In order to guarantee a proper functioning of the Euro, European heads of state agreed in 1992 on a number of fiscal rules for their national budgets. The best known is the 3 percent restriction. This means that the annual budgetary deficit of all members of EU cannot exceed 3 percent, although some exceptions are allowed. If a member state does not comply with the restrictions, it risks financial penalties after a procedure called the ’Excessive Deficit Procedure’. The sanctions could go up to 0.5 percent of GDP. For example, today’s Germany could risk a fine of more than 16.5 billion Euro if it transgressed the budgetary rules.
Why did the members of the EU agree to such penalties? Well, if one member would continue to build up high deficits, its debt could become unsustainable. This would hurt the credibility of the Euro, and other participating countries would have to pay a higher price when they want to make loans for their respective debts. The unsustainable debt level of one member state would push the interest rates up, and so generating negative effects on all countries participating in the Euro.
The rules were adapted several times. First, the Stability and Growth Pact was agreed in 1997 on the request of Germany. Second, modifications to the Pact were made in 2005 because several members transgressed it. For instance, Germany and France were not penalised despite their deficits higher than 3 percent. This is because the Council is responsible for starting the Excessive Deficit Procedure, and both countries blocked its initiation.
The proposed reform
The current setup of fiscal rules did not prevent the economic crisis. Only 5 members of EU had a deficit lower than 3 percent in 2009. In order to update the Pact, the European Commission and the Council agreed on some modifications March 2011. Both institutions are negotiating these modifications with the European Parliament, and are to be concluded in June 2011.
Five new amendments are proposed concerning the budgetary rules. First, the debt ratios (as a percentage of GDP) should be reduced in order to avoid too high debt ratios. For example, if a country has a debt ratio of 100 percent of GDP, it will have to reduce it by 2 percent a year. So high debts such as in Greece and Italy today could be prevented.
Second, the Commission, and not the Council, will decide to apply a sanction to a member state with an excessive deficit. The sanctions can still be prevented by the Council with qualified majority, but it will take more effort than before.
Third, accounting rules of public finances will be harmonised. This aims to prevent own interpretations of member states. For instance, the Greek government misreported its numbers, resulting into difficulties to estimate its total debt level when the crisis hit Greece.
Fourth, member states have to submit each year a Stability and Convergence Plan, explaining their medium-term budgetary strategies. Although it is not yet legally binding, member states have already submitted their plans. Fifth, macroeconomic imbalances will be prevented and corrected. Just like the ’Excessive Deficit Procedure’, a new ’Excessive Imbalance Procedure’ will be introduced. If a high economic imbalance occurs, member states will first be warned and then sanctioned (up to 0.1 percent of GDP) if they do not tackle the imbalance. Again, the Council can only revoke the decision of the Commission with qualified majority. This measure is proposed to prevent imbalances such as the housing booms in Ireland and Spain before the crisis.
Assessing the proposals
The Stability and Growth Pact has been criticised for various reasons since its inception, just as today’s proposals. The new voting mechanism in the Council is not able to guarantee sanctions when legally appropriate. The sanctions might also be too high and generate Euroscepticism. And the preventive measures will not guarantee concrete results .
The budgetary rules at the European level are counting on the willingness of the member states. As Jean-Claude Juncker, President of the Eurogroup, said: ’if the willingness of those who have the duty to implement the Stability and Growth Pact will be of a perfect nature, the implementation will be of a perfect nature.’ So the new Stability and Growth Pact could again be malfunctioning, maybe because of the (unjustified) fear of further European integration?