MPIfG Working Paper
03/10, October 2003
Stability and Growth Pact – Not the Best but Better than Nothing. Reviewing the Debate on Fiscal Policy in Europe's Monetary Union
Max Planck Institute for the Study of Societies
This paper aims to review the
economic literature on the Maastricht deficit rule and the Stability and Growth
Pact. The author tries to expose the contradictions and inconclusiveness of the
debate, highlighting both the criticism and the defense of the fiscal policy
regime in EMU. The paper is non-technical and seeks to provide an overview for a
readership outside the economics profession. The concluding judgment is that the
pact can be criticized on a number of grounds, but that the lack of a
politically feasible alternative makes it a second best solution that should not
be undermined in the present crisis.
Dieses Papier ist eine summarische Auswertung der
wirtschaftswissenschaftlichen Fachliteratur zur Defizitregel des Maastrichter
Vertrages und dem Europäischen Stabilitäts- und Wachstumspakt. Der Autor
versucht, Widersprüche und fehlenden Konsens der Debatte darzustellen, indem die
Argumente für und gegen das fiskalpolitische Regime der Währungsunion einander
gegenübergestellt werden. Der Aufsatz ist nicht technisch und dient dem Zugang
einer an der Materie interessierten, aber wirtschaftstheoretisch nicht vorgebildeten Leserschaft. Das abschließende Urteil sieht den Pakt als in einer
Reihe von Punkten kritikwürdiges Provisorium an, das jedoch mangels einer
realisierbaren Alternative nicht ausgehebelt werden sollte.
The Excessive Deficit Procedure (EDP)
of the Stability and Growth Pact (SGP) has been initiated by the European
Commission and the Council on Economic and Financial Affairs (ECOFIN) against
Portugal, Germany and France – with Italy likely to be the next candidate. With
the 'paper tiger' showing its teeth (at least for the moment), it is obvious
that the SGP has arrived and is likely to stay in the focus of academic and
public debates on Economic and Monetary Union (EMU). So far, the scientific
analysis has been dominated by (political) economists. Political science is only
beginning to take up the issue. In order to facilitate communication between the
two neighboring disciplines, a review of the economic arguments for a readership
of primarily political scientists seems wanting and is attempted in this paper.
I try to condense more than a decade of
economic literature on the deficit rule of the Maastricht Treaty (MT) and its
strengthened version in the SGP. My aim is to situate the SGP debate within the
context of wider, more fundamental themes in economic thinking, while refraining
from inferring strong conclusions from what is essentially still an open and
ongoing discussion. The discourse in the first section is organized around four
'grand debates'. I assess to what extent the need for budgetary discipline
rather than flexibility has been convincingly established in the first place.
This is logically the first step in any economic justification of the pact.
Second, the traditional theme of 'rules versus discretion' in fiscal policy is
applied to interpret the EMU regime. Third, the need or inappropriateness of
fiscal coordination in a monetary union is discussed. Finally, the trade-off
between counter-cyclical demand-side stabilization and budgetary consolidation
is examined. The subsequent section introduces the interaction of fiscal policy
with the monetary side of the macroeconomic policy mix, since the pact has often
been justified by the need to defend the independence of the European Central
Bank (ECB). This section also poses the obvious question of whether or not the
pact will be adhered to and lists a number of proposals for improvements and
alternatives to the regime. Short of a political consensus on major improvements,
however, the conclusion portrays the pact as a second best solution that should
not be undermined.
What would, in theory, be the features
of a 'good' fiscal system, particularly in the eurozone case of a supranational
monetary policy interacting with decentralized fiscal authorities? Furthermore,
a monetary union among economies that, for all that we know today, tend to
diverge rather than converge in their fundamental parameters. And – in contrast
to the optimal solution – how should we judge the specific regime that has been
installed for Economic and Monetary Union (EMU)? With respect to the SGP, the
logical question to start with is whether or not a general need for fiscal
discipline – in the institutionalized form of a rule-based scheme at the cost of
demand-side policies – has been convincingly established.
Fiscal discipline is seen in the
literature as the precondition for a balanced policy mix, since high levels of
debt are likely to induce a restrictive stance of monetary policy (Buti et al.
1998; Thygesen 1999). In other words, the SGP allows the ECB to be less
restrictive compared to the stance that it would otherwise have to adopt in the
face of fiscal laxity (Beetsma/Uhlig 1997). In contrast, it is sometimes argued
(e.g. Deubner 2001) that financial markets provide a sufficient guarantee for
fiscal discipline on their own. However, being far from perfect, financial
markets react with a lag, have a tendency to overshoot the equilibrium rates and
can cause negative contagion effects as well as spillovers to other countries (Thygesen
1999; Artis/Winkler 1999).
A further argument is that political
control over fiscal policy usually suffers from a deficit bias due to incentives
for overspending. Those in charge of 'spending ministries' do not internalize
the social cost of providing benefits within their specific portfolio. Normally,
tendencies to overspend are partially counteracted by the risk of incurring
higher interest rates, not least because of increased inflationary pressure from
a depreciating exchange rate. Yet entry into a monetary union spreads that risk
to all members and thereby increases the relative weight of the incentives for
overspending. The unwanted negative effects of expansive fiscal policy are
externalized onto the community. Conversely, member states cannot only
externalize negative effects of overspending but also free-ride on the
interest-rate benefits achieved by the consolidation efforts of their partners.
EMU therefore aggravates perverse incentives for fiscal looseness and
exacerbates a politically induced deficit bias (Beetsma 1999, 2001). Then again,
this EMU-induced increase of the deficit bias finds new compensation through
export losses. The inflationary result of increased deficits can, inside a
monetary union, no longer be cushioned by exchange rate depreciation (or
devaluation) and will therefore lead to reduced exports. These should go some
way toward substituting the disciplinary effect of the exchange rate in the form
of the export-sector lobbying the government to prevent greater deficits. 
Overall, the jury is out and a risk-averse strategy would imply devising
additional safeguards against fiscal irresponsibility.
