The Growth and Stability PactThe Growth and Stability Pact

Michael CrumrineMichael CrumrineScott SwisherScott Swisher

May 24May 24thth, 2005 – , 2005 – European Economic IntegrationEuropean Economic Integration

A well-intentioned, misapplied fiscal A well-intentioned, misapplied fiscal rule for the European Unionrule for the European Union

Thesis Statement andThesis Statement andHistorical OutlineHistorical Outline

Historical ContextHistorical Contexta)a) The Pact’s languageThe Pact’s language

b)b) Factors leading to the Factors leading to the creation of the Pactcreation of the Pact

c)c) EMU’s condition EMU’s condition before and during the before and during the PactPact

d)d) The breakdown of the The breakdown of the Pact, failure to enforcePact, failure to enforce

e)e) The Pact’s FutureThe Pact’s Future

Thesis Statement :

“The European Union’s Growth and Stability Pact was doomed to failure since its signing and should not be a part of the new EU Constitution.”

Economic Argument OutlineEconomic Argument Outline

Economic Argument- Economic Argument- No Pact in ConstitutionNo Pact in Constitution

a)a) Need for fiscal controlNeed for fiscal control

b)b) Economic Effects of Economic Effects of the Pactthe Pact

c)c) Overconcerned with Overconcerned with deficit spendingdeficit spending

d)d) Fine as political and Fine as political and economic suicideeconomic suicide

e)e) Asymmetry of PactAsymmetry of Pact

Economic Argument- Economic Argument- Doomed from the startDoomed from the start

a)a) Signers unprepared Signers unprepared for recessionfor recession

b)b) Vague Pact languageVague Pact language

c)c) Counter-productive Counter-productive penaltypenalty

d)d) Enforcement Enforcement problemsproblems

e)e) National responsesNational responses

f)f) Narrow Pact focusNarrow Pact focus

The Growth and Stability PactThe Growth and Stability Pact

Excessive deficit: deficit/GDP ratio exceeds 3%Excessive deficit: deficit/GDP ratio exceeds 3% Severe recession : -.75% GDP growth in a yearSevere recession : -.75% GDP growth in a year ““Temporary and exceptional circumstances”Temporary and exceptional circumstances” No-interest loan converted to fineNo-interest loan converted to fine ““Preventive and dissuasive”Preventive and dissuasive” Council regulations concerning the PactCouncil regulations concerning the Pact

Strengthening surveillance of budgetary positionsStrengthening surveillance of budgetary positions Speeding up and clarifying excessive debt procedureSpeeding up and clarifying excessive debt procedure

Historical Context / TimelineHistorical Context / Timeline

Treaty of Rome - 1957Treaty of Rome - 1957 Single European Act - 1987Single European Act - 1987 Maastricht Treaty - 1992Maastricht Treaty - 1992 Three Stages of EMUThree Stages of EMU

Exchange Rate Mechanism (July 1990)Exchange Rate Mechanism (July 1990) Transfer of monetary and economic policy to Transfer of monetary and economic policy to

European institutions (January 1994)European institutions (January 1994) Introduction of single currency (January 1999)Introduction of single currency (January 1999)

Need for the PactNeed for the Pact

Convergence criteriaConvergence criteria Average rate of inflation ceilingAverage rate of inflation ceiling Limit on public deficit as a percentage of GDPLimit on public deficit as a percentage of GDP Limit on public debt as a percentage of GDPLimit on public debt as a percentage of GDP Long-term interest rate capLong-term interest rate cap

Integration of EMU : harmonize business Integration of EMU : harmonize business cyclescycles

Stabilization goal : maintain Euro stabilityStabilization goal : maintain Euro stability

EMUEMU Nations – GDP Growth Nations – GDP Growth RateRate

-0.2

0.3

0.8

1.3

1.8

2.3

2.8

3.3

3.8

1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Effects of Pact - Government Debt (% of GDP)Effects of Pact - Government Debt (% of GDP)

35

40

45

50

55

60

65

70

75

80

1993 1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Effects of Pact – Public Balance (% of GDP)Effects of Pact – Public Balance (% of GDP)

-8

-6

-4

-2

0

2

4

1993 1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Public Balance (% of GDP) – France and Public Balance (% of GDP) – France and GermanyGermany

-6

-5

-4

-3

-2

-1

0

1

2

1993 1995 1997 1999 2001 2003

FranceGermany

Breakdown of Pact / FutureBreakdown of Pact / Future

Breakdown – Failure to punish France and Breakdown – Failure to punish France and Germany despite violations of PactGermany despite violations of Pact

German hypocrisy – they created and German hypocrisy – they created and destroyed the Pact in span of 10 yearsdestroyed the Pact in span of 10 years

