• The Stability and Growth Pact implements the excessive deficit procedure written down in the Treaty of Maastricht. It establishes a limit of 3% of GDP for budget deficits, defines the exceptional conditions under which breaching the limit can be accepted, and establishes how and when fines can be levied against countries that display excessive deficits.
• The only valid concern cited to justify the Stability and Growth Pact is the danger of systemic banking and financial crises in case of debt default by a country member of EMU. The better policy, in this case, is prudential regulation, not a cap on deficits.
• If the objective of the Stability and Growth Pact is to foster fiscal policy coordination, then there is no reason for its asymmetry, banning deficits more than surpluses.
• The objective of preventing one country from imposing high interest rates on the others is invalid, both theoretically as this is a market-based cost that can be dealt with by market-based measures, and empirically as European countries borrow in a market fully integrated to world financial markets, and are too small to affect world-wide interest rates.
• The Stability and Growth Pact includes a number of features which will make it less automatic than commonly believed. Fines are unlikely to be levied because the political fallout could be cataclysmic. Both delinquent countries and their partners will exercise prudence to avoid reaching the stage where a fine is imposed.
• In countries that stay close to the 3% deficit limit the Pact may lead to the loss of automatic stabilizers – the fact that deficits widen during recessions and thus cushion the decline in demand. This effect turns out to be more limited than often feared. Yet it is not negligible; of the same order of magnitude of the optimistic assessments of the welfare gains from EMU.
• The best response would be to re-establish the ability to use automatic multipliers. This can be achieved by running cyclically balanced budgets, i.e. budgets which are in surplus at the peak of the cycle and at a 3% deficit at the bottom of a non-exceptional recession.
• If the current period of expansion proves to be long-lived, bringing the budgets to cyclical balance may prove relatively painless. If the expansion is weak and short-lived, much greater discretionary effort will be necessary.
• In the end the main risk is that, after a decade of painful convergence to pass the entry criteria, public opinion might display ‘Maastricht fatigue’. Policy-makers forced to abide by the Stability and Growth Pact will then be unable to undertake the structural reforms required to deal with unemployment and the effects of an aging population on the welfare system.
• Notes for Editors:

EMU: Prospects and Challenges for the Euro is a special issue of the review, Economic Policy: A European Forum. It contains revised versions of the papers presented to the Twenty-Sixth Economic Policy Panel Meeting held in Bonn on 17/18 October 1997, with the support of the Zentrum für Europäische Integrations-forschung. The Economic Policy Panel meets twice annually to discuss papers that are specially commissioned by the editors to provide timely and authoritative analyses of the choices confronting policy-makers. The articles use the best of modern economic analysis, but are easily accessible to a wide audience and highly readable. Each paper is discussed by a rotating Panel of distinguished economists whose comments are published to provide the reader with alternative interpretations of the evidence and a sense of the liveliness of the current debate.

Economic Policy is published in association with the European Economic Association for the Centre for Economic Policy Research, the Center for Economic Studies of the University of Munich and the Département et Laboratoire d’Economie Théorique et Appliquée (DELTA), in collaboration with the Maison des Sciences de l’Homme.

Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and is currently on leave at the International Monetary Fund, where he is Senior Policy Advisor on issues pertaining to reform of the international monetary system. He is also a Research Fellow in CEPR’s International Macroeconomics and International Trade programmes. Charles Wyplosz, a Managing Editor of Economic Policy, is Professor of Economics at the Graduate Institute of International Studies in Geneva and a Research Fellow in CEPR’s International Macroeconomics and Transition Economics programmes.

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