Download Daniele Franco

27-30 January 2003
Santiago de Chile
XV Seminario Regional de Política Fiscal
Daniele Franco
The Debate on EMU Fiscal
Rules
OUTLINE
a) EU fiscal rules
b) Fiscal outcomes in 1992-2001
c) Criticisms of EU rules
d) Challenges to EU fiscal policies
European Monetary Union
1992: European Union countries decide
to create a monetary union (Treaty of
Maastricht)
1999: exchange rates of eleven countries
irreversibly locked (Greece joins in 2001)
2002: euro coins and banknotes replace
national currencies
New development:
many sovereign countries share a
common currency and retain fiscal
responsibility
 extensive implications for fiscal policy
The need for EU fiscal rules
Budgetary discipline widely recognised
as essential condition for EMU success
Fiscal rules considered necessary to:
 prevent moral hazard
 avoid externalities of deficits and debts
 avoid pressures on European Central
Bank for ex-ante & ex-post bail-out
Rules necessary also for contingent
reasons:
 obtain radical changes in policies
 rapidly ensure credibility of EMU
 select EMU Member States
The development of EU rules
Gradual development of rules:
1992: Treaty of Maastricht set deficit
(3%) and debt (60%) conditions for
access to EMU, but left open issues
1997: Stability and Growth Pact (SGP)
defined rules to accompany EMU
on a permanent basis
1999: specification of operational
aspects (e.g., target year for
reaching balanced budget)
Main aspects of EU rules
1) deficit should not exceed 3% of GDP
unless  exceptional events
 excess is temporary
 excess is limited
2) close-to-balance or surplus target over
the cycle
3) multilateral surveillance (stability
programs, notifications)
4) excessive deficit procedure
(from recommendations to sanctions)
5) common statistical framework
EU rules vs federal countries
rules
EU approach is stricter
 rules defined with reference to
numerical parameters
 ex-ante and also ex-post compliance
required
 non-compliance triggers predefined
pecuniary sanctions
 flexibility margins defined ex-ante for
exceptional factors
 no special provision for investment
spending
Multinational dimension requires formal
& predefined solutions
Why these rules?
1) Multinational context limited available
solutions: cannot have implicit rules
applying to many sovereign countries
2) Solutions influenced by contingent factors
(i) problematic fiscal developments:
 high deficits and rising debts
 rising tax burden
 pro-cyclical policies
 need to obtain radical changes in policies
 need to rapidly ensure credibility of EMU
(ii) need to select EMU members
 rules for selection applied in steady state
EU rules vs Kopits-Symansky
criteria
Ideal fiscal rule
EU fiscal rules
Well-defined
++
Transparent
++
Simple
+++
Flexible
++
Adequate relative to final goal ++
Enforceable
+
Consistent
++
Underpinned by structural reforms +
EU rules vs Inman criteria
Criteria
Strong rule EU rules
Timing for review Ex post
Ex post
Override by
majority rule
Not allowed Not allowed
Enforcement
Enforcer
Access
Penalties
Independent Partisan
Open
Closed
Large
Large
Amendment
Process
Difficult
Difficult
Fiscal outcomes up to 2000
 EU rules successful up to 1998
(deficit declines: 6.4%  1.7%)
 1999-2000: EU governments introduced
tax cuts, without spending cuts
(deficit about stable: 0.8%  0.7%)
 EU and US: similar deficit levels in early
1990s, but US improve budget balance
faster and longer
 Fiscal consolidation: expenditure-based
in EU, spending-and-tax-based in US
1993-2000
GP/GDP
T/GDP
USA -3.4%
+ 2.4%
EU
-4.7%
+0.7%
Fiscal outcomes 2000-2002
 EU reaction to downturn milder than US:
Budget balance:
2000
2002
EU:
-0.7%  -1.7%
US:
+1.5%  -2.6%
GP/GDP
USA +1.7%
EU
+1.5%
T/GDP
-1.8%
-0.5%
 Four EU countries close or above 3%
deficit limit.
- either avoid discretionary anti-cyclical
policies / adopt pro-cyclical policies
- or neglect rules  loss of credibility
 New discussion on EU rules
General Government: Balance
(Surplus (+), Deficit (-))
Net of UMTS proceeds
(% of GDP)
2
1
0
-1
-2
-3
-4
-5
-6
-7
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
USA
EU15
Euro12
General Government:
Structural Primary Balance
(Surplus (+), Deficit(-))
Net of UMTS proceeds
(% of GDP)
5
4
3
2
1
0
-1
-2
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
USA
EU15
Euro12
General Government:
Consolidated Gross Debt
(% of GDP)
80
75
70
65
60
55
50
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Euro-12
EU-15
USA
Conflicting views
"The stability pact is a vote of no confidence by
the European authorities in the strength of the
democratic institutions in the member countries.
