Managing the European economy after the introduction of the Euro
Managing the European economy after the introduction of the Euro

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Managing the European economy after the introduction of the Euro

1.4 The fate of the Stability and Growth Pact

1.4.1 Nature of the pact

With the advent of EMU and the Euro the question of the SGP embodied in the Amsterdam Treaty of 1997 was raised once again (Linter, 2001, p. 68). This pact is designed to ensure that EU member states’ fiscal policies (involving government taxation and expenditure decisions) do not clash with their monetary policies (or, in the case of the Euro-zone countries, with the monetary policy pursued by the ECB). As we have seen, by and large, the monetary policy pursued by the ECB is the one embodied in the Maastricht Treaty of 1992 – namely to have an overriding concern with controlling inflation – and this has also been the policy objective adopted by all the member states as a result. The only difference between the Euro-zone countries and the other EU members is in respect to the manner in which they might go about meeting this objective. This may differ according to the exact way in which the different financial systems work and the way they are regulated.

Formally at least, under the SGP all EU governments are free to conduct their own fiscal policy, but national budgets are to be controlled by limiting government borrowing to a maximum of 3 per cent of GDP per annum, and keeping overall public debt to a maximum of 60 per cent of GDP. In fact, this latter criterion has never been seriously enforced (Greece and Italy have public debts of over 100 per cent of GDP), though, as we will see, the former has been the subject of fierce dispute. Any breaking of this 3 per cent rule would see sanctions initiated by the European Commission, in its role as the ‘guardian of the Treaties’ (which can take the form of fines of up to 0.5 per cent of the offending country's GDP, imposed by the European Court of Justice (ECJ)).

But the question this raises is: how far is an independent fiscal policy compatible with a common currency and a single monetary policy? Does convergence organised around the Euro sit comfortably with divergence in respect to fiscal policies?

Perhaps rather fortunately, in the run-up to monetary union, there were sharp reductions in the deficits of European governments. In part this was a result of a favourable world business cycle, which made achieving lower deficits easier, but it was also the result of incentives to keep to the rules so as not to be disadvantaged by being excluded from the EMU. This was thought to be particularly the case with Italy and Greece. But, rather bizarrely, Ireland was severely reprimanded in 2001 for what the Commission thought looked like an inflationary inducing expansion as it cut taxes and increased government investment expenditure, even though it had a budget surplus of over 4 per cent of GDP at the time (Alesina and Perotti, 2004). What this indicates however, is that there is a temptation written into the Maastricht Treaty and the SGP for the Commission to try to ‘micro-manage’ the overall fiscal stance of member states (and therefore the scope for their pursuit of independent fiscal policies) in the name of the monetary objective of controlling inflation.

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