget rule, authorizing now a structural deficit of 1 percent, given certain conditions. With the natural rate of unemployment being quite high in some countries, this may be justified. But the SGP has remained a subject of controversy. From the beginning, the rules of the pact were subjected to extensive criticism. While it is widely acknowledged that debt sustainability is desirable to preserve the stability of the financial system, most critics have argued that the provisions of the pact are too rigid, impede the growth dimension in the pact and do not sufficiently focus on public debt. The first line of criticism emphasizes the role of deficits in the policy mix, i.e. the interaction of fiscal and monetary policy in maintaining the equilibrium between aggregate supply and demand. Some authors are concerned with asymmetric shocks and regional transfers. Yet, one needs to emphasize that what matters for stabilization policy in a monetary union is the aggregate budget position and not individual country's deficits, because the counterpart to a single monetary policy is overall public sector borrowing. In a large, fully integrated single market with a single currency, regional net spending may affect local demand, but hardly local supply, which may be sourced from anywhere. Thus, local budget deficits are of little relevance for stabilization policy, even in case of asymmetric shocks. Furthermore, the potential disturbance for price stability caused by fiscal policy derives from the aggregate fiscal position (Woodford, 1996). Fiscal policy should stimulate economic activity for the whole Eurozone if resources are underemployed, and it should impose fiscal restraint when production is above potential. By definition, these stabilizing fiscal adjustments are temporary. Permanent or cyclically adjusted budget balances reflect intertemporal preferences for the distribution of tax burden, and here the issue of sustainable debt positions becomes salient. The second line of criticism looks at the sustainability of public debt and resulting risks for the financial system and long term growth. If debt levels are unsustainable, the risk premium in interest rates on government debt augments and the risk of default increases. Furthermore, if the public perceives the debt level to be nonstationary, higher debt/GDP levels imply lower capital-income ratios (less investment) and therefore lower economic growth and lower productivity. Thus, the issue of debt sustainability in Europe is crucial for the long term evolution of economic growth and possibly even for the sustainability of European monetary union itself. However, Collignon and Mundschenk (1999) have argued that participating in European monetary union would strengthen fiscal sustainability, a policy bet that was also made by the Italian government in 1997. While accepting the necessity of the long-term sustainability of debt, some critics argue that governments should have more borrowing flexibility if their debt levels are low. Public authorities should be able to choose how they redistribute the burden of paying taxes for public goods over generations and time. Others emphasize the need to take into account all future assets and liabilities, in particular pension liabilities. The argument then becomes one about the permissible nontransitory deficit, i.e. about the structural deficits, reflecting fundamental choices of intergenerational justice. This raises issues beyond the question whether fiscal policies are sustainable, notably the issue of democracy.

2. Concept of Fiscal Sustainability.

What is a sustainable fiscal policy? No universally accepted definition exists, but scholars agree that an exploding debt is not sustainable. An ever-rising ratio of debt to income would require governments to increase taxes and/or reduce expenditure to service the debt. Such policy cannot go on for ever. So what is an optimal policy? A good starting point for the analysis is the funding constraint:

(1) Gt+ it Dt-1= Tt+ ΔDt+ ΔM t

where G is the level of government spending net of interest payments, T is tax revenue,

i is the interest rate on government debt and D is the stock of public debt. The difference between government spending net of interest and tax revenue is called the primary budget position. Government expenditure on public goods and interest payment to bond holders are financed by taxes, increases in debt held by the private sector and monetized debt held by the central bank. ΔM is the increase in base money. We will assume that the central bank will not monetize government debt, so that ΔM = 0 . Relating these arguments to GDP the funding constraint can be written as:

