Abstract
This paper aims to review the performance of the Stability and Growth Pact through a comprehensive analysis of the policies that were introduced with its implementation.
The Stability and Growth Pact is an agreement among the member states of the European Union, that was created in order to maintain the stability of the Economic and Monetary Union. Since its conception, the EMU has been subject to controversy. The fiscal policies imposed by the Maastricht Treaty, which were clarified in the Stability and Growth Pact are fiercely debated, some believing that the regulations were too strict, while others deeming them inefficient. The Maastricht Treaty was imposed in 1992 and it set certain regulations regarding the level of inflation, interest rates, controlled public debt and spending. In 1997, the SGP complied with the decisions stated that similar regulations should be imposed as soon as the euro is launched.
Introduction
After the successful implementation of the EMU in Europe, along with other fiscal measure, such as the introduction of the euro in 1999, the member states were greatly affected from the point of view of conducting economic policies. These fiscal reforms had now to provide balance and try to reduce asymmetric shocks and achieve price secureness. These objectives are very important in the process of development of small countries, because they require flexible fiscal policies. Many scholars have argued that the reforms imposed with the implementation of the SGP would eventually lead to the change in the processes of the automatic fiscal stabilizers, thus creating procyclical discretionary fiscal policies. However, Gali and Perotti (2003) argue that this resulted in quite the opposite: the discretionary fiscal policy imposed by EMU had actually a countercyclical effect right after the signing of the Maastricht Treaty in 1992.
The EMU is based on a common market system of goods and services which is necessary in order to achieve a proper in the common market, so the fluctuation of the exchange rates between the member states won’t interrupt the natural flow of trade and investments. In other words, one market and one currency. Through this measure, the states have abandoned their economic sovereignty in order to acquire the benefits that EMU provides. The role of the agreement was to ensure that the fiscal discipline will be enforced and maintained. The regulations of the EMU reflect its multinational nature, as well as the lack of political authority of the Federal Bank.
The Maastricht Treaty played an important part in the development of the EMU. It was the first treaty that created the framework of the later Delors Report, which intended to introduce the concepts of ‘learning throughout life’ and the ‘four pillars of learning: to know, to do, to live together’. The report was not created as a plan for an educational reform, but rather as a basis for reflection and debating whether changes should be made in the process of formulating and applying policies. Not only did the Maastricht Treaty set out the convergence criteria for qualifying in the EMU, it also built the framework for the European Central Bank (ECB).
Although the EMU resulted from the outcome of a negotiation between France and Germany, its outline is just German, which can be confirmed by analyzing its convergence criteria. The Maastricht reforms represent a compromise between the monetarists and the economists on the issue of European integration
The main purpose of the EMU is to achieve price stability. According to this goal, in order to maintain a stable currency, balanced public finances are required. This belief is solely based on the fear that rising public debts would decrease the ability of banks to maintain price stability, thus leading to hyperinflation, similar to what happened in 1920s in Germany and in Austria that led to the disaster of World War II (Hagen, 2003) The main cost of the monetary Union is the loss of a policy tool, namely the independent exchange rates. They were used to protect economies from diversified economic conditions; for example, one member state registers an economic growth, but another is facing a recession. These different economic fluctuations are called as asymmetric shocks. (Hix, 1999).
The Stability and Growth Pact (SGP)
The main problem with the Stability and Growth Pact is that it locks in a particular mix of monetary and fiscal policies, whereby the ECB pursues a restrictive monetary policy (as defined by the price stability goal in the treaty), while national governments are forced to pursue restrictive fiscal policies (government budgets must be close to balance or in surplus) (Hix, 2002).
In order to comprehend the objectives of the SGP and the correlation between it and EMU, it is mandatory to examine the asymmetric shocks; they can be part of various mechanisms, such as: the labor mobility, wage and capital flexibility, fiscal transfers and budget deficits. The asymmetric shocks can be also examined through the process of devaluation (or revaluation) of a certain currency; this can be achieved through low or high interest rates. However, in a monetary union this is impossible, because the exchange rates are fixed. One solution to the problem of asymmetric shocks are the fiscal transfers.
Given the permanent aspect of monetary union, certain rules were required to govern the area of public finances throughout the member. To ensure that all member states kept the domain of public finances healthy and productive, which was necessary for the euro to achieve stability, the SGP was developed; it imposed reforms that provided continuity after all of the economic criteria from the Maastricht Treaty were implemented.
Because the euro is a supranational currency, the EU needed to implement rules that are beyond the Maastricht convergence’s policies, in taxation and government expenditure. These needs were partly addressed with the implementation of the Excessive Deficit Procedure, but shortly after it was deemed as vague and unnecessary.
A more comprehensive set of procedures capable of handling excessive debts was proposed in the mid-1990’s in Germany; the country had maintained its policy, which encouraged low inflation; this played an important role in the performance of the German economy. The government wanted to ensure the continuity of that policy, which would limit the ability of any government to deploy inflationary pressure on the European economy. This policy was justified, because the excessive debt cannot be financed through public markets and can lead to financing by the central banks. Moreover, the problem of debt-ridden countries that could overspend to a point where they would demand financial support from other countries still exists. Two council resolutions implemented in July 1997 thoroughly described how procedures against excessive deficits would operate under the SGP.
