Download I. WHAT IS SGP

Does the European Stability and Growth Pact (SGP)
need to be reformed?
Fiorella Kostoris
University of Rome “La Sapienza”
Cyprus,September 2010
Index
I.
WHAT IS SGP
II.
THE RATIONALE OF SGP
III.
THE MAIN CURRENT CRITIQUES AND REFORM PROPOSALS OF SGP
IV.
MY REFORM PROPOSAL OF SGP
1
I. WHAT IS SGP
SGP is an instrument of coordination in
Member States’ (MS) fiscal policy within the
European Union.
It takes the form of reference values for
important fiscal parameters and it includes
various rules for the short- and medium-term
budgetary decisions of the main (national and
European) stakeholders involved.
2
SGP is a written pact.
Basic principles are set in the primary norms
of the European Treaties since 1992 without
any later change (nowadays Art. 126 of last
year’s Lisbon Treaty plus Protocol defining
the reference values for deficit/GDP = 3%
and debt/GDP = 60%).
3
Derogations to these numerical rules exist, according to
Art. 126: compliance exists
• even if deficit/GDP > 3%, if
 “the ratio has declined substantially and continuously
and…comes close”
“or the excess… is only exceptional and temporary
and the ratio remains close”
• even if debt/GDP > 60%, if
“the ratio is sufficiently diminishing and approaching
the reference value at a satisfactory pace”
4
Otherwise, the excessive deficit procedure
(EDP) has to be started by a Commission
Report, a Commission Recommendation
and possibly a Council Decision, ultimately
leading to sanctions of MS.
5
Primary norms do not specify whether reference values
have to be treated as short run or as structural
constraints. But logically they correspond to steady growth
solutions, with a golden rule.
Primary norms are important, because it is very difficult to
modify European Treaties.
However, SGP was officially born only in 1997 with 2
Council Regulations (SGP1) and was reformed in 2005
with 2 additional Council Regulations (SGP2).
Table 1 shows “innovations/specifications” of secondary
norms relative to primary ones: 3 are particularly
important in 1997; 4 in 2005. The debt constraint is
ignored in both.
6
Main changes to the Stability and Growth Pact following the Council Agreement of March 20, 2005
Original (1997): SGP1
Revised (2005): SGP2
1.Main changes in the preventive arm
Medium-term
objective (MTO)
All Member States (MS) have a
medium-term budgetary
objective of ‘close to balance or
in surplus’.
Country-specific differentiation of MTOs according
to stock of public debt and potential growth.
MTOs for euro-area MS are set between -1% of
GDP and balance or in surplus (in cyclically
adjusted terms and net of one-offs).
Adjustment path
towards the MTO
No specific provisions.
Annual minimum adjustment for MS of the euro
area of 0.5% of GDP in their structural balance.
The effort shoud be higher in ‘good times’,
identified as periods where output exceeds its
potential level.
Structural reforms
No specifi provisions.
Reforms will be taken into account when defining
the adjustment path to the MTO and may allow a
deviation from it under the following conditions:
only major reforms (direct/indirect impact on
sustainability);
safety margin to the 3% reference value is
guaranteed;
the deficit returns to the MTO within the
programme period.
Special attention to systemic pension reforms.
7
Original (1997): SGP1
Revised (2005):SGP2
1. Main changes in the corrective arm
Severe economic
downturn
‘Severe economic downturn’ if
there is an annual fall in real GDP
of al least 2%.
An economic downturn may be considered ‘severe’ in
cases of a negative growth rate or accumulated loss of
output during a protracted period of very low growth
relative to potential growth.
‘Other relevant
factors’ (ORFs)
No specific definition of ‘ORFs’
and their role in the excessive
deficit procedure.
The Commission report will take into account:
developments in the medium-term economic and
budgetary position (potential growth, cyclical conditions,
implementation of policies, public investment, quality of
public finances, fiscal consolidation in ‘good times’, debt
sustainability).
Increasing the focus
on debt and
sustainability
No specific provision.
