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Evolution of the stability and growth pact

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Evolution of the stability and growth pact

  1. 1. Evolution of the Stability and Growth Pact A Perspective on the Current Reform Agenda Rodney Thom Paschal Donohoe
  2. 2. “ Economic prosperity and the viability of the monetary union cannot be sustained without tackling past fiscal failures - a trend towards increasing government expenditure and taxation levels combined with high structural budget deficits and government debt accumulation.” The European Commission (2001)
  3. 3. “ I know very well that the Stability Pact is stupid, like all decisions which are rigid.” Romano Prodi, EU Commission President (2002)
  4. 4. Agenda <ul><li>Key Features of the SGP </li></ul><ul><li>Operation of Pact </li></ul><ul><li>Reform Agenda </li></ul><ul><li>Perspectives on Reform </li></ul><ul><li>Different Model </li></ul><ul><li>Conclusion </li></ul>
  5. 5. SGP – Key Features Pact breaks into two distinct periods. <ul><li>Exception to fiscal rules allowed based on economic circumstances. </li></ul><ul><li>Permits consideration of ‘relevant factors’ – pension, R&D spend + investment programmes. </li></ul><ul><li>Council given additional power to determine time frame for corrective action. </li></ul>SGP II (2005 – current) <ul><li>Member States deliver budget deficits below </li></ul><ul><li>3%/GDP. </li></ul><ul><li>Debt/GDP ratios at most 60% or moving to this </li></ul><ul><li>target. </li></ul><ul><li>Excessive Development Procedure (EDP) for </li></ul><ul><li>Member States outside target levels. </li></ul>SGP I (1997 – 2005) Pact
  6. 6. SGP – Key Features <ul><li>Definition of excessive deficit </li></ul><ul><li>Preventive Arm – designed to stop excessive deficits developing. </li></ul><ul><li>Corrective Arm – what Member States should do. </li></ul><ul><li>Sanction Procedure – if corrective action is not taken. </li></ul>
  7. 7. Operation of Pact <ul><li>Evaluate Pact based on key reference points </li></ul><ul><li>Deficit Levels </li></ul><ul><li>Debt Levels </li></ul><ul><li>EDP </li></ul><ul><li>Macroeconomic Stability </li></ul>
  8. 8. Deficit/GDP Levels – Euro Average Euro average only breached target deficit levels twice since Pact foundation. Source : Eurostat
  9. 9. Deficit/GDP Levels – Member States Consistent breaching of 3% reference level by mixture of Member States. 5 1 3 4 6 4 3 3 0 Breach (#) Portugal Italy Greece Germany 12 ‘ 05 Portugal Italy Greece 12 ’ 06 Greece 13 ‘ 07 Malta France Spain Greece Italy Portugal Austria Italy France Greece Germany N’lands Italy France Germany France Greece Germany Portugal Italy Greece Member States 14 12 12 12 12 11 Euro-zone (#) ’ 08 ‘ 04 ‘ 03 ’ 02 ‘ 01 ‘ 00
  10. 10. Debt/GDP Levels – Euro Average Source : Eurostat Continual breaching of Debt/GDP Target across Eurozone.
  11. 11. Debt/GDP Levels – Member States Key economies began to breach 60% reference from 03/04. Exception was Spain…..
  12. 12. Use of EDP <ul><li>Triggered 14 times between 2001 and 2008. </li></ul><ul><li>Did not lead to sanction implementation on a single occasion. </li></ul><ul><li>First Country to be warned was Ireland. </li></ul><ul><ul><li>Target budget surplus of +4.3% in ’01. </li></ul></ul><ul><ul><li>Delievered surplus of +1.7%. </li></ul></ul><ul><ul><li>Commission warned that budget was pro cyclical across period of rising inflation. </li></ul></ul><ul><ul><li>No action taken. </li></ul></ul>
  13. 13. Use of EDP – France and Germany <ul><li>Both France and Germany received Commission warnings between 2002 and 2003. </li></ul><ul><li>In 2003 both Member States breached 3% deficit target. </li></ul><ul><ul><li>France – lower income tax receipts due to policy changes. </li></ul></ul><ul><ul><li>Germany – floods in East Germany. </li></ul></ul><ul><li>By November ’03 neither country delivering ECOFIN recommendations. </li></ul><ul><li>ECOFIN then decided (via QMV) to suspend EDP. </li></ul><ul><li>This decision subsequently rejected by the ECJ. </li></ul>
  14. 14. Macroeconomic Stability - Ireland and Spain -  Both economies delivering Pact commitments.  Both economies experienced massive and rapid fiscal deterioration.  Focused on health of ‘state’ – ignored private and foreign sectors.   EDP Use 36% 25% %Debt/GDP +1.9% +0.1% %Government Deficit Spain Ireland 2007 (Eurostat)
  15. 15. Summary <ul><li>Did not recognise imbalances </li></ul><ul><li>or risks. </li></ul>Macroeconomic Stability <ul><li>Triggered 14 times </li></ul><ul><li>No sanctions </li></ul>EDP <ul><li>Large Member States > 60% </li></ul><ul><li>value </li></ul>Debt Level  Consistent Breaching Deficit Level Performance
