In December 1991 at a summit in Maastricht the twelve nations, which
constituted the European Community at that time, agreed on a treaty to
transform the European Community into an European Union (EU). This Treaty
was signed 1992 and came effective on November 1st of 1993 as an
amendment to the treaty of Rome, the treaty the European Community
was build on. Four years later the treaty of Amsterdam put the treaty of Maastricht into
more concrete terms. The contracting parties agreed in Article B of this
treaty that the Union will set itself (among others) the objective to promote
economic and social progress through the establishment of an economicand
monetary union (EMU), ultimately including a single currency. Under
title V and VI of this treaty the countries also agreed to build up common,
foreign- and security policies as well as to intensify their cooperation in
fields of justice und home affairs. Title VII defines the ideas of a common
economic and monetary policy. The treaty of Amsterdam was signed on
October, 2nd 1997. Since all the Member States had to ratify the treaty by
their respective legislative procedures, it did not come into effect until the
end of May 1999.
The European treaties, taken together, form the primary legislation and
have characteristics of a constitution of the Community. The treaties
provide the legal basis for all secondary legislation, i.e. regulations,
directives and decisions of the institutions of the Community.
1 Peichl, Andreas (2003), p. 1-3.
2 Cowgill, Anthony and Andrew (2003b), p. 2.
Table of contents
Abbreviations
1 Introduction - European Monetary Union: from the Treaty of Maastricht to the Stability and Growth Pact
1.1 The Treaty of Maastricht
1.2 The Treaty of Amsterdam
1.3 Three Steps to the formation of an European Monetary Union
1.4 Criteria of Stability and Convergence - Selection of Member States for the Single Currency
1.5 From the criteria of stability and convergence to the Stability and Growth Pact
1.6 Legal framework of the Stability and Growth Pact
2 New monetarism - The Economic background of the Stability and Growth Pact
2.1 Essential features of new monetarism
2.1.1 Irrational decision making
2.1.2 Debts as an expression of mislead fiscal policy
2.1.3 Inflation
2.1.4 The future role of fiscal policy
3 Mechanics of the stability and growth pact
3.1 The budgetary rules of the Treaty of Amsterdam as basic principles for the SGP
3.2 The budgetary rules of the SGP,,
3.2.1 The government budget deficit rule
3.2.2 The medium-term balance rule
3.2.3 Why 60 % and 3 %?,
3.3 The implementation of the Stability and Growth Pact
3.3.1 “Stability”Committee
3.3.2 Formulation of national stability and convergence programs,,
3.4 Enforcing the SPG - The excessive deficit procedure
3.4.1 Early warning system to avoid excessive deficits
3.4.2 Penalties for Breach of Stability Pact Criteria
4 Assessment of the SGP - a look on the relevant indicators of the membership states of EU, Germany and of those countries joining the EU on May, 1st
4.1 Development within the EU
4.2 Development in Germany
4.3 Development in the “acceding countries”
5 Conclusion
6 Appendix
6.1 References
6.2 Figures
6.3 Tables
Abbreviations
illustration not visible in this excerpt
1 Introduction
European Monetary Union: from the Treaty of Maastricht to the Stability and Growth Pact1
1.1 The Treaty of Maastricht
In December 1991 at a summit in Maastricht the twelve nations, which constituted the European Community at that time, agreed on a treaty to transform the European Community into an European Union (EU). This Treaty was signed 1992 and came effective on November 1st of 1993 as an amendment to the treaty of Rome, the treaty the European Community was build on.2
1.2 The Treaty of Amsterdam
Four years later the treaty of Amsterdam put the treaty of Maastricht into more concrete terms. The contracting parties agreed in Article B of this treaty that the Union will set itself (among others) the objective to promote economic and social progress through the establishment of an economic- and monetary union (EMU), ultimately including a single currency. Under title V and VI of this treaty the countries also agreed to build up common, foreign- and security policies as well as to intensify their cooperation in fields of justice und home affairs. Title VII defines the ideas of a common economic and monetary policy. The treaty of Amsterdam was signed on October, 2nd 1997. Since all the Member States had to ratify the treaty by their respective legislative procedures, it did not come into effect until the end of May 1999.