Another justification of the pact is
provided by the concern over fiscal spillovers in the sense of negative
externalities of fiscal profligacy on other, 'innocent', member states within
the eurozone. This danger is also the main argument of the proponents for
increased policy coordination and has been claimed to grow in line with economic
integration (Masson 1996; Artis/Winkler 1999). However, recent research suggests
that fiscal spillovers are largely absent in reality (Thygesen 1999; Gros/Hobza
2001). Finally, there are reasons for consolidation independent of EMU. These
justify any rule that helps to contain public spending. At the outset, we can
expect a substantial and long-term improvement in growth performance from fiscal
retrenchment (Gros/Thygesen 1998). Even more important is the inevitable need to
prepare public budgets for the demographic change of the coming decades. The
opportunity cost of not promptly addressing this challenge is rising
To summarize; the essence of the
arguments supporting the SGP is the need for fiscal discipline in itself. This
need is increased by the specific requirements of monetary union, where fiscal
policy in general and budgetary deficits combined with the resulting build-up of
debt in particular are seen as the principal menace to monetary solidity. The
pact is perceived as helpful because price stability itself is argued to be
poorly safeguarded by the institutional independence of monetary policy (Giovannini/Spaventa
1991; Grilli et al. 1991). A politically induced deficit bias, exacerbated by
entry to EMU, has to be institutionally contained in order to enable a
growth-enhancing policy mix. However, the debate seems to be inconclusive as to
the initial question of whether or not the need for fiscal discipline really
requires the imposition of a rigid system of rules that come at potentially
substantial costs. In other words, is there no better alternative?
The main criticism of the rules-based
approach to fiscal discipline is that the SGP in its present form is excessively
tight and inflexible and thereby hampers automatic stabilizers in the eurozone
(Andersen/Dogonowski 1999; Eichengreen 1996; Eichengreen et al. 1998;
Eichengreen/Wyplosz 1998; Hagen/Eichengreen 1996). The budgetary stance, it is
argued, remains procyclical and there seems to be a considerable danger of
deflationary tendencies occurring due to the rise in real interest rates (Hughes
Since the EDP is the only component of
the SGP that is equipped with sanctions, the whole edifice ends up being too
strong and, at the same time, applicable only in an asymmetrical way during
economic downturns, as is presently the case. The pact does not encourage
discipline and consolidation when it could be achieved at a much lower cost, i.e.
in upswings,  but is confined to requiring procyclical measures in times of weak
or falling growth. Furthermore, it completely fails to promote an improvement in
the quality of consolidation and in public finance generally. It would be useful
to favor expenditure cutting over tax rises and subsequently consumption cutting
over investment cutting. There is ample empirical evidence that the 'correct'
kind of expenditure cutting is more likely to last and be successful than tax
increases (Alesina/Perotti 1995; Alesina/Perotti 1997; Buti/Sapir 1998; Buti et
al. 1998; Perotti 1996).
The true danger to stability from
fiscal policy is unsustainable public debt, not deficits. The likelihood of
public pressure on monetary policy is most closely related to the cost of debt
servicing, which is a function of the debt level and the interest rate. Of
course, the debt level is determined over the medium term by the succession of
annual deficits (as well as by growth, inflation and the interest rate). But it
remains paradoxical that the SGP exhibits an unjustified overemphasis on
deficits rather than the more substantial debt problem (Rostagno et al. 2001;
Missale 2001; Pisani-Ferry 1996). The explanation is to be found in a reasoning
of political economy: It is easier to control the deficit by rules rather than
the debt level. Yet one wonders if the pact is not overambitious: if the
balanced budget requirement is actually adhered to, debt will virtually
disappear and almost certainly end up below a socially optimal level (determined
by considerations of intergenerational justice and liquidity constraints). The
question remains whether debt limits would not represent a superior alternative.
Besides potentially disabling
cyclically required stabilization measures on the demand side and the relative
lack of importance attributed to the debt level, the SGP focus on the deficit
could deflect policymakers' attention away from the structural problems of the
European economy. Not only does the preoccupation with a few decimal points of
the budget deficit detract from the necessary structural reforms (Eichengreen/Wyplosz
1998; Masson 1996), it might even jeopardize their implementation. Governments
wishing to ease the transition costs for those sectors of the economy that are
negatively affected by the inescapable adjustments could be impeded to do so,
therefore finding it impossible to 'sell' reforms to the electorate. This
problem is aggravated by an absent overall framework that puts fiscal policy in
relation to monetary policy and is geared towards a growth-enhancing policy mix
Lastly, arguments based on
game-theoretic reasoning can be raised in criticism of the non-cooperative
nature of the present EMU regime (Dixit/Lambertini 2001). In the model of Dixit
and Lambertini, monetary and fiscal authorities minimize a quadratic loss
function of inflation and output with varying payoffs. Their finding is that
'fiscal discretion destroys monetary commitment' on the part of the ECB, which
justifies the imposition of budgetary rules when there is a conflict of
objectives between monetary and fiscal authorities. However, if both sides agree
on the ultimate policy targets in what the authors call a situation of
'monetary-fiscal symbiosis', then the preferred outcomes can be achieved.  This
result holds when the model is extended to the EMU case of several fiscal
players. The ideal levels of output and inflation can be attained despite ex
post monetary accommodation of fiscal expansion and without fiscal coordination
because all equilibria collapse into one solution once the ideal points of the
monetary authority coincide with those of all the fiscal authorities. These
findings, if at all applicable to the 'real world', suggest that achieving a
consensus among policymakers on the target levels of output and inflation is
more important than stringent budget limits. In other words, a binding version
of the 'Cologne Process'  or other forms of higher-level coordination would make
the SGP increasingly superfluous.
In sum, the critics of the pact do not
deny the need for fiscal discipline and its increased importance under the
conditions of monetary union. However, concerns about the ability of fiscal
policy to fulfill its equally enhanced responsibility for anti-cyclical
stabilization of the demand side give grounds for considerable doubt as to
whether the particular institutional solution that has been adopted represents a
good choice. Its only effective component, the EDP, focuses asymmetrically and
mechanistically on an arbitrary level of nominal deficits, putting automatic
stabilizers, the priority of structural reforms and an improved overall policy
mix at risk ― thereby possibly undermining the performance and hence the success
of EMU at large.
Departing from the issue of discipline,
how should the fiscal branch of economic policy be procedurally organized? The
alternatives are located on a continuum between complete political discretion at
one end and a fully de-politicized scheme of rules and technocratic agencies at
the other end. The Keynesian tradition would justify a strong and discretionary
role for national governments. It refers to persistent market failures, which
lead to underemployment equilibria through demand insufficiency. An ideal regime
would allow coordinated discretionary action in monetary and fiscal policy,
pertaining to a growth-inducing policy mix, such as the combination of fiscal
expansion and monetary reflation during a recession. Adherents reject any
institutional solution impinging on the discretionary margin of fiscal policy (Pisani-Ferry
1998; Grauwe 1998).
