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In 1997, the Stability and Growth Pact (SGP) expanded on the original concept of the Maastricht Treaty, providing more comprehensive guidelines and procedures to promote fiscal discipline and enforcement. The framework shifts the focus and motivation from the original goal of ensuring the sustainability of the Maastricht Treaty to the broader goal of “strengthening the surveillance of budgetary positions and the surveillance and coordination of economic policies.” The SGP consists of two arms. The first one, based on Council Regulation 1466/97, aims at the prevention of excessive deficit with a budgetary balance or surplus in the medium run. The amount of leeway a government needs is determined by the “minimal balance”, which provides a sufficient safety margin for the 3 percent actual deficit norm not to be breached in normal circumstances which did not explicitly refer to the debt ratio as a rule (although, obviously, it remained in the Treaty of 60 percent). The second one, based on Council Regulation 1467/97, is designed to correct situations where fiscal limits are violated. This is executed by the Excessive Deficit Procedure (EDP), a complicated procedure of semi-automatic sanctions. In the following years, mainly in response to a crisis, the SGP encountered many changes in its structure: in 2005 an amendment to take into account individual national circumstances effectively and incorporate economic rationale into the rules; in 2011 with the Six Pack and The European Semester that oversees the monitoring of both budgetary and economic policies, and sets out minimum requirements for national budgetary frameworks; in 2013 the Two Pack and The Fiscal Compact, which forms part of the intergovernmental Treaty on Stability, Coordination, and Governance (TSCG), mandates national provisions to align with the budgetary objectives set by the SGP; in 2014, 2015, and 2020 the latest reviews of the SGP looking for clarity, simplification, and flexibility, permitting adjustment for answering cyclical conditions.

What happened during the COVID-19 crisis:

The economic crisis triggered by COVID-19 has put enormous pressure on public finances. In March 2020, the Governing Council activated the SGP’s general escape clause, giving member states a limited period within which to increase their public debt beyond fiscal rule limits. Today the SGP is not still reintroduced because the situation is full of uncertainty and various national European governments are not already capable of returning to normal public expenditure. Furthermore, in 2022, the post-pandemic economic situation and the aftermath of the war in Ukraine, mainly in the form of sharply higher energy prices, lead to a historic increase in euro area inflation. In response to this the European Commission in the Fiscal policy guidance for 2023 calls out for “strong coordination of economic and fiscal policies to transition out of the COVID-19 crisis.” Stressing that continued strong fiscal policy coordination is needed to ensure a smooth transition to a new sustainable growth path and fiscal sustainability. Member states and EU organizations successfully mitigated the severe recession in the EU economy through a coordinated fiscal response to COVID-19. In fact, In combination with the suspension of the SGP, the European Union creates a more than €800 billion recovery instrument, the NextGenerationEU, to help repair the immediate economic and social damage caused by COVID-19. Another fundamental recovery tool used by the ECB is the Pandemic Emergency Purchase Program (PEPP), which involves buying large quantities of government bonds in the secondary market. Along with this maneuver, in July 2022, the ECB announced an “anti- fragmentation tool”, the Transmission Protection Instrument (TPI), in response to the fear that the spread of government bonds of highly indebted countries will skyrocket following the Ukraine war. For these reasons, we have now closed the gap to pre-pandemic production levels. However, many issues remain in the public debate on European policies and instruments, including possible revisions to the SGP to allow high-debt countries more time to bring down their debt-to-GDP ratio.

The main weaknesses of the SGP:

Albeit bringing some visible advantages, the SGP is far to be perfect. While can be argued that SGP is an essential tool for sustainable economic development in the Eurozone and for improving coordination between members, the fundamental argument in favor of the SGP is that fiscal indiscipline can become the source of inflation. This is drawn from robust empirical evidence, which is been widely recognized since the German experience of the 1920s, demonstrating that a lack of fiscal discipline can lead to inflation. To address the core issue, the principal weakness of this instrument lies in the very nature of the EMU, which is a far more profound flaw than the lack of flexibility that made Romano Prodi call the SGP “stupid” back in 2002. The SGP can be seen as an imaginary midland between a political federal union and a monetary one that allows singular state authorities freedom in governing regarding fiscal policy. To draw a parallel, while the ECB is equipped with a clear mandate towards price stability and adequate independence that enables it to establish a credible policy, national states must deal, often with poor governance, with a fiscal policy that made them struggle to meet the convergence criteria. Therefore, there has been a past failure to effectively address fundamental structural reforms to fiscal policies during economic “good times.” The result was that, when the 2008 crisis struck, states, like Italy, were limited in their ability to carry out a significant discretionary fiscal stimulus by the need to avert market penalties. As I previously said, the evolution of the SGP is moving toward flexibility and discretional application and, while governments are more favorable to this kind of development, this can turn into a double-edge situation where countries, in a true game theory style, will try to exceed the strict criteria of the SGP to shift the burden of their additional deficit onto more fiscally responsible ones. To tackle this problem, a set of more recent reforms were implemented, known as the Six Pack, Two Pack, and TSCG. These reforms aimed to reinforce and promote economic convergence, coordinate and monitor fiscal policies, and establish clear rules and procedures for budgetary and economic surveillance, like the imperative to submit their draft budget plans to the European Commission for review, to ensure the long-term sustainability of the European economy. However, from what we see from the graph, the result of SGP doesn’t been that brilliant. With these premises, finally, we arrive at our primary question on how the SPG should be reformed.