(2) Δdt≡ dt − dt-1=(rt− yt)dt-1− st

The increase in the debt/GDP ratio depends on the balance between the growth adjusted

debt service and the primary surplus. Equation (2) says that the debt ratio will be increasing indefinitely if the real interest rate r exceeds the growth rate y, unless the primary budget yields a sufficient surplus. We will call the relation of real interest rates to growth the economic environment and the level of the primary surplus the fiscal policy stance. If, but only if, the environment is exogenously given, stability of debt hinges exclusively on the fiscal policy stance. Otherwise, the policy mix may affect long term fiscal sustainability. However, for the sake of simplicity, we will mostly ignore the interdependencies between policy and environment, although we will not assume, as the literature usually does, that the economic environment is stable. Note also that the absolute debt level Dt grows by the amount of the current deficit, which consists of the primary deficit plus nominal interest charges. As a consequence, the deficit/GDP ratio is

(3) deft+1 =Δ dt+1+ (y+ π)dt = (r+π)dt- st+1

with π for inflation rate. If a government borrowed to service the debt, a behavior also known as Ponzi-scheme, the debt ratio would increase until tax payers and bondholders become unwilling to pay. The repudiation of debt may then take the form of outright annulation, monetisation (Sargent and Wallace, 1981) and/or inflation. The sustainability literature has focused on two conditions: a weak solvency constraint whereby the debt-GDP ratio will “eventually converge back to its initial level”. This implies that the debt-GDP ratio is first difference stationary. it fluctuates around a long term constant mean. Asolvency constraint defines sustainability by the maximum level of debt, which governments can sell to bondholders without ever having to repudiate debt. Strong solvency therefore requires weak solvency together with a stationary primary-surplus/GDP ratio. In other words,weak solvency guarantees a stable debt/GDP ratio in the long run (steady state), while strong solvency also requires long-term stability of the policy stance. A well developed literature has sought to assess the time series properties of fiscal variables, including their co-integration. Another way of formulating the concept of sustainability is to say that the public funding arrangements should allow the continuation of a given policy stance into the infinite future without violating solvency constraints.

By rewriting the debt dynamics as:

( 4 ) dt= (1+ rt− yt) dt-1− s

The government can then run a primary deficit in the following year. A surplus is only needed when growth falls below the rate of return on government bonds and the government pursues a debt target. Thus, whether fiscal policy is sustainable or not depends on the sign of the fiscal policy reaction with respect to the target: if an increase in debt is followed by an increase in primary surpluses, debt is sustainable. Bohn (1998) has estimated the US reaction function for the primary surplus in response to a marginal increase in government debt. He finds significant reaction coefficients of the order of 2.8 and 5.4 percent and he concludes that “this provides reliable information about sustainability, regardless of how interest rates and growth rates compared". He recognizes that "permanent primary deficits will lead to excessive debt accumulation in at least some ‘bad' states of nature", noting, however, that “a strictly positive and at least linear response of primary surpluses to the debt ratio is sufficient for sustainability”. The question then is what drives the accumulation of debt and how long does it take to revert? Thus, the key is the fiscal policy reaction function. The excessive deficit procedure of the Maastricht Treaty formulates a fiscal policy rule. Does it assure European public finances of sustainability?

3.Conditions for Sustainable Fiscal Policy

By using (2), (3 and we can formulate a system of two simultaneous linear difference equations, rewritten in continuous time form as

(5) d'=(r-y)d-s

s'=(α(r+π)+ β)d- αs-z

Where the prime indicates the time derivative and the constant z =αz1+ βz2. Solving the difference equations for d(t) and s(t) will give us the time path of the debt ratio and the primary budget position. If these two time paths converge to a pair of inter-temporal equilibrium values, the fiscal policy is strongly sustainable, regardless of the intermediary adjustment dynamics. These equilibrium values are given by the solution for the particular integrals:

