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The Growth and Stability Pact

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

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The Growth and Stability Pact

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

  2. Thesis Statement andHistorical Outline 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.” • Historical Context • The Pact’s language • Factors leading to the creation of the Pact • EMU’s condition before and during the Pact • The breakdown of the Pact, failure to enforce • The Pact’s Future

  3. Economic Argument- No Pact in Constitution Need for fiscal control Economic Effects of the Pact Overconcerned with deficit spending Fine as political and economic suicide Asymmetry of Pact Economic Argument- Doomed from the start Signers unprepared for recession Vague Pact language Counter-productive penalty Enforcement problems National responses Narrow Pact focus Economic Argument Outline

  4. The Growth and Stability Pact • Excessive deficit: deficit/GDP ratio exceeds 3% • Severe recession : -.75% GDP growth in a year • “Temporary and exceptional circumstances” • No-interest loan converted to fine • “Preventive and dissuasive” • Council regulations concerning the Pact • Strengthening surveillance of budgetary positions • Speeding up and clarifying excessive debt procedure

  5. Historical Context / Timeline • Treaty of Rome - 1957 • Single European Act - 1987 • Maastricht Treaty - 1992 • Three Stages of EMU • Exchange Rate Mechanism (July 1990) • Transfer of monetary and economic policy to European institutions (January 1994) • Introduction of single currency (January 1999)

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

  7. EMU Nations – GDP Growth Rate

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

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

  10. Public Balance (% of GDP) – France and Germany

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

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

  13. Economic Argument – No Pact • 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 • Failure of automatic stabilizers under Pact • Unsynchronized business cycles : monetary policy through ECB not enough

  14. Economic Argument – No Pact • The concern that deficit spending would destabilize the euro is exaggerated • 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 • If one member state overspends into deficit, only its credibility will be impacted

  15. Effects of Pact – GDP Growth Rate

  16. Effects of Pact –Unemployment Rate

  17. Effects of Pact –Inflation Rate

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

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

  20. Euro vs. US Dollar Exchange Rate

  21. The Pact’s Punishment System • 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 • Political suicide to fine a major player in the EU : France and Germany are examples • Fining one EMU country hurts all others

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

  23. Alternatives to the Pact • 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 • Another fiscal rule : focus on debt to keep euro strong and credible as a tradable currency

  24. 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 • Economic Argument: The Pact is the wrong tool for a job that might not need doing • Short-term alternatives: fiscal rule or no Pact

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