The debt criterion, and in particular the concept of a debt
ratio ‘sufficiently diminishing and approaching the
reference value at a satisfactory pace’, will be applied in
qualitative terms.
Initial deadline for
correcting the
excessive deficit
The excessive deficit has to be
corrected in the year following its
identification, unless there are
‘special circumstances’.
The rule remains: possible extension by one year based
on ORFs and on the condition that minimum fiscal efforts
have been taken.
8
The reform of SGP1 was induced by critiques on 4
elements
1.its logical inconsistency, as the deficit reference
values are rigidly set independent of the MS’
growth pontential and debt level;
2.its incapability to transform “cigada” MS into
“ants”, compliant with fiscal rules;
3.its insufficient ability to induce MS’ countercyclical
policies stabilising the real economy in the short
run and boost growth in the long run;
4.its inadequate enforceability (see par. IV).
9
II. THE RATIONALE OF SGP
The rationale behind SGP is that a sustainable
and non-inflationary growth requires nominal
stability and the latter requires, particularly in the
Eurozone, limits on MS’ deficits and debts: in the
single currency area, MS do not fully internalise
the inflationary consequences of their fiscal
behaviour and, facing an economic downturn,
have a deficit bias creating negative spillovers on
partners (raising interest rate and inflation), unless
they find a binding constraint.
10
Remark that this argument is correct only if
shocks are asymmetric and concern the supply
side.
In the case of common shocks, MS would fully
internalise the effects of their deficits; in the
presence of negative demand shocks, MS’
expansionary budget policies would create
positive spillovers on partners through the
import-export channel.
11
III. THE MAIN CURRENT CRITIQUES AND
REFORM PROPOSALS OF SGP
Current critiques of SGP2 include 2 old
critiques of SGP1 for new reasons.
2.Fiscal discipline is inexistent: ongoing
excessive deficit procedures concern all the 16
Euro countries (except Luxembourg) and 9 of
the remaining 11 EU MS (except Estonia and
Sweden). Some MS show non-transitory
excessive deficits and debts (Italy); many show
rising debts above 60% (including Germany).
See Table 2.
12
Deficit and Debt (as a percentage to GDP) in some European areas (1997-2010)
European Union
Deficit/GDP
Debt/GDP
1997
-2.5
71.0
1998
-1.6
68.8
1999
-0.7
67.3
2000
1.1
64.1
2001
-1.3
62.9
2002
-2.3
60.4
2003
-3.0
61.8
2004
-2.6
62.2
2005
-2.5
62.7
2006
-1.4
61.4
2007
-0.8
58.8
2008
-2.3
61.6
2009
-6.8
73.6
2010
-7.2
79.6
13
Deficit and Debt (as a percentage to GDP) in some European areas (1997-2010)
Euro Area
Deficit/GDP
Debt/GDP
1997
-2.6
75.3
1998
-2.2
73.7
1999
-1.3
72.7
2000
0.2
70.2
2001
-1.8
69.2
2002
-2.5
68.0
2003
-3.0
69.1
2004
-2.8
69.5
2005
-2.5
70.1
2006
-1.3
68.3
2007
-0.6
66.0
2008
-2.0
69.4
2009
-6.3
78.7
2010
-6.6
84.7
14
Deficit and Debt (as a percentage to GDP) in some European areas (1997-2010)
Italy
Deficit/GDP
Debt/GDP
1997
-2.7
120.2
1998
-2.8
116.3
1999
-1.8
114.9
2000
-0.5
110.6
2001
-3.1
109.5
2002
-2.9
105.7
2003
-3.4
104.4
2004
-3.4
103.8
2005
-4.3
105.8
2006
-3.3
106.5
2007
-1.5
103.5
2008
-2.7
106.1
2009
-5.3
115.8
2010
-5.3
118.2
15
Deficit and Debt (as a percentage to GDP) in some European areas (1997-2010)
France
Deficit/GDP
Debt/GDP
1997
-3.0
59.3
1998
-2.7
59.5
1999
-1.6
58.5
2000
-1.3
57.2
2001
-1.5
56.8
2002
-3.2
58.8
2003
-4.2
62.9
2004
-3.7
64.9
2005
-2.9
66.4
2006
-2.3
63.7
2007
-2.7
63.8
2008
-3.3
67.5
2009
-7.5
77.6
2010
-8.0
83.6
16
Deficit and Debt (as a percentage to GDP) in some European areas (1997-2010)
Germany
Deficit/GDP
Debt/GDP
1997
-2.7
61.0
1998
-2.2
60.9
1999
-1.6
61.2
2000
1.2
60.2
2001
-2.8
59.5
2002
-3.7
60.4
2003
-4.0
63.9
2004
-3.7
65.7
2005
-3.3
68.0
2006
-1.6
67.6
2007
0.2
65.0
2008
0.0
66.0
2009
-3.3
73.2
2010
-5.0
78.8
17
3.Stabilisation of real economies is obtained far
from full employment and growth performance
is insufficient in the EU. The Lisbon Agenda,
setting 10-year targets for 2010 employment,
R & D, etc. was partly unsuccessful.
