Necessary improvement of the Stability and Growth Pact

The European Union is seeking to strengthen economic governance and to clarify the implementation of the Stability and Growth Pact. To this end, the shortcomings experienced so far should be addressed by placing greater emphasis on economic developments in Member States and on safeguarding the sustainability of public finances. The links between the different economic governance instruments should also be strengthened in order to sustain growth.

ACT

Communication from the Commission to the Council and the European Parliament - Strengthening economic governance and clarifying the implementation of the Stability and Growth Pact [COM(2004) 581 final].

SUMMARY

On 3 September 2004 the European Commission adopted this communication in order to strengthen economic governance and clarify the implementation of the Stability and Growth Pact. The communication follows on from the European Council's declaration that Member States are looking forward to the Commission's proposals for strengthening and clarifying the implementation of the Stability and Growth Pact and takes account of the Court of Justice's judgment in Case C-27/04 Commission v Council of the European Union regarding the annulment of Council measures against Germany and France.

Sound management of public finances is essential for sustainable economic growth. The Treaty provisions which lay down the reference values for the government deficit and public debt (3% and 60% of GNP respectively) remain the centrepiece of the system in providing the budgetary framework with the necessary underpinning. Excessive deficits should be avoided and quickly corrected. In an enlarged Union of 25 Member States, a common framework may make the existing provisions more effective by taking into account the differences between the economic situations of the Member States and their economic situations.

Increased focus on sustainability for closer surveillance of debt

The Commission has put forward three suggestions for revising the Stability and Growth Pact: clarifying and rendering operational the debt criterion, identifying country-specific medium-term budgetary objectives and defining the adjustment path in the excessive deficit procedure taking into account issues relating to the sustainability of public finances.

As regards the debt criterion, the revised Stability and Growth Pact could clarify the basis for assessing the "satisfactory pace" of debt reduction provided for in Article 104(2)(b) of the Treaty. In defining this "satisfactory pace", account should be taken of the need to bring debt levels back down to prudent levels before demographic ageing has an impact on economic and social developments in Member States. Member States' initial debt levels and their potential growth levels should also be considered. Annual assessments could be made relative to this reference pace of reduction, taking into account country-specific growth conditions. For instance, if a given Member State's growth is lower than its potential growth, the Pact would allow for a slower rate of debt reduction. Conversely, if that Member State's growth is higher than forecast, then the Pact would not allow for a slower rate of debt reduction.

Allowing for country-specific circumstances in defining medium-term objectives

Medium-term objectives are intended, on the one hand, to provide for sufficient room for manoeuvre to ensure that the government deficit does not exceed 3% of GNP during an economic slowdown without recourse to pro-cyclical fiscal policy. On the other hand, medium-term objectives allow Member States to reduce debt and to prepare for the budgetary impact of ageing populations.

The current Stability and Growth Pact does not give an operational definition of the medium-term budgetary objective. Member States are currently supposed each year to present a balanced budget position throughout the economic cycle. Uniform objectives in an EU of 25 Member States do not appear appropriate from an economic point of view.

The Commission states that a medium-term objective can be based on current debt levels, taking into account their development over time. Furthermore, factors such as potential economic growth, inflation, the existing implicit liabilities related to ageing populations, the impact of structural reforms or the need for additional net investment should also be considered.

Excessive deficit procedure and adjustment path

The scenario of slow but positive economic growth is not considered in the current regulatory framework. The Commission envisages a rethinking of the adjustment path once a country breaches the 3% deficit threshold and/or a redefinition of the "exceptional circumstances clause". A period of zero growth bringing about deficits greater than 3% would not at present trigger this clause that would avoid the Member State being placed in an excessive deficit situation. Regulation (EC) No 1467/97 sets out the exceptions to this. The Commission also feels that it is useful to clarify the concepts of "abruptness of the downturn" and "loss of output relative to past trends", but it highlights the fact that any change to the definition of this clause must be examined in conjunction with changes to the deficit adjustment path.