It is quite surprising that EU-countries have
allowed this to happen, and that they have
agreed to be subjected to control by European
institutions that even the IMF does not impose
on banana republics.” Paul de Grauwe,
Financial Times, 25 July 2002
"Of course, the stability pact restricts the room
for manoeuvre enjoyed by national fiscal
policymakers. But this is the price that must be
paid for a common currency. Historically,
stability between currencies has been possible
only when countries have been prepared to
relinquish some national sovereignty.” H.
Siebert, Financial Times, 6 Aug. 2002
Criticisms 1:
There is no need for fiscal rules
Rules lead to sub-optimal solutions. Better
rely on discretionary decisions
 Either rely on wise governments
or on effective financial markets
High deficit  high interest rates 
pressure on government  consolidation
but:
(i) sufficient information?
(ii) timely reaction of markets?
(iii) timely reaction of governments?
 a risky solution with 12 ( 25)
sovereign countries
Criticism 2: rules are necessary
but there are better rules
Core issue:
What rules would we want if we could
start again from scratch?
Are there rules clearly more intelligent
than the SGP?
Critical aspects of EU fiscal rules:
 reduce budgetary flexibility
 work asymmetrically
 disregard aggregate fiscal stance
 discourage public investment
 focus on short term commitments and
disregard structural reforms
 too demanding for countries in sound
positions
Fiscal stabilisation
 EU rules designed to combine a sound
fiscal position (3% deficit limit) and
budgetary flexibility in recessions
(structural balanced budget)
Deficit fluctuates over cycle (automatic
stabilisers can operate - contrary to past
EU experience)
 But:
(i) problems in the initial transition to
balanced structural budget
(ii) asymmetric structure of incentives:
sanctions for deficits  3% but no
incentive to avoid loosening in upswings
 Need policy-makers with medium or
long-term views
The EMU Fiscal Framework:
A Stylisation
SURPLUS
0
3%
DEFICIT
UNFAVOURABLE
CYCLE LENGTH
FAVOURABLE
Fiscal co-ordination
 No explicit co-ordination procedure.
Implicit rule-based co-ordination: let
stabilisers work over the cycle
 In some circumstances aggregation of
national fiscal policies may not result in
optimal area fiscal stance
- free-riding in stabilisation in bad times?
- pro-cyclical policies in good times?
 However, supranational co-ordination
would be problematic:
- different cycles & policy views
- forecasting & timing problems
- enforceability of decisions
 Does the EU need a federal budget?
Public investment
Balanced budget  tax-finance for public
investment
Risk: reduction of capital accumulation
Transition period problematic: pay for new
investment and pay back debt
Exclude public investments from deficit
rule (golden rule or dual budget)?
but:
• what is capital spending?
• bias in favour of physical capital
• contrasting evidence on effects of
public investments on growth
• multilateral surveillance more complex
(e.g., evaluation of depreciation)
• bigger role of private sector in
infrastructure development
Long-term fiscal sustainability
 no reference to long-term indicators
in EU rules. Outcomes are assessed
on a yearly basis
 this can discourage some tax and
pension reforms (PAYG  funding)
involving a temporary deficit
 but the use of sustainability indicators
(e.g., projections, generational
accounting) would be problematic
(e.g., comparability)
 moreover, balanced budget forces
reforms and determines fast debt
reduction
Alternatives to the SGP?
1) fiscal co-ordination at EU level
1a) one EU fiscal policy
1b) co-ordination of national policies
1c) a market for deficit permits
2) fiscal institutions and procedures
2a) national budgetary procedures
2b) institutional reform (Fiscal Policy
Committee)
3) different numerical rules
3a) golden rule
3b) expenditure rule
3c) permanent balance rule
3d) debt sustainability pact
EU rules:
a preliminary conclusion - 1
 EU without rules: new experiment. Will
have to rely on financial market
discipline. Leap in the dark?