On the other hand, neo-classical and
monetarist authors have contrasted market failures with even greater government
failures. Economic policy is said to suffer inevitably from 'time inconsistency'
(Kydland/Prescott 1977). Without a credible (i.e. discretion-removing)
commitment to an ex ante optimal plan, policymakers will always find it rational
to deviate ex post from their announced course. The implications of assuming
'rational expectations' have been formulated in the 'Lucas Critique', which
denies the applicability of economic models to policymaking altogether (Lucas
1976). Furthermore, fully rational expectations would imply that fiscal action
has no effects due to 'Ricardian equivalence' (Barro 1974). Public deficits do
not matter because private agents, insofar as they have rational expectations,
anticipate future repayment through higher taxes and, accordingly, adjust
current savings upwards. Therefore the effect of deficit spending on aggregate
demand is qualitatively and quantitatively the same as the result of taxation:
reduced private sector activity. Hence, government action should be constrained
by rules or even delegated to an independent agency.  This demand has been
implemented for monetary policy in the form of a 'conservative central bank' (Rogoff
1985), which is independent of time-inconsistent governments and can follow a
predictable rule (Taylor 1993).
Dismissing Ricardian equivalence for
certain policies, the requirement of fiscal discipline is alternatively
established by the 'Fiscal Theory of the Price Level' (Leeper 1991; Leith/Wren-Lewis
2000; Woodford 1994, 1995, 1996, 2001).  Whereas Barro's contribution described
fiscal policy as 'irrelevant' in the sense of public debt and taxation being
equivalent in their effects on the economy, Woodford et al. confirm the
possibility of a non-Ricardian regime. Nevertheless, price stability implies not
only commitment to a monetary policy rule but also an appropriate fiscal
framework. Non-Ricardian properties are still consistent with rational
expectations if the budget does not always neutralize the effects of fiscal
disturbances. The main channel of transmitting effects from fiscal policy to the
price level is through fiscally induced disturbances of private sector budget
constraints, which in turn affect aggregate demand, assuming that government
expenditure substitutes for private consumption. It is important that already
the expectation of a deteriorating government balance can cause the price
level to rise in Woodford's model. He sees a monetary rule with predictable
interest reactions to inflationary developments ('Taylor rule') plus nominal
deficit targeting (resembling closely the actual EMU regime) as a system that is
not only consistent with price stability but also excludes self-fulfilling
deflationary spirals precisely because it constrains fiscal expectations.
The emerging theoretical near-consensus
between rules and discretion seems to point towards 'rules with discretion' or
'rule-bound discretion'. In the short run, output and employment are indeed
affected by shifts in aggregate demand.  A higher budget deficit or an
expansionary monetary policy is thus able to decrease unemployment. However, in
the long run, structural parameters determine a 'natural level' of growth and
employment. Increased money growth only translates into inflation, whereas
public debt decreases capital accumulation and thereby lowers the prospects for
growth. Therefore, in theory, an adequate system of fiscal policy should
generally aim for long-term budgetary consolidation, while leaving room for
automatic or even ad hoc discretionary stabilization in the face of
short-term fluctuations.  In the context of EMU, rule-bound discretion would
translate meaningfully into a regime curtailing the overall,
Union-wide level of debt and, possibly, deficits with the objective to
contain inflationary pressures, while leaving discretionary margins to national
policy. The framework should be geared towards a favorable policy mix through
long-term consolidation, while retaining the option to engage in short-term
stabilizations in response to country-specific output gaps. Does the EMU system
correspond to these theoretically desirable features?
The actual arrangement is characterized
by a central, supranational monetary policy on the one hand, in contrast to a
decentralized set of cumbersome national budget-making processes on the other
hand, involving ministerial direction and parliamentary cycles under a European
fiscal rule (Hagen/Eichengreen 1996; Hagen/Harden 1995). The national fiscal
authorities are subject to a common rule-based framework, legally founded upon
the relevant provisions of the Maastricht Treaty  and the SGP, which itself
consists of a resolution of the European Council  and two ECOFIN regulations.  The
framework is therefore, laudably, constrained-discretionary. However, it suffers
from poor effectiveness with respect to its own stated aims and contains
unavoidable time lags in its implementation. The actors cannot promptly change
the stance of fiscal policy without jeopardizing their credibility and
succumbing to time inconsistency. Worse still, instead of targeting the
union-wide debt level in the medium term, the system prescribes a permanent and
narrow band for national deficits. These deficiencies continue to bear on the
quality of fiscal policy in Europe.
Legally, the SGP is an instrument of
secondary Community law. Its effectiveness hinges on voting behavior in ECOFIN,
which has to decide by qualified majority whether an excessive deficit exists in
a member state (Article 104 TEC). Qualified majority means that 22 out of the 87
weighted votes would be sufficient to prevent the declaration of an excessive
deficit. ECOFIN members normally do not vote but aim at consensus decisions. 
This habit even enhances the likelihood of successfully opposing the
rule-conforming application of the deficit criterion. ECOFIN could therefore
easily derail the 'quasi-automatic' sanctions of the EDP at several stages of
the process. A member state or Community institution could, according to Article
232 TEC, bring an action for failure to act before the European Court of Justice
if the Council fails to decide on the existence of an excessive deficit or if it
fails to impose sanctions, given that the existence of an excessive deficit is
asserted.  Nevertheless, there is no means to force the Council to declare a
deficit excessive (Hahn 1998; Steuer 1998). Even a rule-conforming
interpretation allows significant leeway for only applying the definition
loosely. A deficit of three percent or more of GDP is not excessive if it is
exceptional and temporary. The exceptionality condition is fulfilled in the
event of an annual fall of real GDP of two percent or more. Furthermore,
according to Article 2, third indent of Council Regulation 1467/97, a milder
recession can in principle be claimed to be exceptional, too. As for the second
condition, the deficit is temporary if it is forecast by the Commission to fall
below three percent following the end of the downturn. The deficit rule has
therefore rightly been described as formally too rigid but de facto too
loose (Corsetti/Roubini 1992, 1993).
What then induces ECOFIN to assert an
excessive deficit in the cases of Portugal, Germany and France without the legal
obligation to do so? The rule might already have acquired some institutional
backing of its own, not least through the influence of professional experts in
the respective ministries and in the Monetary and Financial Committee (MFC).
