Will the new stability and growth pact succeed? An economic and political perspective

While the Maastricht Treaty establishes the entry conditions for Member States to join the single currency, the Stability and Growth Pact (SGP) aims to make budgetary discipline a permanent feature of EMU. Consequently, the Pact is commonly interpreted as a major building block of EMU's architecture: the SGP ‘must rank as one of the most remarkable pieces of policy coordination in world history. The purpose of this paper is to offer an initial evaluation of the SGP reform. Section Two reviews the main fiscal policy developments in the early years of EMU which were at the basis of the crisis of the SGP ‘mark I'. Section Three describes the reformed SGP and an assessment of its main features. Section Four presents some reflections on the political economy of the EU rules, comparing the new SGP with the Maastricht Treaty and the SGP ‘mark I'. The final section concludes.Stability and Growth Pact, Economic Monetary Union (EMU), Maastricht Treaty, Buti

A Challenger to the Limit Order Book: The NYSE Specialist

This paper gives a new answer to the challenging question raised by Glosten (1994): "Is the electronic order book inevitable?". While the order book enables traders to compete to supply anonymous liquidity, the specialist system enables one to reap the benefits from repeated interaction. We compare a competitive limit order book and a limit order book with a specialist, like the NYSE. Thanks to non-anonymous interaction, mediated by brokers, uninformed investors can obtain good liquidity from the specialist. This, however, creates an adverse selection problem on the limit order book. Market liquidity and social welfare are improved by the specialist if adverse selection is severe and if brokers have long horizon, so that reputation becomes a matter of concern for them. In contrast, if asymmetric information is limited, spreads are wider and utilitarian welfare is lower when the specialist competes with the limit order book than in a pure limit order book market.Limit order book; specialist; hybrid market

"Constrained Flexibility" as a tool to facilitate reform of the EU budget

The Sapir report in 2004 famously dubbed the EU Budget a historical relic. In spite of calls from many quarters for a comprehensive budget reform, the Council negotiation was hampered by many institutional and political constraints and managed to deliver only limited change.However, the final agreement on the Multiannual Financial Framework 2007/13 did introduce a potentially important novelty, namely a review clause in 2008/9. Such an occasion should be seized to introduce appropriate incentives and tools for revamping the EU budget with the aim of making it consistent with the Lisbon-oriented objectives of the EU. This paper argues for the respect of the Multiannual Financial Framework over the period covered rather than in every single year and per every single heading. This should be accomplished via an inter-temporal guarantee of the respect of the Multiannual Financial Framework and coupled with cost-benefit analysis of the additional spending carried out at the EU level. Such “constrained flexibilityâ€, which can be introduced either under the current or the new Lisbon Treaty, should be supported by appropriate governance arrangements to ensure the respect of subsidiarity, allow an efficient running of the budget and enforce budgetary discipline.EU budget, constrained flexibility, fiscal federalism, Buti, Nava

Budgetary policies during recessions. Retrospective application of the "stability and growth pact" to the post-war period. Economic Papers No. 121, May 1997

Over recent years, the budgetary policies carried out by Western countries during the Post-War period have been analysed extensively in the literature. Several studies have pointed to the interaction of economic and political factors and underlined the important role of institutions and procedures in shaping policies and outcomes1. Considerable attention has been devoted to budgetary consolidation processes, with some studies emphasising the role of the composition of budgetary measures in determining the success of these policies2. The purpose of this paper is to analyse budgetary policies carried out during and after severe recessions, an issue which the above-mentioned literature has not yet focused upon

Close to Balance or in Surplus. A Policy Maker’s Guide to the Implementation of the Stability and Growth Pact

currency; economic integration; EMU; Euro; European Central Bank; political economy; stability pact

Budgetary Policies during Recessions - Retrospective Application of the "Stability and Growth Pact" to the Post-War Period