 Greater EU integration would allow
more flexibility, but unlikely in mediumterm
 EU rules related to traditional solutions:
balanced budget with exception for
cyclical and exceptional events (but not
for investment)
 EU rules present some problems, but no
alternative solutions clearly superior
 Rules-based co-ordination necessarily
somewhat inflexible (implicit mistrust of
other countries’ behaviour)
EU rules:
a preliminary conclusion - 2
 EU enlargement: if current EU members
do not respect rules, can EU ask new
members to do so?
 Radical changes of rules are very difficult
(need unanimity). Risk: revisions can
reduce credibility
 Can EU rules survive the current
slowdown? If not, can monetary union
survive (with up to 25 countries)?
 If rules survive, there is room for
improvement: country differentiation, procyclical bias in good times, transparency
 Rules can be effective and not harmful
only if governments endorse their spirit
and are prepared to make efforts
Are fiscal rules the problem?
the debate on EU rules may divert attention
away from more relevant issues:
EU economic performance is unsatisfactory
in terms of growth, activity and employment
rates
EU
USA
GDP growth rate
1985-1990
1991-2000
3.2
2.1
3.4
3.3
Unemployment rate
1991
2000
8.1
8.1
6.8
4.0
Labour market participation rate
2000
69
78
Fiscal challenges
 EU large public sectors and high tax
burdens induce distortions & inflexibility
 economic integration increase tax
competition and revenue losses reduces
 greater burden on less mobile bases
 inequity, distortions
 the ageing process increases spending:
EU12
2000
18.0%
2050
24.5%
USA
11.2%
16.7%
 need for structural reforms
 a tight budget constraint may increase
the pressure to introduce expenditure
reforms and accelerate debt reduction
Average effective tax rates
on labour
36
32
28
24
20
16
1970
1980
1990
USA
EU-15
2000
Pensions Expenditure
(% of GDP)
14
12
10
8
6
4
2000
2010
2020
EU15
2030
USA
2040
2050
Fiscal co-ordination - 1
1a) Move to single EU fiscal policy
one money  one fiscal policy
Solve flexibility and fiscal stance problems
but: are we ready for a federal country?
1b) Co-ordinate aggregate fiscal stance
Have an aggregate stability programme:
3% limit applies to area deficit (or can
even scrap limit). Political allocation of
deficit permits
Solve flexibility and fiscal stance problems
but:
 national sovereignty problem
 different cycles & policy views
 conflicts in allocation of deficits
 forecasting & timing problems
Fiscal co-ordination - 2
1c) A market for deficit permits
Set total volume of deficit permits & let
countries trade
(A. Casella - drawing from markets for
pollution rights)
Solve flexibility & aggregation problems
but:
• initial allotment of rights?
• small number of traders
• different countries  different
externalities
• who can predict cycle and set amount of
rights?
Fiscal institutions and
procedures - 1
2a) Reform national budget procedures
Introduce institutions and procedures
conducive to responsible fiscal policy
 attack deficit bias at roots
e.g. rules about presentation, adoption and
execution of budgets. “Hierarchical”
procedures more conducive to fiscal
discipline than “collegial” procedures.
But:
• full agreement on solutions?
• national sovereignty problem
• reforms difficult to monitor
• what if (apparently) correct solutions do
not deliver results?