Another part of the answer could be that the ECB has implicitly threatened not
to lower interest rates if ECOFIN decides the other way.  This should be cause
for concern. Strategic conflict between the fiscal and monetary authorities
frustrates the attainment of an optimal policy mix between the two sides even
(Begg et al. 2003) describe fiscal
coordination as a means of addressing two simultaneous dilemmas. Next to the
procedural difficulties of providing a purposeful framework for twelve
interdependent fiscal policies vis-à-vis a single monetary policy, there is the
problem of collective action as affects the guarantee of central bank
independence in a decentralized fiscal environment. But not only credible
independence is a public good in the context of monetary union. A coordinated
approach to consolidation is more effective than uncoordinated attempts by
individual countries because consolidation under EMU has the characteristics of
a prisoners' dilemma (Allsopp et al. 1999). Here arises a second problem of
collective action. One country benefits from another country's consolidation in
the form of a positive externality, primarily through the interest rate channel,
and therefore has an incentive to free-ride and underprovide consolidation
itself. The SGP can hence be seen as a device to impose the cooperative solution
in a consolidation game as well as a guarantee of central bank independence
vis-à-vis potentially irresponsible spending behavior (Artis/Winkler 1997). Yet,
in conjunction with the framework of Broad Economic Policy Guidelines (BEPG), it
is but a very rudimentary approach to ensuring overall coherence of the national
fiscal stances, both in the fiscal domain itself and in the context of the
European-level policy mix with the monetary authority.
The question of economic policy
coordination (see, for example, Alesina/Tabellini 1987; Korkman 2001; Remsperger
1999) should be seen in the context of the wider debate on policy coordination
in general, where the principal categorization falls into 'hard' and 'soft'
forms, depending on whether the mechanisms are fitted with sanctions. For
monetary union, one should distinguish between two further concepts of economic
policy coordination.  First, a limited type would comprise a reciprocal kind of (intergovernmental)
adjustment of national fiscal policies with the minimal aim of avoiding negative
externalities and spillovers between member states. The SGP surveillance
component contains a partial element of this type of coordination, which is
geared towards the medium-term aim of balanced budgets (Thygesen 1999). The
'hard' element of the SGP is asymmetrically focused on preventing excessive
deficits and is therefore insufficiently comprehensive as a coordination device
(Crowley 2001; Korkman 2001). The sanction mechanism does not cover cases that
exhibit negative spillovers or inflationary characteristics but are sufficiently
distant from the three percent limit, such as the expansionary Irish budget of
2000/01. Already the fiscal backslide in most member states during 1999 and 2000
shows the prevalent imbalance of the present regime, which is evidently unable
to induce anti-cyclical consolidation during upswings.
Second, some authors advocate
coordinating the aggregate of decentralized fiscal policies with the
centralized monetary policy, aiming for an 'optimal policy mix'. Inasmuch as
this 'higher-level' type of coordination involves political guidance overriding
the independence of monetary policy, it is what predominantly French authors
have in mind when they speak of economic coordination in general or a
gouvernement économique in particular (e.g. Delors 1997; Marx 2001; Boyer
2000; Conseil d'analyse économique 1998). Higher-level coordination is, however,
not the only way to achieve a favorable policy mix. The limited, exclusively
fiscal form of coordination could still allow mutual adjustment between monetary
policy and fiscal policy.
For proponents of a higher-level system
of coordination that in one way or another encompasses monetary policy, the SGP
is by definition insufficient (Hughes Hallett/McAdam et al. 1999; Willet 1999;
Collignon 2001) or even counterproductive (Breuss/Weber 1999). The EDP
constitutes the 'hard' part of the SGP but comprises only a partial aspect of
fiscal policy coordination, i.e. the avoidance of excessive deficits. The
surveillance mechanism, geared towards achieving balanced budgets over the
medium term, provides a broader approach but is 'soft', as are the more
encompassing coordination mechanisms, above all the BEPG and the procedures
dealing with employment and open-market issues. Only the 'macroeconomic dialogue'
or 'Cologne Process' explicitly involves the ECB but is, unsurprisingly, 'soft'.
Under normal conditions, cyclical
swings of the economy are smoothed through the so-called 'automatic stabilizers'
operating in the public sector in the form of higher government expenditure (e.g.
social transfers) and lower receipts (taxes) at times of economic downturn
(Frenkel/Razin 1987). Empirical research suggests that European economies have
experienced extensive stabilization effects through fiscal policy (Sorensen/Yosha
1998). One can estimate that changes in government revenues across Europe
regularly offset between a third and a half of the initial variation in
disposable income (Bayoumi/Eichengreen 1995). The automatic stabilizers reduce
the first-year effect on real gross domestic product (GDP) of a five-percent
reduction in the marginal propensity to consume by up to 50 percent. As a rule
of thumb for the EU average, the deficit responds to every percentage point of a
cyclical swing with a countermovement of around 0.5 percent of GDP
(Bundesministerium der Finanzen 2001).  The importance of automatic stabilization
has even increased with EMU because the common and, by definition, 'one size
fits all' monetary policy is bound to be destabilizing for countries that find
themselves off the inflation average of the zone (Enderlein 2001; Hughes Hallett/Warmedinger
EMU is designed to accommodate the
conflicting requirements of long-term consolidation and short-term stabilization
(including in principle even discretionary measures) under the assumption that
budgets start from a sufficiently 'safe' position at the beginning of a downturn
– ideally from budgetary balance as envisaged by the Stability Pact. The fact
that budgetary balance had not been achieved in about three quarters of the
eurozone economy by 2001 (despite reasonable strong growth in 1999 and 2000)
cannot be attributed to the Treaty or the SGP. However, given the negative
starting position in a number of core economies and a currently growing output
gap, the system now has a tendency to impose consolidation at the cost of
stabilization and technically requires procyclical retrenchment in those
countries that are close or above the three percent limit. This at least
partially disables the beneficial effects of the automatic stabilizers; the loss
in output and employment is larger than necessary. The automatic stabilizers
were already completely or strongly hampered in Belgium, Germany, Greece,
Ireland, Italy, the Netherlands and Spain during the recession of the first half
of the 1990s, when countries were striving to fulfill the Maastricht criteria
(Bundesministerium der Finanzen 2001). It seems unlikely that the present
slowdown should show a different picture for countries close to the three
percent limit. Particularly worrisome in this context seems the reduction in
public investment associated with the consolidation effort. 
