Can the Stability Pact Be Reformed?

The European Commission recently proposed important changes to how the Stability and Growth Pact (SGP) is to be implemented. Now the Commission and ECOFIN (the committee of euro area finance ministers) are reviewing the proposals, as well as others put forward by member states. A decision is expected in the first half of 2005, but how the Pact will be revised remains uncertain.

The need for reform is self-evident: with structural factors accounting for 75-80% of aggregate budget deficits for the euro area in recent years, the Pact’s 3%-of-GDP ceiling for national budget deficits has been breached repeatedly since 2002. Smaller member states, notably Finland and Ireland (as well as Spain) and the two non-euro area countries Denmark and Sweden, have stuck to the principle of fiscal balance or small – though diminishing – surpluses. But the largest European Union members, including the United Kingdom, France, and Germany, have been unable or unwilling to play by the rules.

Indeed, France and Germany barely escaped financial sanctions in November 2003 for their violations of the Pact. Although the European Court of Justice later declared that decision invalid, the impasse remains. So either fiscal behavior or the Pact’s rules must change.

The European Commission’s recent proposals amount to a relaxation of its earlier hard-line stance, providing a catalogue of ways in which the fiscal rules can be made more flexible. But it is difficult to see how this hodge-podge will “strengthen economic governance” or clarify the Pact’s implementation.