The Regulation stipulates that any Member State breaching the 3% limit should correct the situation "in the year following its identification [of the excessive deficit] unless there are special circumstances" (Article 3(4) of Regulation (EC) No 1467/97). In the Commission's view, one-size-fits-all deadlines for the correction of excessive deficits presents basic limitations as economic differences between countries - such as cyclical developments and debt levels - are not taken into account.

The Stability Pact should define an appropriate adjustment path that takes better into account the economic conditions of a Member State breaching the 3% threshold. Consequently, the excessive deficit procedure must always be launched once the threshold is exceeded, and a rapid correction should always be required. However, the pace of adjustment could differ between countries, with the appropriate adjustment path being defined on the basis of the economic conditions and debt levels of the Member State in question. The Commission also considers it expedient to take into account the reasons behind the excessive deficits and the policies implemented.

In practice, several different approaches can be explored within the framework of the Treaty. One possibility is to continue considering "the year following identification of the excessive deficit" as the basic rule for correction and to give the Member State the opportunity to follow a longer adjustment path by defining the Stability and Growth Pact's "exceptional circumstances clause". Country-specific deadlines as the basic rule is another solution. All the approaches require a maximum time limit for correcting the excessive deficit.

Ensuring earlier actions to correct inadequate budgetary developments

Budgetary surveillance should ensure the appropriate "peer pressure" to favour achievement of the medium-term objectives. The Stability and Growth Pact should reaffirm the Member States' commitment to pursue symmetrical fiscal policies over the cycle in order to prepare for the ageing of the population, to create sufficient room for dealing with economic slowdowns and to ensure an adequate policy mix over the cycle.

Efficient working of the peer-review mechanism in the preventive part of fiscal surveillance is essential in delivering the appropriate policies. The Commission's power to issue "early warnings" directly should contribute to signal early enough the need to correct inadequate budgetary developments. As regards the future of the Union, the Treaty establishing a Constitution for Europe brings in new provisions, such as the Commission's direct "early warnings" and the Council's decisions launching the excessive deficit procedure in the light of the Commission's proposals (rather than recommendations), thus clarifying the complementary roles of the Council and the Commission. The broad economic policy guidelines (BEPGs) can also be more effectively used to address the issue of good policy in good times. On the contrary, if budgetary policies are not in line with the BEPGs, then recommendations regarding the implementation of the BEPGs can be issued.

Coordinating budgetary policies

Reinforcing the link between the BEPGs, the Stability and Growth Pact and the national budgetary processes to make economic policy coordination more effective. Firstly, stability and convergence programmes should play a greater role and define a medium-term strategy at the start of a new government's term of office. Updates of these programmes could be brought forward to the beginning of the year, allowing the BEPGs and any opinions on the programmes to be taken into account when the governments prepare their national budgets. Secondly, a proper EU semester for economic policy would making it easier to factor common orientations into domestic policymaking.

Improving enforcement

The Commission notes that enforcement of the Community framework and of related guidelines and recommendations could be improved at national and Community levels and that the roles of the different institutions should be clarified. The implementation and credibility of the fiscal framework also depend on the quality, timeliness and reliability of fiscal statistics and governments' budgetary assessments. For this reason, the Commission is drawing up minimum European standards for the institutional set-up of statistical authorities. The Commission also would like to see other Member States putting pressure on countries that do not respect their legal obligations deriving from the Treaty and public opinion being made aware of the situation. It highlights national institutions' role in the budgetary process and envisages measures to improve transparency and to make Member States even more accountable as regards their budgetary policy.

RELATED ACTS

Communication of the Commission to the Council and the European Parliament - Towards a European governance strategy for fiscal statistics [COM(2004) 832 final - Not published in the Official Journal]. The implementation of the fiscal framework and its credibility rely on the quality, timeliness and reliability of fiscal statistics. The Commission aims to present a consistent strategy for strengthening the Union's governance as regards fiscal statistics. It considers that:

• the provisions on the quality of fiscal statistical data need to be clarified;
• the operational capacities of the Commission, most notably Eurostat and of the Directorate-General for Economic and Financial Affairs, need to be improved;
• there is a need to establish Europe-wide standards to ensure the independence, integrity and accountability of the national statistical institutes.

Last updated: 19.10.2005