On the other hand, a lot of the
academic criticism voiced along these lines against the SGP is exaggerated. The
pact is considerably more flexible than its critics suggest. A sanction
procedure is extremely unlikely to be launched as long as a member state
government cooperates and takes measures in accordance with ECOFIN
recommendations.  The fact that the pact can be applied in a flexible –
"intelligent" – manner has not sufficiently been communicated so far. This lack
of communication could be attributed to the political purpose of the pact in the
late 1990s, when it was principally sold as a rock-hard guarantee for fiscal
discipline in order to make EMU more acceptable to a skeptical German public (Heipertz/Verdun forthcoming). The pact endangers automatic stabilization only if it
is applied with excessive rigor (which seems unlikely at present) and only in
those countries that have failed to 'do their homework' in the sense of building
up budgetary reserves during periods of growth, which would have placed them
comfortably below the three percent line.
Political Economy of the Pact
A political interpretation of the pact
is that it was proposed by former German finance minister Waigel in 1995 not
primarily as a response to the recognized need for enhanced fiscal discipline
but, more profanely, in order to counter the growing fears of the German public
about EMU and to pre-empt moves of the opposition, poised to capitalize
electorally on these worries. At the time, according to officials in the German
ministry of finance, 'nobody calculated the effects of such a rule.' 
Nevertheless, Waigel's negotiation mantra was that EMU required additional
measures for fiscal discipline. The major political-economy argument in favor of
the pact is that it serves to guarantee the credibility of the political
independence of the ECB, whose stability orientation is called into question by
the inflationary effects of fiscal policy, if not openly jeopardized by bail-out
demands. What, then, are the channels of transmission from fiscal to monetary
policy, in addition to the private sector budget constraint mechanism explored
by the Fiscal Theory of the Price level?
Essentially, the debt ratio affects the
equilibrium inflation rate through the government budget constraint and, like in
the FTPL, leads to a higher interest rate (Grauwe 1996). What is important about
this result is the fact that there is an additional channel, via government
preferences, through which public debt has a positive influence on inflation.
Adding a typical central bank reaction function (Taylor 1993), one would expect
the monetary authorities to increase the nominal interest rate and stifle growth
By preventing and even reversing
further rises in the debt level, the Stability Pact is supposed to pre-empt
political pressure for monetary leniency while ruling out the possibility of and
hence demands for a monetary bail-out in the event of fiscal insolvability (Artis/Winkler
1999; Papadia/Ruggiero 1999; Thygesen 1999; Willet 1999). However, it would be
more helpful and consistent to have a regime that explicitly establishes
monetary leadership over fiscal policy rather than merely an institutional
setting that only strengthens monetary policy in its interaction with fiscal
policy without securing clear primacy (Beetsma/Bovenberg 1995). Nevertheless,
the pact can be seen as a useful commitment device of policymakers vis-à-vis
their domestic constituencies (Buti/Sapir 1998) and a welcome source of external
discipline (Allsopp/Vines 2000).
The SGP at first sight appears to
possess favorable political economy characteristics. The three percent limit,
originally introduced in France to redress the effects of Mitterrand's Keynesian
experiment of the early 1980s, is admitted to be somewhat arbitrary but
nevertheless helpful because it is transparent and at least consistent with a
sixty percent ratio of public debt under conditions of five percent of nominal
growth. Other advantageous political economy features are high public visibility,
the clear incentive structure, political ownership, transparency enhanced by
easy monitoring, and credibility (Buti/Giudice 2002), (Canzoneri/Diba 2001;
On the other hand, should ECB
credibility be the problem at issue, then the ECB's reputation for 'toughness'
that it has successfully built up since 1999 is increasingly making the pact
superfluous (Canzoneri/Diba 2001). What is worse, it could even prove to be
counterproductive. Assuming higher deficits or purely monetary conditions spur
the need to raise interest rates, then countries with high levels of public debt
will immediately blame the ECB that this increases their interest payments to an
intolerable extent and thereby pushes them closer to or beyond the three percent
limit. In this way the pact would in fact provide additional ammunition for
high-debt countries to pressurize the ECB. This scenario is not at all unlikely,
at least for economies with a short-term debt maturity structure (Artis/Winkler
1999). Another reason for increased rather than decreased political and public
pressure on the ECB is the hampering of automatic stabilizers by the pact (Grauwe
1997; Grauwe 1998). After all, it is also a monetary task to address the danger
of deflation in Germany. The vicious circle is that the more politicians and the
public at large demand interest rate cuts, the less inclined the ECB directorate
will be to implement them at the cost of their reputation – central bankers like
to describe themselves as cream that gets stiffer when it is whipped. Yet, when
the ECB finally is pressurized into monetary leniency, the negative effects of
the worsened policy mix on output and employment could be aggravated by capital
outflows (Nordhaus 1994). In both cases, the consolidation achievements of the
1990s would quickly be put at risk by a prolonged period of substantial output
gaps and severe underemployment. There is therefore a considerable risk that the
entirety of the EMU institutional set-up, including ECB independence, will be
threatened by low growth, high unemployment and potentially ensuing political
radicalization (Willet 1999).
the Pact be Adhered to?
Problems of non-compliance with the
pact are not surprising, given alone the pact's incompatibilities with some of
the national fiscal-policy arrangements across the eurozone. National fiscal
systems follow either a delegation approach or a contract approach
(Hallerberg/Hagen 1998). In the former case, hierarchical relationships are
centered in the hands of a dominant budgetary decision-maker (mostly the finance
minister) with strategic powers over the other players. This system internalizes
the inherent externalities of the budget (consisting of the fact that 'spending
other people's money' inevitably involves incentives towards socially wasteful
behavior). In contrast, the contract approach rests on horizontal relationships.
The participants negotiate key budgetary parameters, and some degree of
internalization of the externality problem should ideally occur through the
process of negotiation, which is only monitored but not controlled by the
The SGP and particularly its EDP
resemble the contract approach plus an external enforcement agent (Hagen/Hughes
Hallett/Strauch 2001).  Based on the experience of OECD countries, one can expect
that this method is not going to be adequate for the supervision of single-party
governments and countries applying the delegation approach. However, it is
complementary to countries that have themselves implemented contract approaches
at the national level and can be expected to perform reasonably well in these
cases. An important insight from studies on the implementation of European
legislation in member states is that domestic parameters 'frame' the ways in
which national actors deal with European provisions. The more European
requirements are compatible with national approaches, the better they will be
implemented (see, for example, Börzel/Risse 2000). The size of the 'misfit'
between European and national institutions (in the sense of rules) is a fair
measure of the adaptation pressure, which in the case of the SGP can be expected
to translate into non-compliance. This discussion not only allows us to
highlight the risks of non-compliance with the pact in those countries that
experience a high misfit but also stresses the need to reform national
budget-making procedures in line with the European approach. It is insufficient
to simply superimpose a rule and take its subsequent implementation for granted.
