Carlo Casarosa's law of change of the wealth to GDP ratio. Implications for the EU fiscal rules

The application of the European fiscal rules was suspended after the outburst of the Covid pandemic and the most recent events related to the Ukrainian war. In the public debate, the restoration of the Stability and Growth Pact should accompany a reform of the fiscal rules to adapt them to the profoundly altered economic environment and to overcome some of their drawbacks. The way that the EU will decide to take will be of particular importance for Italy that, in the ranking of countries with the highest debt/GDP ratio, is second only to Greece. Actually, in the public debate some agreement is emerging on making the debt to GDP ratio the anchor of the new framework. The appropriateness of this variable as an indicator of financial stability is, however, questionable. From a theoretical point of view, growth models point at wealth as the pivot variable; form a practical one, the debt to GDP ratio alone is not a good predictor of sovereign crises. Casarosa (1986) had already criticised the rationale underlying the use of the debt to GDP ratio, based on the argument that the debt to (the demand for) wealth is the proper indicator of the financial situation of the public sector. Against this background, the paper proceeds as follows. Section 2 discusses the economic meaning of the debt to GDP ratio vis-à-vis the evolution of the wealth to GDP ratio along Casarosa’s (1986) contribution. Section 3 looks at the evolution of the debt to GDP ratio in Italy in the last 15 years, confronting it with dynamics of the wealth to GDP and debt to wealth ratios and looks at an indicator of fiscal sustainability based on a normalisation of variables using private wealth instead of GDP. Section 4 concludes the paper in the context of the reform proposals of the European fiscal rules.