The Growth and Stability Pact Michael Crumrine Scott Swisher May 24 th, 2005 – European Economic Integration A well-intentioned, misapplied fiscal rule for the European Union

Thesis Statement and Historical Outline  Historical Context a) The Pact’s language b) Factors leading to the creation of the Pact c) EMU’s condition before and during the Pact d) The breakdown of the Pact, failure to enforce e) The 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 Outline  Economic Argument- No Pact in Constitution a) Need for fiscal control b) Economic Effects of the Pact c) Overconcerned with deficit spending d) Fine as political and economic suicide e) Asymmetry of Pact  Economic Argument- Doomed from the start a) Signers unprepared for recession b) Vague Pact language c) Counter-productive penalty d) Enforcement problems e) National responses f) Narrow Pact focus

The 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 year Severe recession : -.75% GDP growth in a year “Temporary and exceptional circumstances” “Temporary and exceptional circumstances” No-interest loan converted to fine No-interest loan converted to fine “Preventive and dissuasive” “Preventive and dissuasive” Council regulations concerning the Pact Council regulations concerning the Pact Strengthening surveillance of budgetary positions Strengthening surveillance of budgetary positions Speeding up and clarifying excessive debt procedure Speeding up and clarifying excessive debt procedure

Historical Context / Timeline Treaty of Rome Treaty of Rome Single European Act Single European Act Maastricht Treaty Maastricht Treaty Three Stages of EMU Three Stages of EMU Exchange Rate Mechanism (July 1990) Exchange Rate Mechanism (July 1990) Transfer of monetary and economic policy to European institutions (January 1994) Transfer of monetary and economic policy to European institutions (January 1994) Introduction of single currency (January 1999) Introduction of single currency (January 1999)

Need for the Pact Convergence criteria Convergence criteria Average rate of inflation ceiling Average rate of inflation ceiling Limit on public deficit as a percentage of GDP Limit on public deficit as a percentage of GDP Limit on public debt as a percentage of GDP Limit on public debt as a percentage of GDP Long-term interest rate cap Long-term interest rate cap Integration of EMU : harmonize business cycles Integration of EMU : harmonize business cycles Stabilization goal : maintain Euro stability Stabilization goal : maintain Euro stability

EMU Nations – GDP Growth Rate

Effects of Pact - Government Debt (% of GDP)

Effects of Pact – Public Balance (% of GDP)

Public Balance (% of GDP) – France and Germany

Breakdown of Pact / Future Breakdown – Failure to punish France and Germany despite violations of Pact Breakdown – Failure to punish France and Germany despite violations of Pact German hypocrisy – they created and destroyed the Pact in span of 10 years German hypocrisy – they created and destroyed the Pact in span of 10 years Future of Pact – definite reform, new EU Constitution includes Pact Future of Pact – definite reform, new EU Constitution includes Pact

Economic Argument – Doomed Signed in expansion, unprepared for recession Signed in expansion, unprepared for recession Vague language of Pact Vague language of Pact Counter-productive fine Counter-productive fine Enforcement problems Enforcement problems “Coping methods” of member states “Coping methods” of member states Narrow focus on one indicator Narrow focus on one indicator Rigid and inflexible structure Rigid and inflexible structure

Economic Argument – No Pact Member states need fiscal control now that they have lost monetary policy control : ECB Member states need fiscal control now that they have lost monetary policy control : ECB Keynesian counter-cyclical fiscal policy needed to get out of recessions Keynesian counter-cyclical fiscal policy needed to get out of recessions Failure of automatic stabilizers under Pact Failure of automatic stabilizers under Pact Unsynchronized business cycles : monetary policy through ECB not enough Unsynchronized business cycles : monetary policy through ECB not enough

Economic Argument – No Pact The concern that deficit spending would destabilize the euro is exaggerated The concern that deficit spending would destabilize the euro is exaggerated One country’s deficit spending would have limited spillover effects on eurozone One country’s deficit spending would have limited spillover effects on eurozone Recent breakdown of Pact had little effect on euro’s stability and status as store of value Recent breakdown of Pact had little effect on euro’s stability and status as store of value If one member state overspends into deficit, only its credibility will be impacted If one member state overspends into deficit, only its credibility will be impacted

Effects of Pact – GDP Growth Rate

Effects of Pact –Unemployment Rate

Effects of Pact –Inflation Rate

Effects of Pact – Public Balance (% of GDP)

Effects of Pact – State Aid (% of GDP)

Euro vs. US Dollar Exchange Rate

The Pact’s Punishment System Any fine used to enforce the Pact is counter- productive and unlikely to be enforced unless automatic Any fine used to enforce the Pact is counter- productive and unlikely to be enforced unless automatic A fine in a deficit situation would force the deficit to grow and make the economy suffer A fine in a deficit situation would force the deficit to grow and make the economy suffer Political suicide to fine a major player in the EU : France and Germany are examples Political suicide to fine a major player in the EU : France and Germany are examples Fining one EMU country hurts all others Fining one EMU country hurts all others

Asymmetric Pact Focus The Pact only focused on deficits, but what about surpluses? The Pact only focused on deficits, but what about surpluses? Surpluses could be used to finance deficit spending to get out of recession Surpluses could be used to finance deficit spending to get out of recession If this is the case, debt would not increase If this is the case, debt would not increase If fines are punishment for running deficits, how about a bonus for being in surplus? If fines are punishment for running deficits, how about a bonus for being in surplus?

Alternatives to the Pact Edited out of the new EU Constitution : laissez-faire, let the member states have control over their respective fiscal policies Edited out of the new EU Constitution : laissez-faire, let the member states have control over their respective fiscal policies Totally co-ordinate fiscal policy in the EMU by using a supranational governing body to make fiscal decisions in each member state Totally co-ordinate fiscal policy in the EMU by using a supranational governing body to make fiscal decisions in each member state Another fiscal rule : focus on debt to keep euro strong and credible as a tradable currency Another fiscal rule : focus on debt to keep euro strong and credible as a tradable currency

Summary “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 of EMU member states under control Historical Context : A need to keep the deficits of EMU member states under control Economic Argument: The Pact is the wrong tool for a job that might not need doing Economic Argument: The Pact is the wrong tool for a job that might not need doing Short-term alternatives: fiscal rule or no Pact Short-term alternatives: fiscal rule or no Pact