Furthermore, the pact's effectiveness
hinges crucially on the negotiating weight of the enforcement agent (here
represented by the functions of the Commission and ECOFIN). Let us suppose that
their influence on large countries is less than on small ones.  Then only small
countries with the contract approach at the national level will pay attention
and comply. There seems to be initial empirical evidence that this is the case.
Among the countries close to the deficit limit, Germany follows a delegation
approach, is a large country, would like to comply, but is unable to do so. 
France follows the delegation approach and is a large country ― it even actively
undermines the pact, based on its traditional view of economy policy. Italy has
a fragmented system of fiscal policymaking and is a large country. Its stance
against the pact is more subtle but no less aggressive than the French one.
However, Portugal, with a contract approach and small in size, seems to be
willing to comply ― based on its rhetoric and information from Commission
officials that the Portuguese administration goes out of its way to cooperate on
the EDP. 
A further indicator of compliance
problems is that one can observe strongly varying patterns of the degree to
which fiscal rules have been implemented as a result of the pact (Hallerberg et
al. 2001; Fischer/Reitano 2001). The measures taken range from the formulation
of internal fiscal targets in the context of the Stability Programmes, in
conjunction with detailed ministerial arrangements for staying close to the
announced targets, on the one hand, to virtually non-existent links between the
Stability Programmes and the budgetary process, on the other hand. A similar
variety is to be found among arrangements at the sub-national level.
Additionally, annual budgetary cycles are usually completely out of tune with
the reporting schedule of the surveillance processes, making it virtually
impossible to accommodate Council recommendations in time. In sum, a strict
application of the framework cannot be taken for granted (Wessels 1998). The
consequences of non-compliance would be a general undermining of the pact due to
lost credibility, possibly triggering the whole range of problems associated
with fiscal looseness that the pact was designed to prevent.
a Policy Rule be Stupid?
The President of the Commission of the
European Communities, Romano Prodi, famously described the SGP as 'stupid' in
the sense of it being a simple and inflexible rule preventing the adjustments of
fiscal policy needed to deal with the current situation (Le Monde, 17/10/02).
This remark suggests that there could be a fiscal policy rule that, unlike the
SGP, qualifies as 'intelligent' in the sense of not hampering (automatic)
stabilization in the short run while achieving consolidation in the long run.
Indeed, some changes to the present regime have been discussed in the literature.
Most often heard is the demand to use
structural rather than nominal indicators, in particular to replace the blunt
budget deficit by a cyclically adjusted or structural measure (Buiter/Corsetti/Roubini
1993; Eichengreen 1996). Excessive deficit evaluations based on structural
figures would leave enough room for automatic stabilizers, but still pose
considerable problems of definition and implementation. The suggestion is also
to amend the asymmetrical focus on deficits by including indicators for debt and
possibly inflation. This would not only give more flexibility to short-term
fiscal policy but also take into account the more substantial danger to
stability stemming from debt rather than deficits.
Furthermore, one could envisage
measures that account for both the quality of public finance (particularly the
investment content) and the quality of consolidation (favoring expenditure-based
retrenchment over tax-based consolidation and reducing government expenditure
rather than public investment). Additionally, national or even European buffer
funds could be devised, such as those that seem to be increasingly popular with
Scandinavian governments. Their function is to automatically cushion the
amplitude of cyclical fluctuations, quite similar to a water reservoir that is
full in times of ample supply, providing reserves for meager periods. They could
represent a useful enhancement of the automatic stabilizers (Buti/Giudice 2002;
Swedish Ministry of Finance 2002).
Another deficit rule was already in
existence before EMU. The 'golden rule' basically states that the deficit must
not be greater than the volume of public investment. It is enshrined in Article
115 of the German Basic Law and also applied by the UK Treasury.  In essence this
approach has the clear advantage over the SGP that it differentiates between
public consumption and public investment. The latter has more significant growth
effects, increases the asset side of the public balance sheet and is seen as a
very suitable instrument for anti-cyclical stabilization. One could even
envisage a definition of the structural deficit that includes a permanent level
of acceptable deficit financing for investment purposes, as now demanded by the
Italian government (Sachverständigenrat zur Begutachtung der
gesamtwirtschaftlichen Entwicklung 1998; Sachverständigenrat zur Begutachtung
der gesamtwirtschaftlichen Entwicklung 2000).  The concept, however, suffers like
the structural deficit from the problem that both the definition and the
empirical assessment of public investments currently pose insurmountable
obstacles, almost inviting budgetary tricks and 'cosmetic accounting'.
A necessary complement to the SGP would
be the introduction of effective national stability pacts in countries where the
central government does not fully control the overall budget deficit. In the
absence of national stability pacts, sub-central governments and other sources
of public expenditure do not internalize the negative effects of their
overspending, which are exclusively born by the central government. The ensuing
problems of moral hazard would have to be addressed, possibly also leading to
tax autonomy for sub-central governments (Hagen/Eichengreen 1996; Scharpf 2002).
Designs for fiscal responsibility that
represent substantially different alternatives to one form or another of a
deficit rule are few in number. Among the hypothetical possibilities, ranging
from a comprehensive reform program of fiscal policy (Eichengreen 1996) to
budgetary control through financial markets, only a concept of tradable deficit
permits has been seriously discussed in the literature. Casella (1999) has
received some attention for her proposal to establish deficit vouchers as a
market-based solution for the allocation of entitlements to public borrowing,
similar to emission permits as a way of achieving an efficient reduction of air
pollution. However, a European stabilization and transfer system in the form of
fiscal federalism  and any radical changes and supranational solutions required
currently seem out of political reach. This also holds for the theoretically
most appealing solution perhaps, an independent fiscal agency.
In the agency approach, a council of
independent experts, the fiscal pendant to Rogoff's 'conservative central banker',
should determine and, if necessary, re-adjust the annual surplus or deficit for
each country according to its output gap (Buti/Giudice 2002; Peffekoven et al.