The graph shows the government’s balances over the course of more than twenty years, the gray zones represent the period in which the SGP wasn’t fully operational.
Source: Eurostat’s Dataset, Government deficit/surplus, debt, and associated data, last update: 21/10/2022,
https://ec.europa.eu/eurostat/databrowser/view/GOV_10DD_EDPT1 custom_5107745/default/table?lang=en
How to reintroduce:

The optimal solution, instead of a reintroduction of the SGP, would be to establish a “fiscal union” that employs a federal approach with a substantial central authority to deliver counter-cyclical transfers in the presence of asymmetric shocks. Nevertheless, this would result in more than just a monetary union. If, in addition, the central government had the power to raise its own taxes, it would, in essence, create a political union. Unfortunately, even if a federal state can work in this situation as the easiest and natural solution, with the absence of popular consensus the real and tough challenge is to perfect a monetary union without establishing a federal one. A first improvement to the SGP would be to integrate a debt restructuring mechanism that would not only prevent debt crises but also allocate rightly the adjustment burden between debtors and creditors, also adopting a more holistic approach to fiscal policy that recognizes the interrelationship between the fiscal, monetary, and macroprudential policies. Another compelling point of view is to focus more on the role of investment in the SGP to stimulate economic growth, rather than exclusively concentrating on deficit and debt reduction. The main question now remains “when” to reintroduce the SPG. The European Commission announced that the general escape clause in the Stability and Growth Pact will remain active in 2023, and the plan is to terminate it in 2024. Likewise, to ensure a uniform economic policy response at the EU level, the Annual Sustainable Growth Survey (ASGS) outlines the key policy prerogatives and guidelines for the year ahead.

Throughout this article, we have seen the strong coordination between various elements of the EU institution. Now, I want to conclude by talking a bit about two fundamental reforms that can strongly impact the efficiency of the SGP in times of crisis. The first one is a fully integrated banking union. During the financial crisis, it was clear that a monetary union without a banking one was too fragile to survive. Communitarian regulation was easy, but, until 2014, national authorities were responsible for supervising the banking system and ensuring its stability. Nowadays, with the Basel Accords, the implementation of the Single Supervisory Mechanism (SSM), and the Single Resolution Mechanism (SRM), our banking system reached a good harmonization level. The only crucial reform not fully conformed is the introduction of a European deposit guarantee scheme, that will convey: increased confidence in the banking system; reduce the risk of contagion between banks and countries in the event of a financial crisis; lower costs of bank funding also due to simplification of the regulatory framework for banks. Hence the Eurogroup reached an agreement in June 2022 stating that: “the future of the Banking Union should focus on strengthening the common framework for bank crisis management and the national deposit guarantee scheme to have a framework that is suited to all types of banks.” The last structural improvement to grant stability and cohesion in the EU would be the implementation of the Eurobonds, often also called “joint bonds,” which refer to bonds issued in euros by a central authority on behalf of a group of member states. Eurobonds can guard Member States against contagion and speculation on financial markets more strongly and essentially than emergency funds, by securing access to market financing with less borrowing cost to countries in fiscal difficulties. However, more risk sharing and secured access to financial markets have a flipside: countries will encounter frailer motivations for keeping fiscal policies sustainable and this requires strict coordination of fiscal policy. This probably may mean that all debt public needs to be financed with centrally issued Eurobonds to avoid opportunistic behavior and enhance integration and grander political unity. Regardless, this might be the subject of a new article, now our present article is ended.

References:
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Eurostat’s Dataset, Government deficit/surplus, debt, and associated data, last update: 21/10/2022,
https://ec.europa.eu/eurostat/databrowser/view/GOV_10DD_EDPT1 custom_5107745/default/table?lang= en