The Stability and Growth Pact

Table of contents

Table of  contents  2

  Abbreviations  4

1  Introduction European Monetary Union: from the Treaty of Maastricht  

  to the Stability and Growth Pact  5

1.1  The Treaty of Maastricht  5

1.2  The Treaty of Amsterdam  5

1.3  Three Steps to the formation of an European Monetary Union  6

1.4  Criteria of Stability and Convergence Selection of Member States for the  

  Single Currency  6

1.5  From the criteria of stability and convergence to the Stability and Growth  

  Pact  7

1.6  Legal framework of the Stability and Growth Pact  8

2  New monetarism The Economic background of the Stability and  

  Growth Pact  9

2.1  Essential features of new monetarism  9

2.1.1  Irrational decision making  10

2.1.2  Debts as an expression of mislead fiscal policy  10

2.1.3  Inflation  11

2.1.4  The future role of fiscal policy  11

3  Mechanics of the stability and growth pact  11

3.1  The budgetary rules of the Treaty of Amsterdam as basic principles for the  

  SGP  11

3.2  The budgetary rules of the SGP  12

3.2.1  The government budget deficit rule  12

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3.2.2  The medium-term balance rule  13

3.2.3  Why 60 and 3  13

3.3  The implementation of the Stability and Growth Pact  14

3.3.1  Stability Committee  14

3.3.2  Formulation of national stability and convergence programs  14

3.4  Enforcing the SPG The excessive deficit procedure  15

3.4.1  Early warning system to avoid excessive deficits  15

3.4.2  Penalties for Breach of Stability Pact Criteria  16

4  Assessment of the SGP a look on the relevant indicators of the  

  membership states of EU Germany and of those countries joining the  

  EU on May 1 st 2004  18

4.1  Development within the EU  18

4.2  Development in Germany  18

4.3  Development in the acceding countries  19

5  Conclusion  20

6  Appendix  22

6.1  References  22

6.2  Figures  27

6.3  Tables  29

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Abbreviations

  Art. Article  

  ECB European Central Bank  

  ECOFIN European Council of Finance Ministers  

  EU European Union  

  EMU European Monetary Union  

  EUR Euro  

  GDP Gross Domestic Product  

  OECD Organization for Economic Cooperation and Development  

  p. page(s)  

  ref. refer to  

  SGP Stability and Growth Pact  

  w/o without  

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1 Introduction - European Monetary Union: from the Treaty of

Maastricht to the Stability and Growth Pact 1

1.1 The Treaty of Maastricht

In December 1991 at a summit in Maastricht the twelve nations, which constituted the European Community at that time, agreed on a treaty to transform the European Community into an European Union (EU). This Treaty was signed 1992 and came effective on November 1 st of 1993 as an amendment to the treaty of Rome, the treaty the European Community was build on.

1.2 The Treaty of Amsterdam 2

Four years later the treaty of Amsterdam put the treaty of Maastricht into more concrete terms. The contracting parties agreed in Article B of this treaty that the Union will set itself (among others) the objective to promote economic and social progress through the establishment of an economic- and monetary union (EMU), ultimately including a single currency. Under title V and VI of this treaty the countries also agreed to build up common, foreign- and security policies as well as to intensify their cooperation in fields of justice und home affairs. Title VII defines the ideas of a common economic and monetary policy. The treaty of Amsterdam was signed on October, 2 nd 1997. Since all the Member States had to ratify the treaty by their respective legislative procedures, it did not come into effect until the end of May 1999.

The European treaties, taken together, form the primary legislation and have characteristics of a constitution of the Community. The treaties provide the legal basis for all secondary legislation, i.e. regulations, directives and decisions of the institutions of the Community.

1 Peichl, Andreas (2003), p. 1-3.

2 Cowgill, Anthony and Andrew (2003b), p. 2.

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1.3 Three Steps to the formation of an European Monetary Union 3

One main issue of the treaty for the European Union was the stepwise introduction of an economic and monetary union, ultimately with a single European currency, by providing a legal framework. The path to this European economic and monetary union had first been outlined in 1989 as a concept of three steps in the so-called „Delors-Report“ named after the former president of the European commission, Jacques Delors 4 . The Maastricht Treaty transformed this proposed three-step plan into a concrete plan with defined timelines.