(6) d=__z______

α (y+π)+ β

(7) s=__(r-y)z______

α(y- π)+ β

If public finances are (strongly) sustainable, the debt-GDP ratio converges to a stationary position that is determined by the nominal growth rate, the reference values and the adjustment parameters. The steady state primary surplus equals the growth adjusted debt service on the steady state debt. We assume that the reference values and the reaction coefficients are structural values determined by the political system. Yet, given that interest and growth rates vary over time, the steady state debt ratio is not constant. As European nominal growth rates have fallen in the 1980s, 90s and early 2000, the implicit steady state debt ratios have risen. Note that this effect is independent of actual budget policies, as the reaction coefficients αand βreflect medium to long term behaviour. The rise in the steady state level reflects the transversality condition in a time-varying macroeconomic environment. If we drop the ad hoc assumption of a stable economic environment, a change in the equilibrium debt level is required to compensate for the change in the discount factor ( see equation 3). Equation (6)reveals another interesting fact. If we set α=0 and only focus on the debt response factor β>0, the equilibrium debt ratio becomes identical with the debt target. Thus, the sustainable debt ratio is arbitrary, like the Mastricht 60 percent, but if one took the reaction function responding to changes in debt, as estimated by Bohn for the USA, the steady state would always be the debt ratio realized in the previous period. Such a rule would turn sustainable debt into a random walk. It is of course, possible that U.S. authorities have an implicit debt target to which they respond. In the Europea case, the target was made more explicit by the Maastricht provisions. Second, if β=0, the steady state for debt reflects the ratio of the deficit target to

the nominal growth rate, which is 60% under the assumptions of the “Maastricht numerology”. But if β>0, the steady state for the debt is lower. Note also, that if 1 z =0,

as implied in the medium term rule of the SGP, and if β=0, the steady state debt ratio

and primary surplus are both zero.

4.Stability Conditions

Next, we need to determine the conditions for the debt and primary surplus ratios to converge to the steady state. This convergence is more rapid if it proceeds in a monotonic fashion; it is slower, if the time path oscillates periodically in its convergence to equilibrium. This distinction may be politically relevant. In the periodic case, the debt ratio may temporarily rise without reflecting a lack of sustainability. For example, we observed that the debt ratio in France and Portugal has risen above the steady state. Does that mean that fiscal policy in theses countries is unsustainable? To judge this, we need to establish the conditions under which convergence occurs either periodically or monotonically. If it were periodic, fiscal policy may still be sustainable, as it will return to equilibrium in the future. Solving the dynamic system (5)for the homogenous part yields the following condition for sustainable financial policies (for the formal proof, see Annex):

Proposition 1.

Given the policy system (5) and assuming α=0, a sufficient condition for

the debt ratio's convergence to the steady state isβ > (r − y)2 .

Proposition 2.

Given the policy system (5), and assuming β=0, a sufficient condition

for public finances to be strongly sustainable is

α > max {r − y, (√r +π − √y +π )²=αmin

This implies:


αmin= r − y is the sufficient condition if r>y


αmin =(√r +π − √y +π )² is the sufficient condition if r<y

Proposition 3.

The time path of convergence to the steady state can take three forms

given the value of α :


Periodic case: Damped convergence is obtained if:

min α <α < r +π + y +π


Critical or aperiodic case: The critical condition for switching between cyclical

(pseudoperiodic) and monotonic convergence of the debt ratio's path to the

intertemporal equilibrium is α = r +π + y +π .


Monotonic case: The necessary and sufficient conditions for rapid convergence

are: α > r +π + y +π .

