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Debate: European Union Stability and Growth Pact

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Does the EU Stability and Growth Pact need reform or abolition?

Background and context

The Stability and Growth Pact was insisted on by Germany to ensure that fiscal policy would not be rapidly eased after short-term manipulation to meet the Maastricht criteria for entry into the euro. In fact, current fears focus on the possibility that fiscal policy is too tight. Government deficits must be kept below a level of 3% of GDP, unless there are ‘exceptional circumstances’, such as a fall of more than 2% of GDP. The enforcement policy is especially criticised, for fines may be levied only after three years of offending, and once voted through by a majority vote of EU member states. In 2002 Romano Prodi publicly termed the Pact ‘stupid’. Portugal breached the deficit limit (at 4.1%) in 2001; Germany in 2002, and France is now unapologetic in saying that it will do so until 2006. The Pact is based on the Amsterdam Resolution of June 1997; and European Council Regulations 1466/97 (for closer surveillance of budgets) and 1467/97 (for swifter implementation of enforcement mechanisms). The resolution is supposed to allow governments to deal with ‘normal cyclical fluctuations’. Members must produce ‘stability programmes’, submitted in 1999 and thereafter annually, which will achieve price stability and growth leading to increases in employment, with plans to deal with fiscal imbalances. Early warning systems are followed by sanctions consisting of ‘a non-interest-bearing deposit of an appropriate size [relative to GDP] … from the participating Member State concerned’ (1467/97) – i.e. a fine of 0.2% GDP, plus ten percent of the excess deficit, up to a maximum of 0.5% of GDP. Only in 1997 and 1998 were the EU countries complying with the Pact’s criteria, with an average of 2.5% deficits. From 1982-96 they were always over 3%. The OECD believes that most recessions need automatic stabilisers (movements in taxation and spending which do not need statutory action, e.g. lower revenues from taxes on business because profits are lower than usual, higher soci

Contents

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Argument #1

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Yes

By attempting to hold down spending in a recession, the Stability and Growth Pact is economic nonsense – increasing instability and impeding growth.

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No

Past history has shown that fiscal indiscipline is all too easily used by governments, for euro entry or electioneering. The Pact makes fiscal policy a matter of economics rather than political gain.

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Argument #2

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Yes

Having lost control of monetary policy to the ECB, automatic fiscal stabilisers are the only way for countries to compensate when economies across the eurozone are out of step. Far more discretion is needed to allow for appropriate short-term adjustment, for the long term impact of too tight a policy is more damaging than short-run borrowing.

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No

Devolving monetary policy to depoliticised central banks has proven to be an economic success. In neither America nor Britain, despite heady predictions, is the economic cycle dead. Over time, the eurozone’s economies are bound to converge, meaning that monetary adjustment is sufficient.

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Argument #3

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Yes

At the time of Maastricht, global fears were of excess inflation; the Pact is not designed for the current risk of deflation which requires fiscal stimulus rather than budgetary tightening.

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No

Inflation will remain a long-term threat; in any case, too much rigour regarding inflation is due to the ECB’s asymmetrical monetary target (it aims to keep inflation below a certain level, rather than within a certain distance above or below a target, as the Bank of England does), rather than to the Pact.

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Argument #4

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Yes

By fudging both euro entry criteria, and through weak enforcement of the Pact, the EU is damaging its economic reputation still more – it would be far better to boldly reform the Pact, which will only become more difficult as time goes on.

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No

The Pact is a vital guarantor of dedication to the euro, and to the fiscal fundamentals which underlay it. Abandonment will endanger the position of the euro on world currency markets.

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Argument #5

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Yes

National sovereignty is harmed by EU intervention into budgets; making it impossible for political parties to guarantee delivery on manifesto commitments on tax and spending, on the basis of which they were elected.

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No

No political party should make rash promises to tax and spend beyond the constraints of sensible economics. The Pact allows for sudden economic shocks (e.g. an oil crisis), which still leaves substantial room for discretion.

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Argument #6

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Yes

The status quo of semi-compliance is the worst case of all, sacrificing both discipline and dignity. This will only become worse when the EU enlarges, placing pressure on countries that need the room for manoeuvre which the Pact fails to provide.

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No

To renegotiate the Pact would require a new treaty, not scheduled until 2005, and this would further confuse new entrants by moving the goalposts. Allowing members to vote on sanctions before their imposition means that flexibility is built into the system.

See also

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