  16. 16. Reform Agenda <ul><li>Sanctions for High Levels of Debt - > 60% </li></ul><ul><ul><li>“ For example, a country would be subject to an excessive debt procedure even with a deficit below 3% if the debt is above 60% and the path of debt reduction is considered unsatisfactory” (Herman Van Rompuy). </li></ul></ul><ul><li>Extend sanction measures to Debt prevention. </li></ul><ul><ul><li>Introduces concept of PFPM (Prudent Fiscal Policy Making). </li></ul></ul><ul><ul><li>Public spending growth should not be faster than expected GDP growth. </li></ul></ul>
  17. 17. Reform Agenda <ul><li>Pursuing Member States that do not address persistently poor competitiveness or macroeconomic imbalances. Rigorous use of score carding systems. </li></ul><ul><li>Changing sanction process. Default is to apply. Can only be overturned by Council via QMV. </li></ul><ul><ul><li>‘ Semi-automaticity’. </li></ul></ul>
  18. 18. Pact Evolution <ul><li>SGP 1 : Corrective </li></ul><ul><li>SGP 2: Exceptions to Corrective Arm </li></ul><ul><li>SGP 3: Preventative Sanctions </li></ul><ul><li> Extensions of Sanctions </li></ul><ul><li> Semi Automaticity </li></ul>
  19. 19. Perspectives on Reform <ul><li>Centralisation of Decision Making </li></ul><ul><li>Credibility of Sanction Application </li></ul><ul><li>Role of Monetary Policy </li></ul><ul><li>Strengthening the Pro Cyclical Bias </li></ul><ul><li>Crisis Management and Resolution Framework </li></ul>
  20. 20. Centralisation of Decision Making <ul><li>Increase in powers of EU Commission . </li></ul><ul><li>Spending and taxation remain national decisions. </li></ul>“ … the European Commission will be able to impose sanctions on national Governments and Parliaments and force them to lower spending and/or increase taxes, while this institution will not face the political sanction of its decisions..” Paul De Grauwer (2010).
  21. 21. Credibility of Sanction Application <ul><li>No successful sanction application in history of Pact. </li></ul><ul><li>Higher frequency of potential sanction due to increase in sanction ‘arsenal’. </li></ul><ul><li>Credibility damage will be greater as ambition is stronger. </li></ul>Will the Commission sanction Member States? Yes No Small Member States Larger Member States Only once for credibility damage
  22. 22. Role of Monetary Policy Expansion of lending played a key role in driving asset price inflation.
  23. 23. Strengthening the Pro Cyclical Bias <ul><li>Proposals widen debt parameters that tigger sanction. </li></ul><ul><ul><li>Pro cyclical bias in place under previous Pacts. </li></ul></ul><ul><ul><li>Bias stengthened due to 1) increase in sanction triggers 2) ‘semi automaticity’ </li></ul></ul><ul><ul><li>Official fine will be in addition to higher lending rates on Government Bond Markets. </li></ul></ul>
  24. 24. Crisis Management and Resolution Framework <ul><li>Current framework is based on prevention. </li></ul><ul><li>Use of sanctions will prevent default. </li></ul><ul><li>Crisis Management ≠ Crisis Resolution </li></ul><ul><li>Sovereign defaults happen. </li></ul><ul><li>Will creation of resolution framework stimulate defaults? </li></ul><ul><li>Not be better to manage this market ambiguity now versus height of crisis? </li></ul>
  25. 25. A Different Model ? <ul><li>Establishment of national fiscal councils or laws underpinned by a Commission template. </li></ul><ul><li>Acknowledgement that financial markets are a source of sanction through higer costs of lending. </li></ul><ul><li>More focus on surveillance vs additional sanction mechanisms. </li></ul><ul><li>Greater focus on surveillance allows lower grower debt levels to trigger flexibility in deficit levels. </li></ul>
  26. 26. Source of Sanctions <ul><li>Exchange Rate Mechanism assumed the DM as system anchor. </li></ul><ul><li>Expectation was that a currency would be devalued if domestic policies were expansionary versus anchor. </li></ul><ul><li>Led to higher local interest rates. </li></ul><ul><li>Similar trend on sovereign debt markets. </li></ul><ul><ul><li>Sanctions already in existence – current not ‘threatened’ in future. </li></ul></ul><ul><ul><li>Different role for institutions. </li></ul></ul>
  27. 27. Reform Focus Sanction START CRISIS END
  28. 28. Reform Focus START CRISIS END MARKET SURVEILLANCE RESOLUTION
  29. 29. Conclusions <ul><li>Pact must work for future stability of euro. </li></ul><ul><li>Current proposals mark significant development in policy through sanction strengthening. </li></ul><ul><li>Surveillance capacity vital given role of macroeconomic imbalances in causing crisis. </li></ul><ul><li>Could be integrated with more decentralisation and acknowledgement of current sanctions? </li></ul>

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