Date: 20 September 2005
Speaker: Marco Buti, Director, Economies of the Member States, DG Ecfin, European Commission

 
On September 20, 2005, Marco Buti, Director for the Economies of the Member States in DG Ecfin of the European Commission, presented the findings from his book (co-authored with Daniele Franco from the Bank of Italy), “Fiscal Policy in Economic and Monetary Union,” at a CEPS lunchtime meeting.  Buti began his lecture by explaining the economic and political rationale behind fiscal rules in EMU.  First, there exists the possibility of spillovers between fiscal policy and economic policy.  He gave the example of fiscal expansion occurring in one country being countered by an increase in interest rates by the European Central Bank.  Budgets become a concern for the entire euro area so as to avoid policy conflict under supply shocks.  Second, due to the aging population of the Eurozone countries, the level of politically sustainable debt is decreasing.  Finally, the fiscal rules provided a screening device for participation in EMU, but as Buti remarked, “history takes revenge,” referring to one of the primary advocates for fiscal rules in EMU (Germany) finding itself in breach of these rules several years later.
 
The spirit of the SGP was to provide Member States with a 3% reference value that would be treated as a “hard ceiling” while also giving states the “medium-term budgetary objective of close-to-balance or in surplus”.  In theory, the actual deficit would decrease as the output gap increased, which is what we already observed in low-debt countries from 1970-1990.  Controlling debt and deficits is of the utmost concern to European governments because of the issue of sustainability.  The aging European population will necessitate increases in public spending, thus decreasing the maximum sustainable level of debt. 
 
However, the first five years of EMU did not conform to the original logic of the SGP.  The culprit: the failure to save during good times (1999-2001).  In 2000 the large countries even promised stabilization, but by then we saw the re-emergence of an electoral calendar in which increases in discretionary fiscal policy occurred prior to election years.
 
Reflecting on the lessons from the first five years of EMU, economically we have seen high structural deficits and debt and the failure to consolidate in good times, but also better stabilization (though Buti does not attribute this to SGP rules).  Buti’s political assessment notes the fading “ownership” of EMU as countries that originally supported the SGP became vocal critics, and the emergence of divisions between large countries that flouted the rules and smaller countries that advocated their strict interpretation.  In contrast to the Maastricht convergence criteria, enforcing the SGP was problematic because of negative domestic political repercussions for meeting the criteria, blurred incentives for SGP adherence, a lack of political ownership of the rules by large members, unclear deadlines, and difficulty in monitoring compliance. 
 
The reformed SGP rules can be viewed as either a case of collusion or genuine reform.  The former interpretation sees lower public visibility, rules that are easier to skirt, support by high deficit countries for the reduced constraints posed by the new SGP, and a collusive policymaking environment.  Those who view this as a genuine reform would point out the improved economic rationale behind the SGP, which would increase political ownership among all Member States and encourage fiscal restraint.  Buti ended his presentation by emphasizing the need to subordinate short-term domestic political gains in favor of European welfare.
 
While Buti placed himself in the category of those who see a revised SGP as genuine reform, Daniel Gros, Director, CEPS, argued in favor of the collusion interpretation, noting that the recent election results in Germany will reinforce this trend.  However, most of Gros’ comments indicated agreement with the issues covered by Buti, though he emphasized how overly optimistic government projections by large states have hampered fiscal consolidation efforts.  Small states, on the other hand, have experienced higher growth than large states, undercutting arguments made by the latter that deficit spending is needed to promote economic growth.  Though the 3 percent deficit rule does not make economic sense for every state, it does for the aging Eurozone.  Short-sighted politicians, however, have failed to implement medium-term strategies advocated by the SGP for short-term political gain.  Finally, Gros asked the audience to consider the effect that deficits have in crowding out private investment.