The Stability and Growth Pact: How Much Co-Ordination? John Fitz Gerald and Adele Bergin The Economic and Social Research Institute

Fiscal Policy under EMU n EMU changed things n Channels for transmission: Financial systemFinancial system Debt defaultDebt default Inflation and Interest ratesInflation and Interest rates n Fiscal Policy Regime – SGP: its role Is it effective in preventing unwise policy?Is it effective in preventing unwise policy? Does it respect subsidiarity?Does it respect subsidiarity?

Financial Stability n All have interest in financial stability n ECB action to handle regional crisis? n Who would handle a regional crisis?

Danger of Default n Pisani-Ferry – If solvency only concern – debt criterion alone n What level of debt? n Investment in Infrastructure Different long-term implicationsDifferent long-term implications Produces a “return”Produces a “return” Intergenerational equityIntergenerational equity

Investment, share of GDP 2001

Public Investment, % of GDP

Government saving % of GDP

Dangers of Inflation n Effect of fiscal policy changed by EMU n Fiscal Policy Under 3 Regimes: Independent Monetary PolicyIndependent Monetary Policy EMSEMS EMUEMU n Example: Fiscal Stimulus in Germany: 2% of GDPFiscal Stimulus in Germany: 2% of GDP Using NiGEMUsing NiGEM

Effect on Interest rates

Effect on German GDP

Effect on French GDP

Under EMU n Only small negative spillover n Inflation effect small n Interest Rate effect small n True for fiscal stimulus in other members

Results n Under EMU: Unwise fiscal policy in one regional economy has limited scope to damage the Euro area economy.Unwise fiscal policy in one regional economy has limited scope to damage the Euro area economy. n Under EMS Unwise fiscal policy in Germany could have serious negative effects elsewhereUnwise fiscal policy in Germany could have serious negative effects elsewhere n The SGP is the child of the EMS

Domestic Fiscal Policy n The cost of a fiscal war of attrition? n Example of Finland n Would it be different for France & Germany? n Rapid adjustment – lower cost? n Maybe SGP is sensible rule for individual countries

Conclusions n Enforce the SGP first? n Replacement for the SGP Should respect subsidiarityShould respect subsidiarity Protect against real potential dangers – Danger of defaultProtect against real potential dangers – Danger of default Debt criterion or Modified “Golden Rule”? – Blanchard and GiavazziDebt criterion or Modified “Golden Rule”? – Blanchard and Giavazzi n How strong a rule?