18
New critiques of SGP2 mainly concern 4
elements (see points 4. 5. 6. 7.)
4.Enforceability is insufficient due to 3 reasons:
4.1. inadequate sanctions: according to Schäuble
(March 2010), MS with EDP should not receive
EU Cohesion Funds, should not participate to
budgetary decisions regarding other MS, should
have their voting rights suspended, and as a last
resort should exit the monetary union, remaining
in the EU;
19
4.2. inadequate surveillance by EU partners on
other MS’ public budgets, according to Merkel
(May 2010): consequently Van Rompuy (June
2010), chairman of the European Task Force,
proposes a “European Semester” every
Spring to reinforce ex ante surveillance; the
Commission Communication (June 2010)
adds that, under the European Semester,
complementarity of national economic policies
will be ensured at the European level before
final decisions on budget are taken in MS;
20
4.3. inadequate involvement of National
Parliaments in the compliance with SGP rules.
Merkel proposes to include in each MS’
Constitution binding clauses on deficit and
debt, as already done by Germany (maximum
federal deficit/GDP = 0.35% by 2016; zero
debt for Länder starting in 2020). Sarkozy is
ready to follow. Moreover, National Statistical
Offices should be more independent in
providing reliable data on MS public finance.
My partial disagreement with diagnoses given
on enforceability will be explained in par. IV.
21
5. Limits on public debt are ignored, whereas debt,
more than deficit, seems negatively correlated
with growth at least beyond a threshold
(Reinhart-Rogoff, 2010). However, it is
necessary to re-examine the reversed causality
problem (Barrios-Schaechter, 2008).
The Greek case in Spring 2010 shows the
negative spillovers on other partners, created by
MS with unsustainable debt, coupled with
general economic weaknesses, insufficient
degree of competitiveness, unreliable statistical
data.
22
6.Connections between MS’ fiscal policies on
the one hand and the convergence of the
underlying real economies, on the other, are
virtually ignored. Yet macro imbalances (such
as those created by diverging degrees of
competitiveness) induce tensions on public
finance and negative spillovers on other MS:
Van Rompuy (June 2010) suggests that
“macroeconomic surveillance should function
next to the budget surveillance of the Pact”.
23
7.Connections between MS’ fiscal policies on
the one hand and the other EU or MS’
economic policies (such as monetary,
financial, labour policies), on the other, are
loose, while they all contribute to a sustainable
growth.
The Commission Communication (June 2010)
stresses this point, indicating that the
“European Semester will integrate the different
strands of economic policy coordination”.
24
The European Council of June 17, 2010 takes the
decision at the political level to
 give more role to debt and overall sustainability in
budgetary surveillance;
 reinforce the preventive and corrective arms of SGP with
more sanctions;
 adopt a European Semester in Spring;
 ensure that each MS has budgetary rules and MTOs in
line with SGP;
 ensure that statistical offices are fully independent from
political pressures and provide reliable data on MS’ fiscal
policy.
