The Stability and Growth Pact: Pros and Cons

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The Stability and Growth Pact: Pros and Cons

1. Introduction

Adopted in 1997, the Stability and Growth Pact (SGP) of the European Union (EU) has been subject to myriad criticisms, which have questioned its effectiveness and sustainability. This paper starts by describing the rationale behind its origination. Section 3 communicates its structure. Section 4 examines the reasons for its reform. Section 5 presents the main leverages and handicaps associated with its implementation. Section 6 concludes. This paper studies how well the SGP fulfills the role of a mechanism that regulates individual fiscal systems of the Member States, as a means of fortifying the European Monetary Union (EMU).

2. Raison d’être

According to Buti and Sapir (2006), Europe experienced two contrasting phases: Golden Age (1945-1973), public finance phase; a theory by Musgrave and the consecutive thirty years (1973-2005), public choice phase, a theory by Buchanan.

During the Golden Age, growth, stability and social unification flourished the region. In the next thirty years, however, growth slowed down, and unemployment rates increased. Escalating public expenditures and large budget deficits caused debt accumulations.

The Maastricht fiscal consolidation process was initiated in 1993 to stop the further deterioration of region’s public finances; however, as the EU started using a single currency with a common monetary policy in 1999, the individual fiscal policies of each Member States were still governed on a national level.

The EU put forward strict prerequisites that members had to deliver in order to be a part of EMU. The outcome of not complying with EU’s exigencies would be exclusion from Eurozone, which no country desired. This partly explains why the fiscal circumstances improved in every single country prior to access to the euro area (Fingland and Bailey, 2008).

The final solution taken by the EU was to set up fiscal consolidation rules to obtain sound fiscal policies, which are a precondition for economic stability, growth, investment and employment. As a result, the SGP was created as a macroeconomic policy that seeks protection of the EU’s common monetary policy and stability of euro, by supervising the fiscal policies of the Member States and correcting those with high deficit and debt levels. (European Commission, 2007)

3. Its constitution

The SGP is composed by the Treaty and Council Regulations and the Resolution of the European Council, along with the Code of Conduct. (Figure 1) (Blyumenthal, 2004)

The fiscal framework of the Pact has two branches: a preventive arm and a dissuasive arm. The former requires the Member States to turn in annual Stability and Convergence programmes, which specify their individual medium-term objective (MTO).

According to the rules of SGP, the MTOs should include a budget that is close-to-balance or in-surplus (Morris, Ongena and Schuknecht, 2006). The rules require that the budget deficit must not surpass the 3% of GDP reference value, and the public debt should be below 60% of GDP.

The stability programmes projected by Member States are examined by the ECOFIN and Commission, which can issue recommendations or warnings to the Council in case of non-compliance. The corrective arm is responsible for making sure countries take adequate actions in case of excessive deficit, and issuing sanctions if the countries fail to do so. (HM Treasury, 2004)

4. The reform

Before the reform, Member States endorsed short-term solutions to their fiscal troubles by taking temporary, one-off measures, which satisfied the numerical requirements of the SGP without actually solving the underlying reasons (Annett, Decressin and Deppler, 2005).

As a result, the reform adopted in March 2005 involves changes in both pillars of the Pact. Countries, instead of remodeling...
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