These are important results. They prove, first, that the short term fiscal policy reaction function is sufficient to ensure long term debt sustainability. No need for simplifying ad hoc assumptions, long-term forecasts of all future net liabilities, intergenerational accounting, etc. Long term sustainable fiscal policy is always made in the here-now. Second, sustainability requires fiscal policy to adjust to changes in the timevarying economic environment. If the growth-adjusted real interest rate increases, higher primary surpluses are necessary to meet the minimal constraints and fiscal policy may have to tighten unless the reaction function coefficient α is already larger than the minimum. This could create a pro-cyclical bias when the growth slow-down is caused by a negative demand shock. But if there is a significant safety margin by which α exceeds min α , the year-by-year fiscal policy can accommodate shocks without having to sacrifice sustainability. Third, it matters what interest rate we use. Because the government collects taxes from bond holders, one should use the after-tax interest rate. Because tax rate data are notoriously unreliable and only with difficulty comparable, I have mostly used pre-tax interest rates in the empirical part of this paper, although I have also calculated an after-tax growth adjusted real interest rate, based on average tax rates over the last 5 years. This gives a conservative bias to our assessment of sustainability. However, with respect to after-tax rates it is also apparent that fiscal consolidation is more efficient for sustainability if it is tax-driven. An increase in the tax rate will simultaneously increase revenue and lower the post-tax interest rate, while a cut in government spending will only affect the primary surplus.

III. Fiscal Sustainability and Macroeconomic Stability.

(Case of Albania)

Fiscal sustainability has drawn increased attention in transition countries, recently. Indeed,

almost all transition economies as like as Albania, have experienced large deficits in both balances since the start of the transition process. On one hand Albanian economy collapsed, prompting the government to adopt an expansionary fiscal policy in the form of increased expenditures (to build up social and physical infrastructure) and extended tax incentives to encourage investment. Moreover, fiscal deficits expanded as government tried to absorb the revenue and expenditure pressure associated with the sharp falls in GDP and fiscal restructuring. Consequently, a substantial increase in the public debt/GDP ratio has emerged in the region. Moreover, a stable public finance is an explicit criterion for many transition economies' eligibility for Economic and Monetary Union (EMU). The most common way of assessing a given economy's fiscal position is to analyse fiscal sustainability, where the ‘sustainable' level of the fiscal imbalance was that level consistent

with solvency, i.e. satisfies the criterion that the total public debt to GDP ratio should not increase. In 2001 a regular economic fiscal surveillance procedure was established for the candidate countries. It aims at preparing countries for the participation in the multilateral surveillance and economic policy co-ordination procedures currently in place in the EU as part of the Economic and Monetary Union. The Pre-Accession Economic Programmes (PEPs) are part of this procedure. The PEPs have developed, since their start in 2001, into increasingly important platforms for the authorities to develop and communicate appropriate economic, fiscal and structural policies over the medium term, consistent with their EU membership aspirations. For this reason a similar, though slightly reduced, exercise was started in 2007 with the potential candidate countries, with the submission and assessment of annual EFPs as important element. The EFPs have two objectives: first, to outline a medium-term policy framework, including public finance objectives and structural reform priorities needed for EU accession; and, second, to offer an opportunity to develop the institutional and analytical capacity necessary to participate in the Pre-

Accession Fiscal Surveillance Procedure and eventually, in the long-term, in EMU with a derogation in regards to the adoption of the euro upon accession, particularly in the areas of multilateral surveillance and co-ordination of economic policies. The development of the institutional capacity to co-ordinate between the various ministries, government agencies and the central bank is a particularly important aspect ensuring the success of the Economic and Fiscal Programmes. The Economic and Fiscal Programme (the EFP 2007) covers the period 2007-2010 presenting the medium-term framework of economic and fiscal policies in Albania. Recent macroeconomic developments have been broadly favourable, with relatively strong economic growth of 5.5% annually in 2006, and fairly moderate inflation at around 3%. The general government deficit was kept below 4% of GDP in 2006; the public debt ratio has decreased. In 2009- 2011 the fiscal balance is projected to improve only gradually, the deficit amounting to close to 4% of GDP. The structural and institutional reform agenda of the programme is adequate, corresponding to the criteria listed in the European Partnership with Albania.