The European treaties, taken together, form the primary legislation and have characteristics of a constitution of the Community. The treaties provide the legal basis for all secondary legislation, i.e. regulations, directives and decisions of the institutions of the Community.3
1.3 Three Steps to the formation of an European Monetary Union
One main issue of the treaty for the European Union was the stepwise introduction of an economic and monetary union, ultimately with a single European currency, by providing a legal framework. The path to this European economic and monetary union had first been outlined in 1989 as a concept of three steps in the so-called „Delors-Report“ named after the former president of the European commission, Jacques Delors4. The Maastricht Treaty transformed this proposed three-step plan into a concrete plan with defined timelines.
The first step concerning the start of an Exchange Rate Mechanism was taken on July, 1st 1990. It was already under way before the Maastricht Treaty was even ratified. The Second stage started January, 1st of 1994, it related to the transfer of certain aspects of monetary and economic policy from the Member States to European institutions. At a Summit in Madrid in December 1994 the European Council agreed on January 1st 1999 as the start date for the Third stage of EMU, which ultimately introduced the Euro, the name of the common currency, as single currency for the Member States of the EMU.5
1.4 Criteria of Stability and Convergence - Selection of Member States for the Single Currency
The treaty of Maastricht defined conditions under which a country may join the EMU6. The reason for defining an entry barrier to the Single Currency was the idea that member states should achieve a high degree of economic convergence, i.e. the national economic indicators of all countries should approach those of the most successful ones.
This approach was taken to guarantee a maximum of stability for the Euro.
Price stability was defined as the highest goal of a common monetary policy. One of the objectives for the newly founded European Central Bank (ECB) was to guard over the achievement of this goal7
The Treaty of Maastricht defines four criteria of stability and convergence a country has to fulfill to be eligible for joining the EMU (Art. 109 j):
- inflation: inflation rate should be no more than 1.5 % greater than that of the three best performing states.
- interest-rate: nominal long-term interest rate should not exceed, by more than 2 %, the rates of the three best performing member states.
- exchange rate: currency has stayed within the margins of normal fluctuation during the two years preceding stage 3 of EMU.
- excessive budget deficit: planned or actual government budget deficit to GDP at market prices does not exceed 3 % and the ratio of government dept to GDP at market prices does not exceed 60 %.
The deficit- and debt criteria are goals that have influence on the fiscal policy of each membership state wanting to join stage three of EMU.8
1.5 From the criteria of stability and convergence to the Stability and Growth Pact
While the convergence criteria defined strict criteria for the eligibility of a country to join the EMU, there was no instrument in the original treaty of Maastricht defining a continuous control over the future economic development of the Euro countries. In its earliest form the Stability and Growth Pact was mainly encouraged by Theo Waigel, Germanys former finance minister.
Meeting in Madrid in December 1995, the European Council confirmed the crucial importance of securing a continuous budgetary discipline in “stage three” of EMU. This stage marks the introduction of the Euro. In Florence, six months later, the European council reiterated this point of view. Finally, in December 1996, during its Dublin summit it agreed on a pact, which was now officially named “the Stability and Growth Pact (SPG)”. Although some member states, especially France, had reservations the Stability and Growth Pact was agreed upon in a Resolution of the European Council in June of 1997 (resolution of the European council from June, 17th of 1997 on the SPG due to the endorsement of the treaty of Amsterdam). The Pact started operating on January, 1st 1999 and is intended to ensure that the Euro will be able to maintain its value.
1.6 Legal framework of the Stability and Growth Pact
The Stability and Growth Pact encompasses the legislative text and political resolutions regulating fiscal policy and public finances in the EMU. It sets the rules for the fiscal policy conducted by the member states of the EMU, organizes the multilateral fiscal monitoring, spells out the discipline requirements of the Maastricht Treaty and specifies the sanctions to be applied in case of budgetary misbehavior. In short, the SGP, together with norms insuring the independence of the European Central Bank, is the main building block of the EMU.