2002; Swedish Ministry of Finance 2002; Wren-Lewis 2000; Wyplosz 2001). This,
unlike the rule-bound parliamentary process used today, would allow
counter-cyclical stabilization as well as credible ad hoc readjustment in the
light of changing circumstances. Controlling the excess or shortfall of public
revenue over public spending, the agency would still leave the total size of the
budget and its redistributive dimension to political choice. What it would
predetermine, however, is the cyclical effect of the budget. The Belgian
Conseil Supérieur des Finances can be seen as a first and successful step in
this direction (Hagen et al. 2001). Waigel's original proposal for the SGP
contained an independent 'Stability Council' that would have been responsible
for determining the existence of an excessive deficit in the place of ECOFIN
(Bundesministerium der Finanzen 1995). However, a real transfer of fiscal
competence to a non-political, independent expert body is at the moment not
politically feasible. Appropriating the state budget for electoral purposes
while hiding behind the fig leaf of democratic legitimacy is still too much of a
temptation for current decision-makers. Yet even if there were progress in that
direction, instinctive French inclinations to turn the agency into a
gouvernement économique with jurisdiction over the ECB would make the idea
unacceptable to the Dutch and Germans.
Budgetary rules are generally quite
successful disciplinary devices in federal states but usually fall short of
their stated goals (Poterba 1996; Alesina/Bayoumi 1996). In comparison to US
balanced budget rules, the SGP appears to be more effective with respect to ex
post evaluation and the toughness of its sanctions (Eijffinger/Haan 2000; Inman
1996). Also judged against the Kopits-Symansky desiderata of 'good' fiscal rules, 
one can confirm a satisfactory performance of the SGP (Buti/Giudice 2002). The
effects of the Maastricht convergence process that it tries to secure for Stage
III are seen to have been beneficial on the whole (Buti/Sapir 1998). A number of
member states have corrected their unsustainable fiscal paths (Corsetti/Roubini
1992; Masson 1996), and the consolidation even triggered non-Keynesian effects. 
However, these events are probably unique, at least in their magnitude, because
of the one-off chance to consolidate parallel to interest rates falling from
historic heights. The success is also overshadowed by accounting tricks and
one-off measures. The strong political incentives provided by the selection of
entry to Stage III are only imperfectly substituted by the SGP incentive
structure. This justifies the concern that the criteria have either lost or are
soon going to lose a great deal of their political force, making way for
'convergence fatigue' (Hardenet al. 1995).
All in all, there is no lack of
amendments and changes being proposed for a more useful type of arrangement –
including joint deliberations by the French and German treasuries to introduce
inflation measures into the fiscal rule (Le Monde, 15/10/02). Yet, skepticism
remains warranted even with regard to an 'intelligent' rule. The more
complicated and elaborated the rule becomes, the more prone it will be to abuse,
accounting tricks and measurement failures. It will lose its transparency and
visibility in the public eye, and thereby a lot of its bite. I fear that, for
reasons of political economy, a fiscal rule will have to be either 'stupid' and
effective or 'intelligent' and ineffective. An intelligent and effective
solution, if it exists, is not within political reach for the moment.
This paper has attempted to condense
the economic debate on the Stability and Growth Pact, concentrating on the core
issues. The current regime can be seen as enabling 'rule-bound discretion'. It
allows for fiscal flexibility up to the 3% limit at which discipline is enforced
– albeit to a less rigid degree than hitherto expected. The sanctions are
politicized and function asymmetrically in the realm of dissuasion, not
for the sake of preventing budgetary slippages. In doing so, the pact
shows a potentially costly preference for consolidation over stabilization, the
need for the latter having greatly increased through EMU. This is the case
irrespective of the valid point that all European governments have to address
the challenge of budgetary consolidation and that a number of them have failed
to do so in time. Obviously, the 'soft' incentives for prevention provided by
the SGP framework have been insufficient in this respect. Even the most
essential aim of the pact might be badly served: It is at least unclear whether
the political economy of EMU will not develop strong tendencies towards an
undermining of both fiscal discipline and central bank independence. Even short
of that, the present system is likely to impose substantial costs through a
discordant rather than consensual way of monetary-fiscal interaction.
The stability pact is part and parcel
of an economic policy design which forces the member states to focus on
short-term budget deficits at the expense of anti-cyclical stabilization,
structural reforms and medium-term debt consolidation. This approach could prove
counterproductive and its legitimacy is debatable. Governance in the EU and
economic policy in the eurozone in particular are void of opportunities to
provide 'input legitimacy' in the form of voter participation. If Europe, on top
of this, confines itself to solutions that do not demonstrate the necessary
problem-solving capacity, then the corresponding lack of 'output legitimacy'
will contribute to a further undermining of popular support for EMU, for the
wider field of European integration and, ultimately, for national systems of
democratic governance altogether (Scharpf 1999). At Maastricht, there was no
window of opportunity for the design of comprehensive economic institutions
under the label of 'political union'. EMU was created with a focus on monetary
policy and entirely along the lines required by the 'paradigm of sound money'
(Dyson 2000). With this unilateral and asymmetric approach, it contributes to
rather than reverses a process through which nation states are becoming
increasingly impotent in addressing the challenges of globalization. On the
other hand, given the lack of political will to design a truly bold and
comprehensive regime that would effectively address the entirety of economic
policy dimensions in relation to monetary union, the pact goes a long way to
remedying the shortages of the Maastricht Treaty. It is surely not the optimal
solution. However, the second best is still better than nothing. Those
governments who currently make it their business to undermine the pact will have
to show that they in fact prefer a superior alternative to the vacuum that an
undermined pact would leave. For the moment, you cannot beat something with
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The paper has greatly benefited from comments by
Fritz W. Scharpf, Anke Hassel, Birgitta Rabe, Eric Jones, Amy Verdun and Pieter
Bouwen. I gratefully acknowledge their contribution while assuming
responsibility for all remaining errors.
I owe this point to Fritz W. Scharpf.
Most large economies of the eurozone did not use the
opportunity for further consolidation during the growth period of 1999/2000.
This issue is also stressed by Demertzis et al. (1999),
who highlight the risk of heightened conflict between left-wing governments and
the central bank, which would increase the gains from co-ordination. An earlier
approach along the same lines was followed by Alesina/Tabellini (1987), who
analyze a game-theoretic model where a monetary regime with commitment does not
necessarily improve welfare compared to a discretionary regime unless fiscal
policies are coordinated.
The Cologne Process was initiated by the German presidency
in 1999, aiming at an encompassing 'macroeconomic dialogue' that involves not
only Member State governments and the ECB but also 'social partners' in the
wider sense, particularly trade unions and employer organisations. The process
has never taken off towards effective coordination of macroeconomic policies and
remains a mere forum for the exchange of views.
Both the rule and the agency could then follow Keynesian
premises in theory, while in practice being rightly associated with neoclassical
and monetarist theorists. I owe this point to Anke Hassel.