The fiscal framework of the programme is well integrated in the overall policy objectives and soundly based on the presented medium-term economic framework. The programme does not mention possible relations of its objectives with the Progress Report assessment or European Partnership priorities. The presented framework is coherent, consistent and relatively comprehensive, and to a large extent also influenced by the current IMF programme. The key measures on the revenues and expenditure side are well explained but not supported by quantitative estimates. The envisaged budgetary development is oriented to improving fiscal balances (except for the one-off effect of a largescale

infrastructure project in 2008). Fiscal risks are insufficiently analysed, with only some risks

identified as being low (a more accurate account of risks is provided in the public debt section). The fiscal strategy foresees public revenues to increase slightly relative to GDP, with a decreasing role of the profit tax and customs revenues. General government expenditure is projected to remain at the level of 31% of GDP except for 2008 when a large-scale one-off infrastructure project is planned. The general government budget deficit is projected to increase to 7.9% of GDP (recently revised to 5.2%) in 2008 and thereafter to decrease to below 4% of GDP in the following years.Public debt is projected to reach 56% of GDP in 2008, decreasing to 52% in 2010.

Preliminary estimates suggest that the deficit remained below 4% of GDP in 2007 mainly due to underspending in capital expenditure. The budget revenues are projected to be 1.1 percentage points of GDP higher compared to the 2006 EFP. Higher revenues were supported by the introduction of the flat tax system on personal income and higher excise tariffs on fuels and alcoholic drinks, changes effective from 1 July 2007. Customs revenues are projected to decrease due to lowering the customs tariff to zero on imported vehicles, but also due to a reduction of customs duties resulting from WTO and SAA commitments. Additionally, changes were introduced in national taxes and local taxes, the net effect of which is projected to remain modest on the budget in 2007. The budget expenditures are projected to increase somewhat less than the revenues, the main increasing components being higher expenses on personnel and on social and health insurance compared to the 2006 EFP. The capital expenditures are also projected to increase modestly, affected by the newly introduced procedures of public investment. Changes in the public debt management are projected to decrease expenditures on interests of domestic debt in 2007. The impact of a large one-off government subsidy to the national power utility is not discussed in the programme; the effect is expected to remain below one percentage of GDP. Overall, the programme lacks ambition as the margin of manoeuvre gained from increases in revenue is being used mainly to increase expenditure and only marginally to reduce the deficit. For 2008, a further sharp deterioration of the fiscal balance is projected. The government budget deficit forecast for 2008 is 7.9% of the projected GDP in the 2007 EFP (recently revised to 5.2%), coinciding with the approved government budget for 2008. Budget revenues (as a ratio to GDP) are projected to remain at a level comparable to 2007 (26.4% of GDP, see Table 2), affected mainly by the reduction of profit tax (effective from 1 January 2008). The lower tax rate aims at extending a taxable basis and creating a more favourable business environment. Temporarily lower profit revenues are projected to be compensated by increased excise duties and higher local tax rates (effective since 2007), as well as improving revenue collection. Also, planned privatisations are expected to reduce revenues from public enterprises. For 2008, the expenditures are foreseen to increase by 2.8 percentage points of GDP to 34.3% of GDP mainly due to planned large scale infrastructure projects. According to recent information the government is now committed to cut down planned investments in 2008, in order to achieve a significantly lower fiscal deficit. In parallel, the EFP foresees that current expenditures will decrease slightly relative to GDP, as personnel costs and social and health care insurance costs are projected to return close to the level of 2006. Policy changes of reducing subsidies and increasing expenses of the local government, as a result of continuous decentralisation process, are expected to have relatively low impact on the consolidated budget. Infrastructure projects are planned to be financed partly by loans. The government budget for 2008 is consistent with the planned one-off surge in capital expenditures. Increasing financing needs are foreseen to be covered mainly by foreign borrowing (public debt increasing by 2.55% of GDP). The projected increase in public investments is foreseen to be virtually neutral to domestic demand as large-scale infrastructure projects are being mainly implemented by foreign companies. The experience of recent years however raises doubts on the government capacity to implement such increases in projected public investments, and lower expenditure outcomes are not excluded. Additionally, the plan to reduce subsidies is ambitious. In order to reduce the need for government support in public enterprises, the latter need to have a development strategy based on increased self-financing. An action plan is urgently needed especially in the case of the loss making power utility, notably by increasing tariffs to cost-recovery levels. In the 2008 adopted budget current expenditures are relatively contained, but in view of elections in 2009 the government will also need to resist to pressure to increase them. On the revenue side the tax administration needs to be strengthened further in order to ensure the projected collection. Public revenues also remain largely dependent on the overall economic performance, requiring a credible and sustainable policy mix. In 2009-2010, the government expects to reap the benefits from a number of policy measures. The revenue collection is expected to improve and expenditures are projected to return down to below 2007's level (as a ratio to GDP). The budget deficit is expected to be reduced below 4% of GDP, with revenues reaching 27% of

