Here is the main message that came out of the December 9 European Council.

*We commit to establishing a new fiscal rule, containing the following elements: **General government budgets shall be balanced or in surplus; this principle shall be deemed respected if, as a rule, the annual structural deficit does not exceed 0.5% of nominal GDP….*

We understand this as the deficit being on average around 0,5% over the cycle and allowing therefore at most deficits around 1,5% (taking into account a 2% output gap and 0,5 elasticity of the deficit to GDP). A substantial shift from allowing at most a 3% deficit to GDP as before.

Think back in time, around 15 years ago. Where did the rules of not exceeding a 60% debt/GDP ratio and a 3% deficit to GDP ratio come from? Well the argument was approximately the following: “we expect nominal GDP growth to be around 5%, 0.05, arising from a realistic 3%, 0.03, of real growth and 2%, 0.02, inflation as accepted by the ECB. With these numbers, the desired steady- state debt-GDP ratio of 60%, 0.6, is compatible with a deficit to GDP ratio, d, of 3%, 0.03. If now d, the highest deficit GDP ratio, changes to 0.015 (1,5%) with the new “austerity Pact”, then a 60% steady-state debt to GDP ratio is reached with approximately a 2,5% of nominal growth. This implies that our Governments have decided to leave in world of either one of the following:

a) 2% inflation and 0,5% growth; b) 0% inflation and 2.5% growth; c) Any combination you might like adding up to 2.5%.

We think scenario a) the most likely to be in the minds of our politicians, also because the ECB, if there is one thing we know, is that it still aims at price stability of a 2% kind.

So here is what happened over the past 15 years. From a Continent that promised it would deliver a 3% average yearly GDP growth, welcome to a new era of 0,5% growth. A total surrender to an age of diminished expectations.