The SPG consists of three components9: a single EC Resolution and two Council Regulations which where adopted on July, 7th 1997. The resolution commits all parties, member states, the Commission and the Council “to implement the Treaty and the Stability and Growth Pact in a strict and timely manner”. The Council Regulations, unlike the Resolution, have legal force:
- Council Regulation 1466/97 on strengthening of the surveillance of
budgetary positions and the surveillance and co-ordination of economic policies
- Council Regulation 1467/97 on speeding up and clarifying the excessive deficits procedure10,11
2 New monetarism - The Economic background of the Stability and Growth Pact
The Stability and Growth Pact was written in the course of an accelerating increase in public expenses within Europe which where financed with ascending taxes and a growing government debt12,13. Together with at the same time increasing unemployment rates this increase in public expenses was assumed to have negative effects on stability and growth in the member states of the future Euro-Region. One goal of the EMU, besides unifying Europe, is to “increase welfare, the efficiency of competition while ensuring stability of monetary value”14. According to Arestis, McCauley and Sawyer the Stability and Growth Pact can very well be described as based on a theory which is called in the literature “new monetarism”15.16
2.1 Essential features of new monetarism1
The neo-classic concept is a counter-concept to the theory of instability proposed by Keynes17. This concept is based on monetarism and follows the assumption that the private sector of a market economy will always be stable18. Changes in the activation of this sector are explained as a (cumulative) process of adoption to real and monetary disturbances that will ultimately end in a self-stabilizing control sequence. Disturbances of this balance actually arise from discretional behavior of governments in their fiscal and monetary policies.
2.1.1 Irrational decision making
On the one hand the democratic progress in general and politicians in particular cannot be trusted with economic policy formulation as they tend to make decisions that appear to have stimulating short term effects19 (e.g. reduction of unemployment rate) but which tend to have negative outcomes in longer terms (e.g. notably rise in inflation). Central bankers on the other hand usually can take a longer term perspective as they are less susceptible to short-term popularity than politicians. In the theory of new monetarism it is assumed that there is a conflict between the short-term and the long-termperspective. Therefore, stopping policy makers from making irresponsible fiscal policy might be an important goal within the Euro zone.
2.1.2 Debts as an expression of mislead fiscal policy
From this neo-classic point of view debts are an expression of mislead fiscal policy in the past. Hence, fiscal policy should be permanently constrained by the SGP and monetary policy be removed from national authorities and especially from political authorities and transferred to the European Central Bank (ECB). The intention of the stability and growth pact therefore is to keep the membership countries compliant to the convergence criteria after they have joined the EMU. This is meant to e.g. stop certain countries from financing their governmental budget in an unacceptable way by expanding their debts and thereby avoiding that such financial policy might risk the stability of the common currency.
2.1.3 Inflation
Another idea based on20 new monetarism is that inflation is a monetary phenomenon in the medium to long-term range and which can therefore be controlled through monetary policy. Although it is hard to directly control the money supply, monetary conditions can be influenced by the key interest rate set by the central bank, which in turn can influence the inflation rate of the future.
