EU Needs Fiscal Watchdog to Replace Stability and Growth Pact

Monitoring European Integration Volume 13

Authors: Antonio Fatás , Andrew Hughes Hallett , Anne Sibert , Rolf Strauch , Jürgen von Hagen

4 December 2003

Since the start of European Monetary Union, fiscal conditions in the member states have slipped dramatically. The fiscal policy framework of EMU and the preventative arm of the Stability and Growth Pact, which should preclude excessive deficits in member states and fine any transgressors, have now been suspended. This failure is the result of the problems inherent in using a regime which focuses on arbitrary numerical values and employs sinners to sit in judgement on sinners. The authors of the latest CEPR Report in the Monitoring European Integration Series titled Stability and Growth in Europe: Towards a Better Pact argue for the establishment of a Sustainability Council, an independent institutional framework allowing for informed and credible judgment in the short run while preserving sustainable public finances in the long run.

Their proposal advises that stability of the common currency needs an appropriate framework for fiscal policy in order to maintain the sustainability of public finances. The original institutional setting adopted by the Maastricht Treaty provides a viable basis for amending existing procedures. The authors argue for the creation of a Sustainability Council for the euro area: an independent panel of experts with a clear mandate, a credible enforcement mechanism, and a well-designed procedural setting guaranteeing independence and accountability at the same time. The use of a Sustainability Council allowing for judgment in the short run while preserving sustainable public finances in the long run is the right direction of reform.

The Sustainability Council would be based on a nomination process involving only the European parliament. Dismissal of the Sustainability Council would be possible only collectively. Contracts would be fixed term, non-renewable, and preclude working for member governments afterwards. The Sustainability Council would have the sole statutory task of safeguarding the sustainability of public finances in the euro area. The debt criterion would therefore be pre-eminent. National governments would submit their annual and medium-term fiscal plans to the Sustainability Council, which would judge the compatibility of the implied change in general government debt with sustainability. Replacing rigid rules by judgmental assessment of the fiscal situation and outlook of each euro-area member state can take into account all relevant aspects of the situation. This makes room for more flexible fiscal policies in the short run.

The Sustainability Council would have no operative role in fiscal policy. It would set neither taxes nor public expenditures. The use of the instruments of fiscal policy would be entirely left to the national governments according to their priorities, but subject to the needs of fiscal sustainability. The Sustainability Council would be required to make its judgments fully public. It would have the right to select its own definitions, techniques of analysis, data, etc. It would declare a member state in excessive deficit if it judged that government's policies to be incompatible with sustainability. It would have the sole right to recommend changes or the imposition of sanctions on member states to the ECOFIN Council, which would have to vote to veto this proposal.

As a European institution, the Sustainability Council must rely on pressures generated through public opinion and the financial markets to enforce fiscal discipline effectively and impartially on large and small member states alike. It would not be restricted in whom it was allowed to talk to. The reliance on public opinion ensures that the Sustainability Council must safeguard its own reputation of high-level expertise and fair judgment. The link between fiscal policies and the sustainability of public finances goes far beyond the effect of annual budget deficits on public debt. It includes in particular the consequences of the quality of fiscal policies for economic growth in the short and the long run.

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