Introduction
1. We take it for granted that fiscal discipline is important: i) fiscal policy volatility can undermine
growth; ii) a pro-cyclical policy can destabilise the economy; iii) large deficits and rising debt undermine
the long-run sustainability of fiscal policy and iv) excessive deficits will be a burden on future generations
(Fatas, 2005). Fiscal rules are one way to cope with such fiscal policy biases, but they need to be
underpinned by institutional settings so that they can be enforced at the national, and in the case of the euro
area, at the Community level.
2. The EU fiscal framework was set to underpin the single currency. It was designed to address one
key concern, namely that once exchange rates within the single currency area ceased to exist, financial
markets would not longer discipline fiscal policy. Fiscal profligacy in one country could affect area-wide
interest rates and crowd out economic activity in other countries. As interest rate differentials across the
euro area countries have become small despite a divergent fiscal performance, there is little evidence of
spill-over effects, probably because there is little to crowd out due to persistent economic slack in the large
euro area countries.
3. This may be one reason why the arguments in favour of rules-based fiscal co-ordination have
shifted towards long-term issues, not least because ageing-related concerns oblige governments to recognise
the implications of current budget decisions for public finances in the future. Also, greater weight has
progressively been put on the incentives built into budgetary institutions that produce fiscal biases (higher
deficits, expenditure and taxes). But, while these institutions have improved to some extent, they are still
lagging best practice in many euro area countries.
4. At the same time, calls to make the Pact more flexible have mushroomed. Some were motivated
by new member countries’ need to boost infrastructure outlays, against the backdrop of relatively low
public debt levels. Some observers have argued in favour of the “golden rule”, along the lines of the one
introduced in 1997 in the United Kingdom.
5. Another rationale for a rewrite of the rules, and the topic of this conference, is that structural
reform may yield long-term economic gains but entail up-front costs. The estimated gains of structural
reforms are usually uncertain, whereas any immediate political and budgetary costs, such as compensation
schemes to offset redistributive effects, are felt immediately and more tangibly. Moreover, some reforms
will involve J-curve effects; a cut in taxation will reduce budget receipts immediately while effects on
incentives to work, save and invest may be slow to materialise. This asymmetry could discourage reforms,
especially in a monetary union, where they cannot be supported via an easing of monetary policy. Similarly,
a move towards privately funded pension schemes would lead to deficits in the public scheme but initial
surpluses in the private schemes as contributors transfer to them.
6. According to the fiscal rules a waiver could be granted under the excessive deficit procedure to
countries on the basis of “exceptional circumstances” (EC 2005a). While the Treaty had already stipulated
that “other relevant factors” should be part of the “exceptional circumstances”, these were not specified.
The revamped Pact decided by the European Council in March 2005 specifies them and the conditions
under which they are taken into account. These include a country’s efforts to pursue the Lisbon agenda, to
foster R&D or “a high level of financial contributions” to underpin the “unification of Europe” and
“international solidarity” (development aid). Consideration would also be given to pension reforms.
Concerning the Lisbon agenda, the new Council Regulation observes: “In order to enhance the
growth-oriented nature of the Pact, major structural reforms which have direct long-term cost-saving
effects, including through raising potential growth, and therefore a verifiable impact on the long-term
sustainability of public finances, should be taken into account when defining the adjustment path to the
medium-term budgetary objective for countries that have not yet reached this objective and in allowing a
temporary deviation from this objective for countries that have already reached it” (EC, 2005b). All these
provisions, however, only apply if “an excess over the reference value is temporary” and if the deficit ratio
“remains close to the reference value”, as stipulated in the Treaty.
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