• need time for testing
Fiscal institutions and
procedures - 2
2b) Introduce Fiscal Policy Committee
Assign to FPC (accountable to Parliament)
management of stabilisation policies on the
basis of predefined mandate and judgement
FPC responsible for setting the budget
balance within debt sustainability constraint
defined over a number of years
FPC expected to deliver both long-term
sustainability and short-term stabilisation
Problems:
(i) difficult to separate stabilisation from
allocation & distribution
(ii) government interference (appointments)
(iii) need time for testing
Numerical fiscal rules - 1
Given multinational context and need for
rapid results
 permanent numerical constraints on
domestic fiscal policy in terms of indicator
of overall fiscal performance
• simpler to evaluate compliance
• easier to grasp by public opinion and
policy-makers
• solution based on long debate on
budgetary rules
What rule? golden rule, expenditure rule,
debt rule
Numerical fiscal rules - 2
3a) Exclude public investments from
budget balance (golden rule)
Solution adopted in some countries and
decentralised governments
Dual budget (current & capital): old issue
(Musgrave, 1939) long debated (Sweden)
Main pro:
• spreading cost of durables over time (analogy
to private sector finance)
But:
• what is capital spending? (opportunistic
behaviour)
• bias in favour of physical capital
• unlimited borrowing  low attention for
projects
Numerical fiscal rules - 3
Moreover,
• dual budget discussed but little used
• contrasting evidence on effects of public
investments on growth
• bigger role of private sector in
infrastructure development
• multilateral surveillance more complex
(e.g., evaluation of depreciation)
• in developed countries small net
investment (Germany 1980-1999 = 0.6%)
Numerical fiscal rules - 4
3b) Expenditure rule
Introduce comprehensive expenditure
target (all primary items; central & local)
Solution adopted in some countries
Benefits: spending can be controlled by
government; monitoring easier; medium
term framework
But problematic in multinational context:
• cannot have uniform EU rule, must rely
on countries’ programmes
• cannot commit future governments
• deficit & debt may increase because of
tax cuts
Numerical fiscal rules - 5
3c) Permanent Balance Rule
Buiter & Grafe (2002): PBR would ensure
sustainability while considering country
differences
Permanent budget in balance or in surplus
= difference of future values of tax revenue
and spending
(strong form of tax smoothing: tax rates
constant with G depending on cycle,
interest tates, structural factors)
Implementation problems: estimates of
permanent value of tax and spending 
take into account future preferences
Numerical fiscal rules - 6
3d) Debt Sustainability Pact
Pisani-Ferry (2002): countries (i) with debts
50% and (ii) publishing comprehensive
fiscal accounts can opt out of EDP and
embrace a DSP
Countries indicate five-year target for debt
ratio & have greater flexibility in short term
• Avoid excessive tightening on sound
countries. But can we fully overlook the
deficit level?
• Better fiscal accounting would provide more
discipline by the financial markets. Estimate
of future liabilities problematic: uncertainty
related to macroeconomic, demographic and
behavioural scenarios
General Government: Total Outlays
(% of GDP)
50
45
40
35
30
25
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
USA
EU15
Euro12
General Government:
Current Tax and Non-Tax Receipt
(% of GDP)
50
45
40
35
30
25
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
USA
EU15
Euro12
Old-age dependency ratios 2000-2050
(baseline scenario)
65%
Year 2050
Year 2025
60%
Year 2000
55%
50%
45%
40%
35%
30%
25%
20%
EU
UK
S
FIN
P
A
NL
L
I
IRL
F
E
Gr
D
Dk
B
15%
Average effective tax rates
on consumption
22
20
18
16
14
12
10
1970
1980
USA
1990
EU-15
2000
Average effective tax rates
on capital
28
26
24
22
20
18
1970
1980
USA
1990
EU-15
2000
DIFFERENT MEDIUM TERM
TARGETS
 Fix medium term targets also on the basis
of debt level and future budgetary trends
If debt and contingent liabilities are low:
allow deficit up to minimal benchmarks
 This would allow funding of net investment
without distortions and monitoring
problems
 Need transparent fiscal accounting and
accurate long-term projections
IMPROVE TRANSPARENCY
 Transparency can increase credibility of
rules and allow greater flexibility in
implementation
 Current framework problematic: (i) oneoff measures, (ii) delays in data provision,
(iii) limited data on off-budget liabilities
(i) Publicise one-offs, lower danger threshold
for early warnings, net one-off in
computing structural balances
(ii) Make greater use of cash data and debt
(more timely and less subject to estimates).
More independent statistical authorities
(iii) Have regular and transparent estimates
of off-budget liabilities, net asset positions
& long term budgetary trends
MISBEHAVIOUR IN GOOD
TIMES
 Try to have some sanctions for slippages
in good times and facilitate countries to
behave prudently
(i) Use early warning procedures in goods
times when deficit diverge from
structural target
(ii) Allow the use of rainy-day funds: surplus
in good times can increase room for
manoeuvre in bad times
Rainy-day funds require a change in ESA
accounting: transfer should affect deficit
(now they would be considered financial
transactions)
IMPLEMENTATION OF RULES
 Now enforcement is partisan: national
authorities apply the rules to themselves.
