Europe Starts To Bicker Over The Stability Pact

by Ulrika Lomas, Tax-News.com, Brussels

28 August 2001

All those years ago when the European Central Bank was launched, the euro was conceived, and the Growth and Stability Pact was cobbled together to comfort German burghers faced with losing the Deutschmark, the doomsayers foretold a time when the contradictions at the heart of the new European economic and monetary structure would break it apart.

Since then times have been good, or anyway not too bad, and only the madcap Irish have made a national challenge to the status quo - successfully it appears.

But now times are looking maybe not so good, and national voices are being raised against the Pact. The latest of these is Luxembourg Prime Minister Jean-Claude Juncker, who last week added his voice to an increasing number of euro-zone officials calling for budget restraints to be eased. Juncker told the German business newspaper Borsen-Zeitung that deficit targets should not be followed "obsessively".

Mr Juncker however was careful not to attack the Pact head on: "I think giving the impression today that we want to draw a line through the (Growth and) Stability Pact would have a devastating effect. But it would be just as devastating to be restrictive and obsessive about deficit targets that were set at a particular moment, without looking at the overall context."

The Growth and Stability Pact commits euro-zone countries to keeping budget deficits below three percent of gross domestic product in times of weak economic conditions and maintaining a balanced budget or a surplus when economies are growing.

Juncker said that it should be possible "to allow for minimum and temporary straying from the Stability Pact in certain states because of reduced tax income."

He also said that a distinction should be made in the budget constraints between operating expenses of states and investment expenses, which would give governments more room to manoeuvre.

"I don't think it would be sensible from an economic perspective to revise investment programs now because of the poor situation, simply to respect deficit targets," he said.

The European Central Bank however is having none of it, complaining in its latest Bulletin about national rigidities that prevent sound fiscal policy.

' The frequent emphasis on the importance of labour market reforms to unlock the euro area's full growth potential should not be allowed to overshadow the fact that national rules and institutions also need reforming,' says the Bank. 'While EU-wide rules and institutions are supportive of stability-oriented and sustainable fiscal policies and thereby foster growth, national fiscal policies are not as efficient as they could be. As long as there is no comprehensive reform at national level, there will be no reversal of the growing gap of the last two decades between US and euro-area growth.'

The Bank says that EU member states made the right commitments towards national reform at the Lisbon European Council, but 'the incentives to implement this strategy are insufficient and the absence of reforms in the framework of national rules and institutions is an important reason for this.'

The ECB is happy with the Stability and Growth Pact: automatic stabilisers can operate freely to smooth output fluctuations and discretionary policy changes should not jeopardise the long-term sustainability of public finances. But the Bank wants national budget processes to complement the EU-wide framework, saying that tax cuts are often not part of a comprehensive reform strategy and in some cases have turned out to be pro-cyclical and therefore counter-productive in terms of inflation control. It says that benefit reforms have been largely piecemeal and half-hearted, leaving the public sector and the tax burden much larger than in most competitor countries.

The Bank says that expenditure reform is 'perhaps the most important area in which changes in the fiscal policy framework could make a difference and, as a second round effect, permit further tax reductions.' The Bank wants taxation and the social benefit system to be connected in a compatible way to prevent employment and investment disincentives. It also sees privately managed, funded pensions and the privatisation of public sector goods and services provision as a large part of the answer.

The Bank says that if the individual member states of the EU would only run efficient fiscal policies then its own work to maintain price stability would be much easier. This is all fairly mild stuff so far, but it remains to be seen what will happen when economic push comes to shove.

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