The Stability and Growth Pact and Its reforms

The Stability and Growth Pact (SGP) was signed in 1997. Its aim was to prolong control over the public accounts of countries joining the euro club - in the convergence period ensured by the Maastricht criteria on deficits and debts (see Chap. 2) - also for the period subsequent to the euro’s introduction. The pact was adopted because of German pressures; the ‘Growth’ specification is only a formal compensation (required in particular by France), without any real consequence. The general position of the EU institutions was that sound public accounts would guarantee also higher economic growth in the long run.

The provisions regarding the public deficit were that: (i) it should not exceed 3% of GDP apart from temporary and exceptional circumstances (including very deep recessions); (ii) it should converge towards zero in the medium run (the so-called ‘medium-term objective’). Surpassing the 3% ceiling would cause an ‘excessive deficit procedure’, implying stringent requirements on the infringing country, then a zero-interest deposit, and finally a fine (proportional to GDP and to the excessive deficit, with a maximum of 0.5% of GDP). The ‘early warning’ procedure was the preventive arm of the pact: the Eurozone countries should present a Stability Programme3 every year, and the Commission would send recommendations to countries whose accounts were considered at risk.

The difference between the two targets for the deficit - not exceeding 3% of GDP always, and zero in the medium term - was intended to assure some flexibility of the public budget over the cycle.4 During recessions the deficit normally increases, but the 3% margin was considered sufficient by EU institutions for the working of automatic stabilisers (at least in normal recessions). This opinion was disputed by many experts, because in some countries (e.g. the Scandinavian ones) the sensitivity of the public budget to the cycle is greater. Furthermore, they also criticised the choice of the relevant figures5: note that, in stationary state models, 3% for the deficit/ GDP ratio and 60% for the debt/GDP ratio are mutually consistent if nominal GDP growth is equal to 5%. This was not far from the reality in the early 1990s, but certainly not now.6 The rejection, in the pact, of the

‘golden rule’ of public finance, according to which public investment expenditure can be run in deficit, since it is automatically financed in the long run (investment increases growth capabilities and thus generates the tax revenues in the subsequent years), was also stigmatised. A final criticism was that the rules ofthe pact were asymmetric, because there were no incentives to reduce the deficit adequately in good times, that is, during positive economic cycles.

In the original pact, the procedure was that the warning on the infringement of the deficit rule was issued by the EU Commission, but possible penalties would be inflicted by the EU Council (according to a majority vote). This is why in the first decade after 1999, out of about 100 cases of excessive deficit (only in one-third of them was there a large recession), not one country was fined. There was a lively debate when in 2004 the council decided not to inflict sanctions on Germany and France, both of which had exhibited an excessive deficit since the previous year.

In general, it was widely believed that the rules of the pact were too rigid (even the former President of the EU Commission, Romano Prodi, called them ‘stupid’). Hence in 2005, a first reform introduced the following key changes: (i) a longer span of time to reduce the deficit below 3% or to reach the medium-term objective; (ii) a differentiation of the latter objective as a function of the original debt situation (requiring in any case a yearly improvement of at least 0.5% in the structural balance); (iii) various exceptions for the non-application of sanctions (e.g. in the presence of an increase in public investment, the introduction of structural reforms etc.).

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