25
IV. MY REFORM PROPOSAL OF SGP
While I share most of the above critiques
and policy proposals/decisions, I think
that these changes will prove ineffective
unless the SGP enforceability is much
strengthened. This requires a
modification in the EU governance of
SGP and an improvement in the intrinsic
rules of SGP.
26
The SGP enforceability is weak because
the governance of the European Council, which
has the duty to decide EDP, is ill-conceived, as
surpervised Finance Ministers coincide with
supervisors: the probability and the moral cost of
sanctions decrease when the number of fiscal
delinquents (today almost the unanimity) increases;
the intrinsic rules of SGP are misspecified: no
distinction is made between asymmetric and
common shocks hitting MS, and between demand
and supply shocks.
27
It can be shown that the 3% ceiling on deficit may
be too large facing a negative supply shock, when
essentially no deficit should be allowed; it may be
correct facing a mild asymmetric negative demand
shock, when automatic stabilisers are sufficient to
restore output; it is suboptimal when there is a
systemic and/or a very strong negative demand
shock, hence a discretionary expansionary fiscal
policy beyond automatic stabilisers is called for and
is beneficial for all MS.
28
It is possible to amend the present
formulation of SGP, taking into account
the relevant distinction on shocks that I
propose, without changing primary
norms, but reinterpreting in secondary
norms the “exceptional” conditions for
derogations from EDP.
29
Reliable and rapid information on the type of
shock facing different MS is needed. A crude
set of indicators is immediately available,
and is understandable and trusted by
national policy-makers, given that every
quarter each MS and the European
Commission produce harmonised series on
output, inflation and constraints limiting
manufacturing firms.
30
The distinction between a demand and a
supply shock can then be obtained every
quarter on the basis of a positive correlation
between the real output growth and the
inflation rate in the former case, of a
negative correlation in the latter.
When all MS face a common negative
demand shock, they all show a
contemporaneous decrease in both the
growth rate of real output and inflation.
31
When this negative demand shock is very
strong, firms are constrained in their
demand rather than in their productive
capacity at an increasing rate and above
the average trend (the corresponding
curve in Graphs 1 is rising and above the
threshold of 10)
32
Demand and Supply Shocks in the European Union
(Annual Data)
16,0
14,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
12,0
10,0
8,0
Real GDP annual rate of
change(%)
6,0
4,0
2,0
Inflation rate (%)
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
-2,0
1998
1997
0,0
-4,0
-6,0
Years
Demand and Supply Shocks in the Euro Area
(Annual Data)
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
16,0
14,0
12,0
10,0
Real GDP annual rate of
change(%)
8,0
6,0
4,0
2,0
Inflation rate (%)
-6,0
Years
10
20
09
20
08
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
20
99
19
-4,0
19
19
97
-2,0
98
0,0
33
Demand and Supply Shocks in Germany
(Annual Data)
20,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
15,0
10,0
Real GDP annual rate of
change(%)
5,0
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0,0
Inflation rate (%)
-5,0
-10,0
Years
Demand and Supply Shocks in France
(Annual Data)
18,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
16,0
14,0
12,0
10,0
Real GDP annual rate of
change(%)
8,0
6,0
4,0
Inflation rate (%)
2,0
-4,0
Years
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
-2,0
1997
0,0
34
Demand and Supply Shocks in Italy
(Annual Data)
15,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
10,0
Real GDP annual rate of
change(%)
5,0
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0,0
Inflation rate (%)
-5,0
-10,0
Years
Demand and Supply Shocks in Italy
(Quarterly Data)
16,0
14,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
12,0
10,0
8,0
Real GDP rate of change
relative to previous quarter
(%)
6,0
4,0
Inflation rate (%)
2,0
19
97
19
99
20
01
20
03
20
20 05
07
20 Q1
07
20 Q3
08
20 Q1
08
20 Q3
09
20 Q1
09
20 Q3
10
-Q
1
0,0
-2,0
-4,0
Years
35
The Graphs show that all EU MS were
hit in 2009 by a systemic, strongly
negative demand shock. Limiting deficit
spending that year was irrational. And it
was impossible. Never before in the
years under consideration something
similar had happened.