The Finance Committee of the council decides whether a member state has an excessive shortage if its annual government deficit exceeds 3 per cent of GDP, unless there has been a severe economic downturn or an unusual event has occurred which is not in the control of the member state. Afterwards, the council offers recommendations to the concerned member state; a deadline is established (typically four months) for corrective action to be taken, which normally means that the deficit should be eliminated in the year after its identification. If the member state fails to comply after it has received a notice, the Council can decide to impose sanctions, at the latest of ten months after the reporting the deficit. Sanctions usually mean a non-interest deposit with the Commission. The deposit is composed of a fixed constituent, equal to 0.2 per cent of the GDP and a variable that is linked to the deficit, depending of its size. If the country still fails to comply, the council will simply intensify the sanction by requiring an additional deposit. However, the annual amount must not exceed 0.5 per cent of the GDP. This deposit may be converted into a fine if the excessive deficit has not been corrected after more than two years.
The council can decide to abrogate the sanctions, depending on the progress that the member state has made. Unfortunately, the fines that were already imposed are not reimbursable.
Disadvantages of the SGP
SGP places a severe constraint on any member state that is running a large enough deficit that might threaten the stability of the euro. Most of the time, a political decision is needed to impose various sanctions. The main problem with the SGP is that if an asymmetric shock occurs, because of the rules imposed by the pact, the government, being unable to run under a budget deficit, has to find another method of gaining money. Either it will cut certain expenditure programs or it will raise taxes. This will be a major problem, since a state that finds itself at the bottom of an economic cycle will not be able to raise taxes. It will only decrease the competitiveness of the economy because the production and wage costs will certainly increase. Also, raising taxes will decrease the current reserve of money that is out of circulation, consequently creating an even bigger economic crisis.
National governments are forced to engage in these restrictive fiscal policies in order to keep the funds in equilibrium. These policies have proved to be anti- inflationary, but there is a high chance that they will be impractical and unpopular in the member states that experience low levels of growth.
Through divergent cycles, the interest rates that have been set up by the ECB are going to be higher than those required by a state that finds itself the bottom of an economic cycle. In this case, the state will not have the ability to borrow money in order to overcome the present economic crisis. Additionally, because of the harshness of the monetary policies that the EU impose, states are highly unlikely to introduce any form of structural rectifications.
The EMU would work more efficiently if the states would reform their labor markets. However, structural reforms would produce another problem, which is high unemployment in the short run. Consequently, the public would certainly not support such policies, unless they were balanced with some sort of monetary reforms to help stimulate the economic growth.
Many of the contradictions regarding this policies within EMU came to surface in 2003, when the French and German governments wanted to borrow money in order to resolve the problem of steadily rising unemployment combined with a slowing economy, knowing that raising taxes or introducing labor market reforms will not constitute feasible solutions. Through and increase in borrowing, the governments quickly exceeded the 3 per cent annual deficit criterion stated in the SGP. However, France and Germany were able to secure the support of many member states which concluded with the excessive deficits procedure being suspended. The commission was shocked when hearing that the member states will actually support Germany and France, which meant a complete abandonment the SGP. The decision of the commission was to take the case to the European Court of Justice.
Corrections applied to the SGP
In 2005, as a result of the pressure imposed by France and Germany, the EU Council decided to relax the rules. To respond to the criticism, the Council simply stated that there was insufficient flexibility, and these changes will ensure that the pact will be more enforceable. Thus, ECOFIN maintained the SGP regulations that were previously imposed, which stated that the budget deficit should not exceed 3%, as well as 60% for the public debt. What has changed is only the criteria by which a country is declared to be on excessive deficit.
In 2011, after the European sovereign debt crisis, the member states imposed a new reform under the premise of coordination, which meant to nourish the rules, through harsher penalties in case of infringing the debt regulations.
Afterwards, the new Euro Plus Pact was designed as a more rigorous version of the SGP. The measures that were imposed are highly controversial, because of the abstract way in which it was developed, and also the goals that it implied. The primary goals of the EPP were: fostering competitiveness and employment, contributing to the sustainability of public finances and reinforcing the financial stability. primary balance and expenditures at both national and sub-national levels. Additionally, the European Financial Stability Facility (EFSF) was developed by the euro member states. The EFSF’s purpose is to assure the financial stability in Europe by providing assistance to the states, through various macroeconomic adjustment programs. Basically, the EFSF was just a temporary rescue mechanism.
Conclusions
The sovereign debt crisis that affected the euro area is just a manifestation of various policy failures combined with a high rate of deficiencies. The EMU was not able to function in to the asymmetric economic cycles, especially after the beginning of the crisis from 2008. Many analysts argued that the problem with the monetary union was the absence of economic policy coordination.
The review has clearly shown that the GSP presents some disadvantages, especially in the areas of investment and financing; the lack of asymmetric incentives and lack of any long-term views
References
‘ Hix, S., (1999), ‘The Political System of the European Union’ European Union Series. New York: St. Martin.
‘ Hix, S., (2002), ‘A constitution for the EU: a comparative political science perspective’, Collegium (23).
‘ Fata”s, A., Hagen, V. J., (2003), ‘Stability and growth in Europe: towards a better pact’, London: Centre for Economic Policy Research.
‘ Buti, M., Eijffinger, C., and Franco, D., (2003), ‘Revisiting the Stability and Growth Pact: grand design or internal adjustment’. Brussels: European Commission. Directorate-General for Economic and Financial Affairs.
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