GDP and the expenditure down to 31% of GDP. After the expansionary stance of 2007-2008, the government will need to come back to a more conservative fiscal policy and continue with structural reforms in order to promote a favourable business climate. The above-listed risks apply also in 2009-2010. Fiscal risks are only briefly discussed in the submitted programme. The revenue risks of noncollection of taxes and the uncertainty of the recovery of profit tax revenues are considered to be low. Regarding the uncertainty of success of the respective reforms, the risks may be underestimated. Risks on the expenditure are not discussed.

The public debt ratio is projected to fall gradually except for a one-off increase in 2008,reaching 52.4% of GDP in 2010, from 53.6% in 2007. This declining trend is due to a lower increase in net borrowing compared to the foreseen GDP growth. Privatisation revenues are expected to decrease considerably after a peak in2007, lowering to below 1% of GDP in 2009- 20101, therefore the deficit will have to bemainly financed through public borrowing. Exchange rate risks to the public debtmanagement are relatively low as 70% of the debt is denominated in domestic currency and 30% in foreign currency. The 2007 EFP foresees an increase of the share of the external debt compared to domestic debt, which may increase exchange rate risks, although it may reduce interest rate risk, as mentioned in the programme. Interest rate volatility risks are also foreseen to be reduced by increasing the share of long-term domestic debt (from the current 30% to 67% in 2010, relative to total domestic public debt).


European Union has settled on an original framework to manage public finances, called the Stability and Growth Pact (SGP).

There is a need for the EU and ECB to present to the public a clear conceptual framework to motivate and explain the concepts of fiscal sustainability and excessive deficits, and to relate these fundamental notions to concrete quantitative fiscal-financial objectives (which could be time- or state-contingent) and to specific policy actions or rules.

In recent years policy makers have become increasingly concerned with the consequences of aging and the issue of long-term fiscal.

The Stability and Growth Pact was revised in 2005 to include sustainability concerns into the definition of medium-term budget objectives.

In sub-optimal currency area, fiscal policy needs more flexibility across countries. Yet, since the Maastricht Treaty was signed, fiscal policy has become more homogenous.

Fiscal policy should stimulate economic activity for the whole Eurozone if resources are underemployed, and it should impose fiscal restraint when production is above potential. Thus, the issue of debt sustainability in Europe is crucial for the long term evolution of economic growth and possibly even for the sustainability of European monetary union itself.

Fiscal sustainability has drawn increased attention in transition countries, recently. Indeed, almost all transition economies as like as Albania, have experienced large deficits in both balances since the start of the transition process.

In 2001 a regular economic fiscal surveillance procedure was established for the candidate countries. It aims at preparing countries for the participation in the multilateral surveillance and economic policy co-ordination procedures currently in place in the EU as part of the Economic and Monetary Union. The Pre-Accession Economic Programmes (PEPs) are part of this procedure.

The Economic and Fiscal Programme (the EFP 2007) covers the period 2007-2010 presenting the medium-term framework of economic and fiscal policies in Albania.

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