36
For example, in the period 2001-2003,
Germany was hit by a moderately negative
demand shock, France was not.
A reformed SGP would have perhaps avoided
in 2003 the dramatic conflict between the
Commission and the Council (with consequent
loss of SGP credibility), suggesting to allow
Germany to overcome the 3% limit (as decided
by the Council) , but to start the EDP towards
France (as demanded by the Commission).
37
The year 2010 looks very different from 2009 and
not identical for all MS: a positive rebound in
demand is observed everywhere, real output
growth rates are recovering, inflation is rising.
Looking at quarterly data (Graphs 2), Germany
does not appear any longer to be constrained at
all on its output demand, as world trade is now
expected to sharply increase (by 11% this year,
while it was decreasing by 9% in 2009), while the
country has been gaining in competitiveness in
the last decade relative to other EU MS (in
Graphs 3 gains in competitiveness are indicated
under the threshold of 100).
38
Demand and Supply Shocks in the European Union
(Quarterly Data)
16,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
14,0
12,0
10,0
Real GDP rate of change
relative to previous quarter
(%)
8,0
6,0
4,0
Inflation rate (%)
2,0
1
Q
3
Q
20
10
-
1
Q
20
09
-
3
20
09
-
1
Q
20
08
-
3
Q
08
-
20
Q
1
Q
20
07
-
05
01
07
-
20
20
99
03
20
-4,0
20
19
-2,0
19
97
0,0
Years
Demand and Supply Shocks in the Euro Area
(Quarterly Data)
16,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
14,0
12,0
10,0
8,0
Real GDP rate of change
relative to previous quarter
(%)
6,0
4,0
2,0
Inflation rate (%)
19
97
19
99
20
01
20
03
20
20 05
07
-Q
20
1
07
-Q
20
3
08
-Q
20
1
08
-Q
20
3
09
-Q
20
1
09
-Q
20
3
10
-Q
1
0,0
-2,0
-4,0
Years
39
Demand and Supply Shocks in Germany
(Quarterly Data)
20,0
10,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
5,0
Real GDP rate of change
relative to previous quarter
(%)
0,0
Inflation rate (%)
1
Q
3
Q
20
10
-
1
20
09
-
3
Q
09
-
20
Q
1
Q
20
08
-
3
08
-
20
Q
1
Q
20
07
-
05
20
07
-
03
-5,0
20
01
20
99
20
19
19
97
15,0
-10,0
Years
Demand and Supply Shocks in France
(Quarterly Data)
20,0
(D-C)/Average (D-C 19972010) Detrended demandconstrained (D) relative to
capacity-constrained (C)
business regime (x 10)
15,0
Real GDP rate of change
relative to previous quarter
(%)
10,0
5,0
Inflation rate (%)
1
Q
3
20
10
-
1
Q
20
09
-
3
Q
09
-
Years
20
Q
1
20
08
-
3
Q
08
-
20
Q
1
07
-
20
Q
05
07
-
01
99
03
20
20
20
20
-5,0
19
19
97
0,0
40
Harmonised competitiveness indicators and real effective exchange rates
based on consumer price indices (period averages: 1999-Q1=100)
110,0
105,0
100,0
Euro Area
Italy
95,0
France
Germany
90,0
85,0
80,0
1996- 20012000 2005
2006
2007
2008
2009
2010 2010
March April
2010
May
2010
June
Years
41
Germany is probably ready to start an exit
strategy to reduce fiscal imbalances
according to the old SGP rules.
France and Italy are recovering at a
different pace and probably need more
time, the former having gained less in
competitiveness and the latter having lost
it continuously for 10 years and a half.
42