The first step concerning the start of an Exchange Rate Mechanism was taken on July, 1 st 1990. It was already under way before the Maastricht Treaty was even ratified. The Second stage started January, 1 st of 1994, it related to the transfer of certain aspects of monetary and economic policy from the Member States to European institutions. At a Summit in Madrid in December 1994 the European Council agreed on January 1 st 1999 as the start date for the Third stage of EMU, which ultimately introduced the Euro, the name of the common currency, as single currency for the Member States of the EMU.

1.4 Criteria of Stability and Convergence - Selection of Member States for

the Single Currency 5

The treaty of Maastricht defined conditions under which a country may join the EMU 6 . The reason for defining an entry barrier to the Single Currency was the idea that member states should achieve a high degree of economic convergence, i.e. the national economic indicators of all countries should approach those of the most successful ones.

3 Bundesministerium für Finanzen (2003), p. 2.

4 European Community (1989).

5 Cowgill, Anthony and Andrew (2003a), p. 2.

6 Griemert (2003), p. 1.

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This approach was taken to guarantee a maximum of stability for the Euro. Price stability was defined as the highest goal of a common monetary policy. One of the objectives for the newly founded European Central Bank (ECB) was to guard over the achievement of this goal 7

The Treaty of Maastricht defines four criteria of stability and convergence a country has to fulfill to be eligible for joining the EMU (Art. 109 j):

- inflation: inflation rate should be no more than 1.5 % greater than that of the three best performing states.

- interest-rate: nominal long-term interest rate should not exceed, by more than 2 %, the rates of the three best performing member states.

- exchange rate: currency has stayed within the margins of normal fluctuation during the two years preceding stage 3 of EMU.

- excessive budget deficit: planned or actual government budget deficit to GDP at market prices does not exceed 3 % and the ratio of government dept to GDP at market prices does not exceed 60 %.

The deficit- and debt criteria are goals that have influence on the fiscal policy of each membership state wanting to join stage three of EMU.

1.5 From the criteria of stability and convergence to the Stability and

Growth Pact 8

While the convergence criteria defined strict criteria for the eligibility of a country to join the EMU, there was no instrument in the original treaty of Maastricht defining a continuous control over the future economic development of the Euro countries. In its earliest form the Stability and Growth Pact was mainly encouraged by Theo Waigel, Germanys former finance minister.

7 Treaty on the European Union (1992), Art. 105

8 ref.: Resolution of the European Council on the Stability and Growth Pact (1997).

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Meeting in Madrid in December 1995, the European Council confirmed the crucial importance of securing a continuous budgetary discipline in “stage three” of EMU. This stage marks the introduction of the Euro. In Florence, six months later, the European council reiterated this point of view. Finally, in December 1996, during its Dublin summit it agreed on a pact, which was now officially named “the Stability and Growth Pact (SPG)”. Although some member states, especially France, had reservations the Stability and Growth Pact was agreed upon in a Resolution of the European Council in June of 1997 (resolution of the European council from June, 17th of 1997 on the SPG due to the endorsement of the treaty of Amsterdam). The Pact started operating on January, 1 st 1999 and is intended to ensure that the Euro will be able to maintain its value.

1.6 Legal framework of the Stability and Growth Pact

The Stability and Growth Pact encompasses the legislative text and political resolutions regulating fiscal policy and public finances in the EMU. It sets the rules for the fiscal policy conducted by the member states of the EMU, organizes the multilateral fiscal monitoring, spells out the discipline requirements of the Maastricht Treaty and specifies the sanctions to be applied in case of budgetary misbehavior. In short, the SGP, together with norms insuring the independence of the European Central Bank, is the main building block of the EMU.

The SPG consists of three components 9 : a single EC Resolution and two Council Regulations which where adopted on July, 7th 1997. The resolution commits all parties, member states, the Commission and the Council “to implement the Treaty and the Stability and Growth Pact in a strict and timely manner”. The Council Regulations, unlike the Resolution, have legal force:

9 Bundesministerium für Finanzen (2003), p. 2-3.

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