2.1.4 The future role of fiscal policy
Fiscal policy is unable to control real variables and therefore should be subordinate to monetary policy in controlling inflation. Fiscal policy should essentially be passive and government budget position is only accepted to fluctuate due the course of the business cycle. All membership countries of the EMU are forced by the SPG to follow the midrange goal of a balanced budget or even a budget surplus to build a foundation for price stability and sustainable growth.21
3 Mechanics of the stability and growth pact
3.1 The budgetary rules of the Treaty of Amsterdam as basic principles for the SGP
According to the Treaty of Amsterdam even in stage three of EMU the budgetary policy remains an exclusive competence of the Member States. However, there are rules of budgetary discipline and coordinating procedures at the Community level (Title VII, Chapter I on “Economic policy” of the Treaty of Amsterdam) that are meant to resolve the conflict between budgetary autonomy of member states and the existence not only of a single monetary policy, but also of common policies in the areas of agriculture, trade and competition.22
Member states are requested to conduct their economic policies in a way that they contribute to achieving the objectives of the Community. The close coordination of member states` policies is to take place within the so- called “ECOFIN Council”. This council is composed of the Ministers of Finance and Economy of the member states. Each member state frequently provides the Council with information about the most important measures they have taken in order to fulfill their economic policy responsibilities. In case the economic policy conduct of a Member State should conflict with the guidelines or severely put the proper functioning of EMU at risk, the Council is allowed to address a recommendation to such a member state and - if necessary - make this recommendation public.23
3.2 The budgetary rules of the SGP
The basic idea as layed down in Article 104 and in Protocol No. 5 on the excessive deficit procedure annexed to the Treaty of Amsterdam is that member states shall avoid excessive government deficits. Essentially, the pact consists of the convergence criteria for the introduction of the Single Currency, which had been defined in the Maastricht Treaty. The two convergence criteria for fiscal policy - the upper limit to deficits and the debt criteria will also have to be met by each member state once it joined the EMU, committing the countries to form so called stability programs to ensure medium-term budgetary discipline.24 25
The SPG fiscal rules are given as follows:
3.2.1 The government budget deficit rule
This rule defines the yearly deficit in government finances must not exceed 3 % of GDP. If this reference mark is exceeded it will be evaluated if the ratio of the budget deficit to the GDP has strongly or permanently decreased in the recent past or under exceptional circumstances (severe recession) if the reference mark has been exceeded only once exceptionally or transient. Basis of the calculation of the values are those derived from the balance of payments. The national deficit is composed of budget deficits of all public corporations, e.g. in Germany these are constituted of the federation, states and communities together with social insurances. The UK, because of its EMU opt-out, is not subject to this requirement.
3.2.2 The medium-term balance rule
This rule defines that the gross general debt should not exceed 60% of the nominal annual GDP. This value of 60% has to achieved by each member state at any time or should even be fallen short of. If a state exceeds this 60% mark it may be accounted as being achieved in case the state may provide evidence that the 60% is continuously approached; this means if the debt ratio is continuously decreasing and will be approaching the 60% reference mark in an acceptable period of time.26,
3.2.3 Why 60 % dept and 3 % deficit?
The fiscal criteria are subject to discussions. The figure of 3 % for the upper limit to government deficit has elements of arbitrariness27. There is no theory explaining why an excess debt to 60 % of GDP or a budget deficit of more than 3 % of GDP constitute a threat for a monetary union28 rather to e.g. a combination of 55 % and 4 %. In fact, the 60 % debt criterion represents the average of all EU member states of 1991 when the treaty of Maastricht was agreed upon.
[...]
1 Peichl, Andreas (2003), p. 1-3.
2 Cowgill, Anthony and Andrew (2003b), p. 2.
3 Bundesministerium für Finanzen (2003), p. 2.
4 European Community (1989).
5 Cowgill, Anthony and Andrew (2003a), p. 2.
6 Griemert (2003), p. 1.
7 Treaty on the European Union (1992), Art. 105
8 ref.: Resolution of the European Council on the Stability and Growth Pact (1997).
9 Bundesministerium für Finanzen (2003), p. 2-3.
10 Arestis, MyCauley and Sawyer, p.2 - 4.
11 Executive Board of the ECB, group of authors (1999), p. 44 - 55.
12 Feldmann (2002), p 169.
13 Liebermann (2002), p. 1.
14 Duwendag, Ketterer et al. (1999), p 2.
15 Arestis and Sawyer (1998), p 5- 10.
16 Arestis and Sawyer (1998), p 5- 10.
17 Piekenbrock, Dirk (1988)
18 Kress (1999), p. 1.
19 Obstfeld (1998), p. 2.
20 Arestis and Sawyer (1998), p 5- 10
21 Executive Board of the ECB, group of authors (1999):, 47-54.
22 Andreas Peichl (2003), p. 3.
23 Görgens / Ruckriegel / Seitz (2001), p. 38 - 40, Ohr, Schmidt (2001), p. 427 - 430.
24 Treaty on the European Union (1992), Art. 98 - 102.
25 ref. Bofinger, Peter (2003), Feldmann, Horst (2002), Peichel, Andreas (2003), Weber, Axel (2004)
26 Heup, Dietmar (2003), p. 13.
27 Thygesen(2002), p. 2.
28 Ohr, Renate / Schmidt, André (2001), p. 427.
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