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Friday January 22, 2010 - 17:57:57 GMT
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The Former Stability and Growth PactWill the European Monetary Union countries return to the
budgetary discipline of the Stability and Growth Pact? Can they bring
their future national finances into line with the treaty limits on
deficits and debt?
The 1997 Stability and Growth pact was based on the Maastricht Treaty
and was the operational precursor to the euro launch in 1999. It will
now join the Kellogg-Briand Pact, the Locarno Treaties and other
international agreements that have attempted to control the natural
inclinations of governments and failed. But unlike those anti-war and
disarmament treaties from the 1920s, whose goals disappeared along with
the treaties in the conflicts and wars that followed, the Stability and
Growth Pact will disappear but its chief goal and the great achievement
of European unity, the euro, will live on.
The pact was a German sponsored addition to the Maastricht
Treaty that set up the euro. It set a yearly deficit limit of 3%
percent of GDP and an overall national debt limit of 60% of GDP for all
countries adopting the euro. Its purpose was to enforce the fiscal
discipline of the convergence criteria which set monetary and financial
parameters for joining the euro.
The pact was designed to rein in the perennial deficit spenders of
Southern Europe. It was to be reassurance to the Germans who were
giving up the stability of the Deutsche Mark for the euro and an image
makeover for the Italians, Greeks and other profligates; it was a
complete success. For a few years the spenders pretended that the euro
had disciplined their public finances as it eliminated the recourse to
competitive currency devaluation. The pact helped establish the
credibility of the ECB as a worthy inheritor of the sound money German
Bundesbank and gave the euro a credible beginning and a decade of
In short order the euro was established, accepted and valued by the
worldâ€™s financial markets. It was the most successful introduction of a
currency and central bank in history. The euro is a competitor to the
dollar and yen in world markets and a growing competitor in reserve
status to the dollar. The ECB is the worldâ€™s second central bank and
holder of the best inflation reputation. All of these are at least
partially due to the rigorous criteria of the Stability and Growth
But the pact has been another victim of the financial crisis and
recession. Almost every member of the European Monetary Union (EMU) had
a 2009 budget deficit above the 3% percent limit and all are expected
to be over the limit in 2010. But that has not stopped the lectures
from the central euro duo of Germany and France.
"No government, no state can expect any special treatmentâ€ť.
"Some governments, one in particular, has very difficult decisions to
takeâ€ť. Jean Claude Trichet, the president of the European Central Bank
said in his stern in his warning to the Greek government. German
Chancellor Angela Merkel noted that Greece's fiscal woes could hurt the
The budget woes in Greece, Portugal, Spain and Ireland are not
the only consideration weighing on the euro. European economic growth
is moribund. The German Finance Minister expects GDP to be flat in the
fourth quarter after 0.4% expansion in the second quarter and 0.7% in
the third. EMU growth was 0.4% in the third quarter and is not expected
to be very different in the fourth. ECB interest rate policy is
stationary and there will not be a fast withdrawal of the crisis
liquidity from European money markets. In all of these factors, except
perhaps GDP growth, the euro is no worse off than its two major
competitors the dollar and the yen; only the United States is likely to
have a stronger recovery in the fourth quarter.
German and French government deficits are moderate compared to
those of Greece, Portugal, Ireland and Spain. But the ability of the
two central members of the EMU to enforce the 3% deficit limit or even
to lead by example is very limited.
This is not the first breech of the deficit limit by Germany
or France. The German deficit was over the limit for four consecutive
years in the first half of the last decade. And the French ignored the
limit when it suited their interests. The German deficit in 2009 was
3.2% and will likely be over 5.0% in 2010. This is of course nowhere
near the level of Greece whose 2009 deficit was 12.7% of GDP, or
Spainâ€™s at 11.8%.
But despite brave talk by the European Commission, national and ECB
officials, it is the Greek government that holds the whip hand. It is
the Athenian politicians who must cut their budget and answer to their
voters. If the Greek government is unable or unwilling to meet the
demands of Germany, France and the European Commission what then? If
the Greek voters remove the current government for doing what the
Northern Europeans want, what happens? Will Greece default on its
sovereign debt? No. Will they leave or be forced out of the euro? No.
Will the Greek Government then make some very public efforts to bring
down their deficit levels? Yes. Will the Greeks be able to stabilize
their deficit under the 3% limit anytime in the next generation? Very
problematical. What exactly can the French and Germans do if the
Greeks, Spanish and Portuguese do not cooperate?
The truth is that in a democratic system foreign governments
have little recourse to enforce international agreements on unwilling
countries that can bear the consequences of their actions.
So what will and will not be the results of the EMU deficit and debt crisis?
The euro will not be abandoned; sovereign debt will not be
repudiated; profligate governments will not suddenly develop budget
discipline. But the Stability and Growth Pact, specifically the 3%
deficit and 60% debt limits, will fade into history. The primary
purpose of the pact was the adoption and introduction of the euro; the
pact has served its purpose well. Publicly European and ECB officials
will continue to praise the pact and demand adherence. But the
schedules for compliance to the 3% limit will stretch into the next
decade. Privately they will admit the game is up.
The most successful central bank of the past decade will now fall to
earth. The ECB has been able to make disciplined monetary policy
because the Stability and Growth Pact has limited the inflationary
tendencies of the EMU governments. That restriction is now gone; the
euro can only suffer in consequence.
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