This may also reduce the incentive to
behave well in good times
 Solution: give more responsibilities to the
Commission
- Commission responsible for technical
assessment of compliance to the rules
(excessive deficit)
- Council decides what measures to require
to countries in excessive deficit
- Council decides sanctions on the basis of
Commission recommendation
32
31
93
90
Total primary expenditure (% of GDP)
30
29
02
USA
28
00
27
26
29
30
31
32
33
45
93
44
43
EU-15
42
90
02
41
40
00
39
41
42
43
44
45
General government tax and non tax receipts
(% of GDP)
General Government: Structural Balance
(Surplus(+), Deficit(-))
Net of UMTS proceeds
(% of GDP)
2
1
0
-1
-2
-3
-4
-5
-6
-7
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
USA
EU15
Euro12
The old debate on fiscal rules
• Fiscal policy usually based on rules:
either implicit (conventional wisdom) or
explicit (laws)
• Theoretical case for formal rules at
national level: ambiguous results
- counter deficit bias,  transparency
- induce distortions, lack of flexibility
• Traditional solutions: budget balance
with three main exceptions
- capital expenditures
- extraordinary finance
- effects of the cycle
budget balance over business cycle
full employment balance
functional finance
Total primary expenditure (% of GDP)
32
31
93
90
30
29
02
USA
28
00
27
26
29
30
31
32
General government current tax and non tax
receipts (% of GDP)
33
(% of GDP)
Total primary expenditure
45
93
44
43
EU-15
42
90
02
41
00
40
39
41
42
43
44
General government current tax and non tax
receipts (% of GDP)
45
A comparison
EU
USA
GDP growth rate
1985-1990
1991-2000
3.2
2.1
3.4
3.3
Unemployment rate
1991
2000
8.1
8.1
6.8
4.0
Labour market participation rate
2000
68
79
Budget balance
1996-2000
-2.0
-0.1
Rules vs discretion
Debate reflects the old discussion on rules:
• counter deficit bias & increase transparency
• but induce distortions & lack of flexibility
Conflicting views:
"The stability pact is a vote of no confidence by the
European authorities in the strength of the democratic
institutions in the member countries.” Paul de
Grauwe, Financial Times, 25 July 2002
"Of course, the stability pact restricts the room for
manoeuvre enjoyed by national fiscal policymakers.
But this is the price that must be paid for a common
currency.” H. Siebert, Financial Times, 6 Aug. 2002
Predominant view: monetary union without
fiscal rules would be a risky experiment (a
leap in the dark)
Rules vs discretion
Debate reflects the old discussion on rules:
• counter deficit bias & increase transparency
• but induce distortions & lack of flexibility
Conflicting views:
"The stability pact is a vote of no confidence by the
European authorities in the strength of the democratic
institutions in the member countries.” Paul de
Grauwe, Financial Times, 25 July 2002
"Of course, the stability pact restricts the room for
manoeuvre enjoyed by national fiscal policymakers.
But this is the price that must be paid for a common
currency.” H. Siebert, Financial Times, 6 Aug. 2002
Predominant view: monetary union without
fiscal rules would be a risky experiment (a
leap in the dark)
• EU rules aim at combining a sound
stabilisation
fiscal Fiscal
stance (3%
limit) with
budgetary flexibility in recessions
(structural balanced budget)
 Deficit fluctuates over cycle
(automatic stabilisers can operate)
The asymmetric structure of incentives is quite
problematic in this regard. It has been widely
recognised that, ideally, the SGP should be
complemented by fiscal policy guidelines
encouraging EMU members to avoid fiscal
laxity in periods of upswing and buoyant
activity
SURPLUS
0
3%
DEFICIT
BAD TIMES
GOOD TIMES
LENGTH OF CYCLE
EARLY LESSONS
 One-off measures and new accounting
and financial operations extensively used
to meet targets  EMU FRAMEWORK
SUCCESSFUL IN REDUCING DEFICIT
AND DEBT
 3% PERCEIVED AS “HARD
CEILING”
 GRADUAL CONVERGENCE TO
CLOSE-TO-BALANCE
BUT: IN 2000 NO PROGRESS IN
STRUCTURAL TERMS
PROGRAMMES FOR 2001:
IMPROVEMENTS DUE TO CYCLE
AND INTEREST PAYMENTS
SLOWDOWN IN GDP: TARGETS
THE COMPOSITION OF
FISCAL ADJUSTMENT
EMU RULES DO NOT CONSIDER
 COMPOSITION OF FISCAL
ADJUSTMENT
 SIZE OF GOVERNMENT
SUBSIDIARITY REASONS
SEVERAL STUDIES: ROLE OF
COMPOSITION OF ADJUSTMENT
(SUSTAINABILITY, ETC)
EURO-AREA:
1992-1993: REVENUE BASED
1994-1997: EXPENDITURE BASED
1998-2004: EXPENDITURE BASED
(CONSOLIDATION + TAX CUTS)
LONG-TERM
SUSTAINABILITY - 2
CHALLENGE OF AGEING :
PENSION EXPEND.:  3 to 5 % OF GDP
TOTAL EXPENDIT.:  5 to 8 % OF GDP
CAN CURRENT REVENUE LEVELS BE
MAINTAINED IN AN INTEGRATED
ECONOMY?
