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by Ines Trépant | 25 March 2005
Improving the implementation of the Stability and Growth Pact
Analysis of the main outcomes of the ECOFIN Council’s report (as adopted at the extraordinary ECOFIN meeting on 20 March 2005)
Taking into account the difference of positions between countries in this respect (for instance, France wanted investment in research, aid to poor countries and military expenditure to be excluded from the deficit calculations, while Germany wanted the costs of its 1990 reunification to be excluded), the meeting of the Eurogroup and of the Ecofin managed to reach a compromise, which could satisfy all.
The idea of a list giving details of the "relevant factors" allowing for a flexible interpretation of the Pact was abandoned. Instead, the interpretation of "relevant factors" the Member States can invoke in justification of an excessive deficit higher than but close to 3% of GDP will be based on general and basic principles.
The Commission and the Council will above all take account of the potential growth, implementation of the policies of the Lisbon Agenda, research and development and innovation policies, but also efforts made in times of strong economic growth to improve the quality of public finances and public investment. Attention will also be paid to "international solidarity" and of "European political objectives, notably the unification of Europe if it has a detrimental effect on the growth and fiscal burden of a Member State". Through this formula, German and French requirements are implicitly covered.
Main "features" of the "smarter" Stability and Growth Pact:
What has not changed: The Council confirms that the Stability and Growth Pact is an essential part of the macroeconomic framework of the Economic and Monetary Union. The two nominal anchors of the Pact - the 3% of GDP reference value for the deficit ratio and the 60% of GDP reference value for the debt ratio - continue to be the centrepiece of multilateral surveillance. sanctions maintained in the range of pact instruments; the Commission is confirmed in its role to initiate excessive debt procedure...
What has changed: clarification of the criteria which should be considered as allowing a deficit above 3% of GDP; better take into account specific national characteristics (which comes down to calling into question the damaging "one-size-fits-all approach" which prevailed till now); extra time is given to Member States to come into line with the reference value, etc.
More generally, the main proposals put forward by the Commission, in its communication of 3 September 2004 on "Strengthening economic governance and clarifying the implementation of the Stability and Growth Pact" were maintained.
In brief, the guidelines of the reform are:
Short analysis (see also note written by Jochen Dekinger on this subject in january 2004)
A good way to evaluate the reform of the Pact is certainly to come back to its main flaws:
1. The Stability and Growth Pact was designed as a framework to prevent inflationary processes at the national level. For this purpose, it obliges national governments to follow the simple rule of a balanced budget or a slight surplus. However, experience showed that "simple rules" don’t fit with the complexity of economic and monetary policies.
3. The rigidity of the Pact had much to do with its "one-size-fits-all approach":
4. If the SGP is regarded as a framework that contributes to price stability, it suffers from the weak link between government deficits and inflation. Indeed, as a matter of fact, a negative budgetary position can be caused for instance either by excessive government spending (which can impede on the inflation rate) or a poor growth performance. Arising from that, it makes no sense to sanction countries with weak growth and inflation rates below the ECB’s target.
5. If one can argue that the SGP helps to establish fiscal discipline which could be lacking without such a framework, the most dangerous bias of the SGP is certainly the neglect of macroeconomic requirements in fiscal policy. In this respect, one of the major shortcomings of the Pact was certainly its "inconsistency", since it forced EMU countries to conduct procyclical policies in period of economic recession (e.g. Germany was a case in point, since the respect of the "rationale" of the Pact implied to reduce expenditure and to raise taxes when recession was looming). More generally, the rigidity of the Pact during the downturn worsens recession since it could imply the cutting down of crucial expenditures like education, basic research and investment.
As regards to these major shortcomings, the overall result of the reform of the Stability Pact is positive, since the Member States have opened the way to a "flexible interpretation of the Pact" on the one hand, and have taken into account the new economic challenges facing the EU on the other hand: the fear of inflation and a weak euro is no longer on the agenda, as it was the case in the inception of the EMU. Instead, many countries suffer from weak growth and increasing unemployment.
Among the positive elements introduced by the reform of the Pact, one can point out the following ones:
In conclusion, by allowing a flexible interpretation of the Pact, this one could turn into a better mechanism to foster a more qualitative European economic growth and will definitely be a better tool to ensure economic policy coordination than previously (at least, by reconnecting the GSP to the global macroeconomic framework, economic policy coordination should not be limited to "coordinate" nominal budgetary discipline between countries). With this new Pact, it will be easier to reach the goals set by the Lisbon Strategy. However, one should bear in mind that the reform of the Stability and Growth Pact is not enough to face the issue of growth or employment for instance.
Indeed, if the functioning of the Stability and Growth Pact till nowadays stands among the reasons why the employment policy of the EU has so far been disconnected from its macroeconomic framework, it’s certainly not the only one. In this respect, it needs to be recalled that among others, the monetary policy led by the ECB was not helpful in fostering growth recovery in the euro area. If it can be explained by the statutory mandate of the EBC, which is precisely to maintain price stability, the bank did not seem able to meet the challenge posed on one side by its new capacity to influence global economic variables such as the exchange rate, and on the other by the constraints on fiscal policy in the EMU that leave monetary policy as the only union-wide tool to sustain growth and income.
In short, in order to "reap the benefits" of the reform of the Pact as a means to achieve the goals set by the Lisbon strategy (and more broadly, the goal of "sustainable development"), it needs to be interlinked with other issues, among which the monetary policy led by the ECB and the financial perspectives.