Future of Pact – definite reform, new EU Future of Pact – definite reform, new EU Constitution includes PactConstitution includes Pact

Economic Argument – DoomedEconomic Argument – Doomed

Signed in expansion, unprepared for recessionSigned in expansion, unprepared for recession Vague language of PactVague language of Pact Counter-productive fineCounter-productive fine Enforcement problemsEnforcement problems ““Coping methods” of member statesCoping methods” of member states Narrow focus on one indicatorNarrow focus on one indicator Rigid and inflexible structureRigid and inflexible structure

Economic Argument – No PactEconomic Argument – No Pact

Member states need fiscal control now that Member states need fiscal control now that they have lost monetary policy control : ECBthey have lost monetary policy control : ECB

Keynesian counter-cyclical fiscal policy Keynesian counter-cyclical fiscal policy needed to get out of recessionsneeded to get out of recessions

Failure of automatic stabilizers under PactFailure of automatic stabilizers under Pact Unsynchronized business cycles : monetary Unsynchronized business cycles : monetary

policy through ECB not enoughpolicy through ECB not enough

Economic Argument – No PactEconomic Argument – No Pact

The concern that deficit spending would The concern that deficit spending would destabilize the euro is exaggerateddestabilize the euro is exaggerated

One country’s deficit spending would have One country’s deficit spending would have limited spillover effects on eurozonelimited spillover effects on eurozone

Recent breakdown of Pact had little effect on Recent breakdown of Pact had little effect on euro’s stability and status as store of valueeuro’s stability and status as store of value

If one member state overspends into deficit, If one member state overspends into deficit, only its credibility will be impactedonly its credibility will be impacted

Effects of Pact – GDP Growth RateEffects of Pact – GDP Growth Rate

-0.2

0.3

0.8

1.3

1.8

2.3

2.8

3.3

3.8

1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Effects of Pact –Unemployment RateEffects of Pact –Unemployment Rate

4

5

6

7

8

9

10

11

12

1993 1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Effects of Pact –Inflation RateEffects of Pact –Inflation Rate

0.4

0.9

1.4

1.9

2.4

2.9

3.4

1993 1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Effects of Pact – Public Balance (% of GDP)Effects of Pact – Public Balance (% of GDP)

-8

-6

-4

-2

0

2

4

1993 1995 1997 1999 2001 2003

EurozoneFranceGermanyUK

Effects of Pact – State Aid (% of GDP)Effects of Pact – State Aid (% of GDP)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1992 1994 1996 1998 2000 2002

EurozoneFranceGermanyUK

Euro vs. US Dollar Exchange RateEuro vs. US Dollar Exchange Rate

The Pact’s Punishment SystemThe Pact’s Punishment System

Any fine used to enforce the Pact is counter-Any fine used to enforce the Pact is counter-productive and unlikely to be enforced unless productive and unlikely to be enforced unless automaticautomatic

A fine in a deficit situation would force the A fine in a deficit situation would force the deficit to grow and make the economy sufferdeficit to grow and make the economy suffer

Political suicide to fine a major player in the Political suicide to fine a major player in the EU : France and Germany are examplesEU : France and Germany are examples

Fining one EMU country hurts all othersFining one EMU country hurts all others

Asymmetric Pact FocusAsymmetric Pact Focus

The Pact only focused on deficits, but what The Pact only focused on deficits, but what about surpluses?about surpluses?

Surpluses could be used to finance deficit Surpluses could be used to finance deficit spending to get out of recessionspending to get out of recession

If this is the case, debt would not increaseIf this is the case, debt would not increase If fines are punishment for running deficits, If fines are punishment for running deficits,

how about a bonus for being in surplus?how about a bonus for being in surplus?

Alternatives to the PactAlternatives to the Pact

Edited out of the new EU Constitution : Edited out of the new EU Constitution : laissez-faire, let the member states have laissez-faire, let the member states have control over their respective fiscal policiescontrol over their respective fiscal policies

Totally co-ordinate fiscal policy in the EMU Totally co-ordinate fiscal policy in the EMU by using a supranational governing body to by using a supranational governing body to make fiscal decisions in each member statemake fiscal decisions in each member state

Another fiscal rule : focus on debt to keep euro Another fiscal rule : focus on debt to keep euro strong and credible as a tradable currencystrong and credible as a tradable currency

SummarySummary

“The European Union’s Growth and Stability Pact was doomed to failure since its signing and should not be a part of the new EU Constitution.”

Historical Context : A need to keep the deficits Historical Context : A need to keep the deficits of EMU member states under controlof EMU member states under control

Economic Argument: The Pact is the wrong tool Economic Argument: The Pact is the wrong tool for a job that might not need doingfor a job that might not need doing

Short-term alternatives: fiscal rule or no PactShort-term alternatives: fiscal rule or no Pact