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1.

Introduction

Martin Larch and Joao Nogueira Martins*

Fiscal indicators are the backbone of effective fiscal policy-making, including the
coordination and surveillance of budgetary policy at the EU level. The quality and
success of the EU surveillance framework, in particular the timeliness and
appropriateness of any policy recommendation or decision taken in the context of the
Stability and Growth Pact (SGP), crucially depend on the quality of its diagnostic
instruments. The right conclusions can only be drawn if the underlying analysis is
comprehensive and accurate.

Ever since its inception, the history of fiscal surveillance in the EU and of the SGP has
inter alia been characterised by a continuous upgrading of the analytical toolkit, so as to
be able to respond to new requirements and challenges with the ultimate goal to provide a
robust, consistent and accurate assessment of fiscal policy in the Economic and Monetary
Union.

The 2005 reform of the SGP has confronted us with a number of important new
challenges. Key requirements of the reformed Pact are made contingent on the prevailing
economic conditions in the Member States and are expressed in structural terms, net of
cyclical factors and one-off and other temporary measures. As a consequence, the reform
has broadened and stepped up the scope for gauging the economic and fiscal
performance.

As regards the preventive arm of the reformed Pact, the adjustment process towards
sustainable medium-term budgetary positions can be modulated depending on prevailing
or expected cyclical conditions. In good times the annual structural adjustment should be
higher than the 0.5% of GDP benchmark; it can be less than that in economic bad times.
The medium-term objectives (MTOs) themselves are defined in structural terms. Finally,
as regards the corrective arm of the reformed Pact, the annual adjustment to be achieved
by Member States with an excessive deficit is also expressed in structural terms.

Besides the increased focus on structural budget balances, there is another and more
complex element in the reformed Pact with important implications for the assessment of
fiscal performance, notably long-term sustainability. The EU Council agreement of
March 2005, which underpins the reform of the Pact, while confirming the key role of the
3% and 60% of GDP thresholds of the government deficit and debt, puts additional
emphasis on the public finance developments over the long term. It specifically identifies
the surveillance of debt and sustainability as one of the main areas where improvements
can be made to revive the provisions of the SGP.

The views expressed in this chapter are those of the authors and are not attributable to the European
Commission. Assistance by Fabio Balboni and Stig Malmedal is gratefully acknowledged.

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