Other, less prominent theoretical foundations than the
Fiscal Theory of the Price Level are the Domar-Tobin Formula (which can be used
to check the consistency of deficit criteria and debt levels – 60% debt level is
sustainable with a 3% annual deficit if nominal growth is at 5% p.a.; Domar
1944, Tobin 1984) and Dornbusch's Commitment Model, where policymakers have an
incentive to reduce the real value of debt through inflation (Dornbusch 1997).
They both also point to the need for fiscal discipline.
Fundamental to this view has been the New Keynesian
explanation of sluggish wage and price adjustments through staggering,
efficiency wages, menu costs, etc. (see, for example, Mankiw 1985).
It has to be noted that, starting from a position of
balanced budgets, the SGP would in principle exactly fulfill that function (Buti/Sapir
1998). The major policy error, then, lies in entering stage three of EMU
prior to completing the transition to balanced budgets (Eichengreen 1996).
On the other hand, it is doubtful whether the incomplete convergence and
consolidation process could have been implemented at all without the incentive
of hitting the 1999 deadline.
Article 104 and Protocol 20 of the Treaty establishing the
Resolution of the European Council on the Stability and
Growth Pact, O.J. 1997, C 236/1
Council Regulation No. 1466/97 of 7 July 1997 on the
strengthening of the surveillance of budgetary positions and the surveillance
and coordination of economic policies, O.J. 1997, L 209/1; and Council
Regulation No. 1467/97 on speeding up and clarifying the implementation of the
excessive deficit procedure, O.J. L 209/6.
The Council decision to send an early warning to France on
21 January 2003 was the first time that member states proceeded in voting
relative to the pact. France abstained; the other 14 finance ministers of the EU
– including the 'outs' – voted in favor.
The government of the Netherlands has threatened to do so
in the current crisis (Handelsblatt 12.09.2003).
Interview with a former member of the Economic and
Financial Committee, December 2002.
Hallerberg (2001) lists four goals for the coordination of
fiscal policy: (1) avoidance of moral hazard problems (one country free-riding
on the consolidation benefits of another or externalizing the costs of fiscal
profligacy), (2) exchange of information and analysis, (3) mutual adjustment of
national fiscal policies, improving convergence, and (4) promotion of fiscal
discipline and more prudent macroeconomic policies.
The effect of automatic stabilization can be enhanced by
discretionary measures adopted by the fiscal authorities. However, the
beneficial nature of discretionary stabilization policy is highly debatable.
Above all, even if the fiscal authorities could react swiftly and appropriately,
how should they know in advance their position in the economic cycle and the
future development of the latter? Additional problems are posed by inevitable
judgment errors of the output gap and time lags in the policy implementation,
not to mention the overarching concern of time inconsistency.
In this context, it is interesting to note that the
official attitude toward the balance between stability and stabilization is not
biased against the requirements of fully functioning stabilizers: "Since, after
the introduction of a single currency, the adjustment to adverse cyclical
developments and country-specific disturbances will to an important extent rest
with budgetary policy, it will be of paramount importance to ensure that the
automatic stabilisers will be able fully to play their role." (Council of the
European Union 1998, Section 5)
This is precisely the difference in behavior between
Portugal and Germany on the one hand, who at least pretend to play by the rules,
and France on the other hand, openly challenging them.
Interview with senior official in the Federal Ministry of
Financial Affairs on 12 December 2002.
More precisely, the function of the enforcement agent is
split between the Commission and ECOFIN, so it is only partially external.
Small countries tend to pay more attention to
international organizations, even more to the degree that they receive financial
transfers through them (Katzenstein 1991).
There are structural reasons why Germany's deficit will
continue in the current downturn to push beyond three percent (Allsopp 2002).
The finance minister will be frustrated in his efforts to contain the slippage
as long as an effective national stability pact cannot be signed by the federal
government, the Länder and the major social insurance schemes.
Author's interviews in the Directorate General for
Economics and Finance of the Commission of the European Communities, 2002/3.
The Kohl government's habit of using off-budget funds for
the financing of unification-related transfers was only the last in a series of
steps that have undermined the rule in Germany. The golden-rule debate is
summarized in Balassone/Franco (2001).
According to Milesi (1998), the German government sought
to introduce a golden-rule type arrangement into the Maastricht Treaty, and it
was Mitterrand who preferred a nominal deficit rule, which had already been
employed in the French consolidation exercise of the 1980s. This choice was
favored by monetarist circles in France and seems to have framed the French
approach to the formulation of a European rule.
The MacDougall Report (McDougall Committee [Study Group on
the Role of Public Finance in European Integration], 1977) stresses the need for
fiscal federalism at the scale of at least five percent of European GDP to
offset asymmetric shocks in a monetary union. Italianer/Pisani-Ferry (1991)
devise a system that manages with only two percent of GDP. The Delors Report (Council
of the European Union / Committee for the Study of Economic and Monetary Union,
1989) admits, however, that fiscal federalism is politically not feasible. The
generally assumed reason for the political infeasibility of fiscal federalism is
a lack of the degree of solidarity that is present at the national level.
According to Kopits/Symansky (1998) and Kopits (2001), a
'good' fiscal rule should be well-defined, transparent, simple, flexible,
adequate relative to the final goal, enforceable, consistent with other policies,
and underpinned by public finance reforms.
Traditionally, one expects a dampening of economic
activity to result from fiscal retrenchment. 'Non-Keynesian effects' operate in
the opposite direction, through a consumption and investment impact of lower
anticipated future taxes and increased confidence. These effects seem to be
stronger for expenditure-based consolidation than for tax-based consolidation,
and are positively correlated to the size of the retrenchment. They have been
studied by, among others, Giavazzi/Pagano (1990), Giavazzi/Pagano (1995),
Perotti (1996), and Roeger/in't Veld (1997). Buti assumes non-Keynesian effects
under EMU to coincide with enhanced liquidity due to financial liberalization
and the associated diversification of financial instruments, thereby further
enhancing domestic consumption. For Germany, non-Keynesian effects seem to be
relevant over the long term, whereas government expenditure is positively
correlated with growth in the short term (Bundesministerium der Finanzen 2001).
Non-Keynesian effects seem to have been present in Italy during the 1990's
consolidation (Commission of the European Communities 1999). Also Hagen et al.
(2001) note a 'Maastricht effect' and the presence of non-Keynesian effects, but
question whether they can prevail once the high visibility of the Maastricht
convergence is over with the start of Stage III. The signaling and commitment
powers of the Maastricht criteria are no longer existent, so the cost of
consolidation can be expected to have risen again.
Copyright © 2003 Martin Heipertz
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