New rules to underpin the Euro

THE ONGOING Stability and Growth Pact saga appears to be over…for the time being anyway. Against the odds, EU finance ministers were finally able to reach a deal on reforming the Pact, which is considered by many to be the key plank of EU economic stability.

A short history

A stipulation in the Maastricht Treaty stated that countries participating in European Monetary Union must lower their budget deficits to no more than three per cent of gross domestic product (GDP). To ensure there was no backsliding once countries had qualified, the now infamous Stability and Growth Pact was established in 1997, decreeing that under normal circumstances no participating country’s deficit can exceed three per cent of GDP. To enforce the rule, any country breaching this ceiling could face sanctions unless there are exceptional circumstances.

For the past three years, France and Germany have breached the three per cent rule, but managed to thwart European Commission attempts to sanction them. Greece has also breached the limits, but got away for a while thanks to some clever accounting.

Many countries have argued that the Pact was put into place when economic growth was stronger. They said greater flexibility was needed to increase spending in difficult economic times. France and Germany were the strongest supporters for reform, while Italy called for more “intelligent” rules. On the other hand, the smaller States strongly opposed any changes.

The Pact was suspended last November and, since then, finance ministers have been busy trying to negotiate reforms. Focused talks in March did not go well initially and it appeared likely that the Pact would remain unchanged.

The main sticking point was a debate over what factors should be considered when deciding whether to punish a country in breach of the rules. But, after 12 hours of emergency talks, a deal was finally reached and stamped by EU leaders a few days later.

The new Pact

The three per cent of GDP limit remains in place. No excessive deficit procedure will be launched against member states experiencing negative growth or a prolonged period of low growth.

States recording a “temporary” deficit close to the three per cent limit can refer to a series of “relevant factors” to avoid an excessive deficit procedure. These include potential growth, the economic cycle, structural reforms (pensions, social security), policies supporting research and development, and medium-term budgetary efforts.

Leeway will be given where countries spend on efforts to“foster international solidarity and to achieving European policy goals, notably the reunification of Europe”.

States now have two years to correct an excessive deficit. This deadline may be revised and extended in cases of “unexpected and adverseeconomic events with major unfavourable budgetary effects occurring during the procedure”. Countries must show proof that they have adopted the recommended correction measures.

Member states have committed to using unexpected fiscal receipts during periods of strong growth to reduce their deficits and debt.


Juncker: The deal does not change the fundamental basis of the Pact, which is still aimed at maintaining the stability of the Euro. The new pact will be credible, putting pressure on EU members to consolidate their budgets during upswings, while giving more room for manoeuvre in downturns.

European Central Bank: It is “seriously concerned” about the changes to the fiscal rules, saying they could weaken budgetary discipline in Europe. It hinted that interest rates may have to rise as a result: “The (ECB) governing council remains firmly committed to deliver on its mandate of maintaining price stability.”

Bundesbank: The Pact’s rules have become more complicated and less transparent.It expressed fears about the backdrop against which future monetary policy decisions will be taken.

German industry leaders: “Our children and grandchildren will have to pay the price for the failure of politicians to look after the money they were trusted with.”

German Finance Minister, Hans Eichel: He was delighted that the costs of German reunification could be taken into account as aspecial circumstance. He spoke of a “new start”.

Gordon Brown, Chancellor of the Exchequer: The new rules will make it difficult for a Labour government to join the Euro. “We insisted that we would not allow the UK’s plans for investment in the long-term growth of our economy to be undermined or jeopardised by new Commission guidelines or rules.”

Bank of England: “In the long run, it is difficult to imagine monetary union being successful without genuine cohesive fiscal discipline. We are seriously concerned, indeed dismayed would be a better word, at this turn of events.”

European Association of Chambers of Commerce and Industry: “The review of the Pact should be based on economic objectives and principles. Instead, political considerations seem to be the decisive factors.”

Stockmarkets: There was no reaction from the markets, but economists warn the effects may be felt in financial markets when governments draw up public spending and tax plans for the years ahead.

Is the Stability and Growth Pact saga over? I suspect it may rear its ugly head again. It clearly has not been well received by everyone. Also, as the rules stand, member states must submit “relevant factors” when requesting a reprieve from an excessive deficit disorder, and this will be given “due consideration” by the Commission and Council. We may well be in for some more debate when these rules are called into question in the future.

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