On the Theoretical Underpinning of the Stability and Growth Pact

Abstract

The Maastricht Treaty of 1992 has installed a special procedure to enforce fiscal discipline and convergence as a precondition for a country to participate in the Economic and Monetary Union (EMU). As regards government finance, the entry conditions, commonly referred to as the Maastricht criteria, specify a reference value for a country’s general government net borrowing equal to 3 percent of its GDP, and for gross government debt equal to 60 percent of GDP. The Treaty of Amsterdam, signed in 1997, has enshrined such reference values in the so-called Stability and Growth Pact (SGP), which is intended an integral part of the practical operation of EMU. While the reference value for debt still con stitutes a requirement for future entry of new members, it loses relevance once a country becomes a member. On the other hand, in addition to the 3 percent reference value for actual net government borrowing, the Pact also requires each member country government to aim for a medium term budgetary position which is “close to balance or in surplus.” A surveillance procedure is meant to ensure consistency of each government’s fiscal policy with this requirement, and with a proper functioning of EMU more generally. More importantly, if a country exceeds the 3 percent reference value, a so-called Excessive Deficit Procedure (EDP) is set in operation which involves corrective action, and even fines in case of lasting violation. The SGP thus includes an enforcement mechanism which is unusually tough for agreements between sovereign nations.