BUT FAST DEBT REDUCTION
OFFSETS PRESSURES OF AGEING
INCREASING ROLE OF LONG-TERM
ISSUES IN EU SURVEILLANCE:
RECOMMENDATIONS, PROJECTIONS
FISCAL RULES -1
Conventional wisdom against borrowing:
“And thou shalt lend unto many nations, but
thou shalt not borrow” - Deuteronomy
“The budget should be balanced,
the treasury should be refilled,
public debt should be reduced ...” - Cicero
“Our modern expedient is to mortgage the
public revenues … a practice which appears
ruinous” - David Hume
FISCAL RULES -2
For a long time the orthodox view of
economists reflected such common wisdom:
“What is prudence in the conduct of every
private family, can scarcely be folly in that of a
great kingdom” - Smith
borrowing allows governments “… to conceive
gigantic projects that lead sometimes to
disgrace, sometimes to glory, but always to a
state of financial exhaustion” - Say
debt is “… one of the most terrible scourges
which was ever invented to afflict a nation, …
a system which tends to make us less thrifty, to
blind us to our real situation” - Ricardo
FISCAL DISCIPLINE AND
FLEXIBILITY
Fiscal stabilisation recognised as a
fundamental function: area cycles &
asymmetric shocks
deficit ceiling + close-to-balance target 
balance fluctuates over the cycle:
stabilisers can operate freely
Problems:
 transition to close to balance
 fiscal policy in good times (lack of sticks
and carrots)
 lack of consensus on estimation of
cyclically adjusted balances
TECHNICAL CRITICISMS - 1
 SGP reduces budgetary flexibility
it may require pro-cyclical policies or may
prevent discretionary action
(i) true in transition
(ii) unlikely in steady state: safety margins
sufficient to cope with most recessions +
exceptionality clause
 SGP disregards aggregate fiscal stance
aggregation of national fiscal policies may
not result in optimal area fiscal stance
possible, but
- if stabilisers work, no problem in most cases
- coordination of national policies problematic
- close-to-balance better than past situations,
when high deficit constrained policies
TECHNICAL CRITICISMS - 2
 SGP discourages public investment
no longer be possible to spread the cost of an
investment project over all the generations of
taxpayers who benefit from it
true, but
- GR problematic: distortions, monitoring
- net investment not big in several countries
 SGP focuses on short term commitments
and disregards structural reforms
true, but
- long term indicators operationally
problematic
- close to balance   debt  ageing
TECHNICAL CRITICISMS - 3
 SGP works asymmetrically
does not curb incentives to cut revenue or
increase expenditure in good times
true: need peer pressure, long-term views
 SGP does not sanction politicallymotivated fiscal policies
unlike 1997 convergence, sticking to rules do
not pay politically
true: need peer pressure, long-term views
 SGP too demanding for countries in
sound positions
SGP treats equally countries with different
long-term prospects and debt levels
true
Fiscal outcomes
 EU rules successful up to 1997
(Deficit declines: 6%  2.5%)
 Balanced budgets targeted for 2002
 But, once monetary union was started,
governments introduced tax cuts
(without spending cuts)
 2002: four countries constrained by the
3% deficit limit. Either
- avoid discretionary anti-cyclical
policies or adopt pro-cyclical policies
- or neglect rules (loss of credibility)
 New discussion on rules
Criticisms 2: EU rules now
hamper stabilisation policies
 Short-term approach
 But solutions to current policy dilemma
depend on views about SGP in steady
state:
- if rules are unnecessary or SGP
inferior to other solutions, why bother?
- if rules necessary and no solution
clearly superior to SGP, better retain it
and bear some adjustment costs
Critical views of EU rules - 1
Three main arguments:
 There is no need for fiscal rules. Rules
lead to sub-optimal solutions. Better rely
on discretionary ad hoc decisions
 EU rules may be fine in principle, but
they are now an obstacle to adequate
stabilisation policies
 Rules are necessary, but we could have
more intelligent rules than the EU rules