Cover pagesText AnnexesThe purpose of this paper is to analyse budgetary policies carried out during and after severe recessions. Since the agreement on the "Stability and Growth Pact" by the European Council in Dublin in December 1996, interest in this issue has increased significantly. The Stability and Growth Pact, which sets the rules for budgetary behaviour in stage three of EMU, singles out severe recessions as specifically problematical periods during which a certain budgetary flexibility could be allowed. The rules laid out in the Stability and Growth Pact are used in this paper as a benchmark to evaluate past budgetary behaviour during recessions in the fifteen European Union Member States. More specifically, the paper provides elements to examine the following issues: what type of budgetary policies have been adopted during severe recessions in the past? Were the automatic stabilisers allowed to operate fully and did governments adopt an expansionary budgetary policy stance? Which factors influenced the policies undertaken and what was the composition of the measures adopted? Can the accumulation of debt, which took place in the past two decades in Europe, be explained by "tax smoothing" during periods of economic hardship?II/195/97-ENConcluding remarks The application of the provisions of the Excessive Deficit Procedure and the Stability and Growth Pact to the past is obviously a highly speculative exercise. Its results do not address the following questions: to what extent is past budgetary behaviour a reliable guide to assess the likely behaviour of national budgetary policies in EMU during recessions? More specifically, would Member States need larger or smaller changes in their budgetary positions to provide the degree of stabilisation which occurred in the past?A number of factors will play an important role:New policy regime under EMUDuring the third phase of EMU, the conduct of monetary policy will be centralised at the European level and will therefore no longer be available as a policy tool at the national level. Budgetary policy will thus be the main macroeconomic policy instrument still available for individual Member States to combat recessions, especially when shocks are asymmetric. The impossibility of lowering interest rates and resorting to currency devaluations might require larger deficit changes.On the other hand, according to the Mundell-Fleming framework, budgetary policy will in principle become more effective in dampening the amplitude of cyclical fluctuations in the new policy environment of EMU with centralised monetary policy and irrevocably fixed exchange rates between Member States.If, however, EMU enhances the process of economic integration, trade leakages of budgetary policies will gradually increase, thereby reducing the "domestic" effectiveness of budgetary policies. Unless national policies are co-ordinated, this factor raises the changes in the budget deficit required in order to attain the same degree of stabilisation achieved in the past."Pre-recession" deficit levelActual deficit changes observed during past recessions were applied in our retrospective exercise to "pre-recession" deficit levels chosen specifically for the exercise (0% and 2% of GDP). However, the actual deficit changes which took place during past severe recessions usually started from markedly higher pre-recession deficit levels. The impact on the economy of budgetary policy changes during recessions also varies depending on the deficit and debt levels. For instance, the markets' perception of an increase in the deficit from 0% to 2% of GDP during a severe recession will be different from that of a rise in the deficit from, say, 8% to 10% of GDP, the latter more likely being interpreted as shifting the deficit to an unsustainable path. This may lead to an increase in the risk premium on interest rates which reduces the effectiveness of the fiscal expansion.High budgetary imbalances may inhibit policy makers from using the budgetary instrument for stabilisation purposes. Indeed, the higher risk premiums which would raise the interest burden may represent a powerful disincentive to expanding fiscal policy in spite of the recession. As was pointed out in Section 4, budgetary reactions to economic downturns differ depending on the initial public finance conditions before the recession: countries with high deficit and debt levels tend to conduct tighter fiscal policies during recessions than those with lower deficit and debt levels. In the future, when medium-term targets have been achieved, Member States would have more room for manoeuvre to undertake accommodating policies.These factors point in different directions. As a consequence, the net effect on the requirement for budgetary stabilisation is ambiguous. If it proved necessary to reinforce the working of the automatic stabilisers during recessions in EMU, larger swings in budget deficits compared to the past would have to be allowed for. Under the provisions of the Stability and Growth Pact, this would imply, however, that during the third phase of EMU, Member States, and especially those with large automatic stabilisers, would have to run budgetary surpluses when in medium-term equilibrium.The present paper far from exhausts the issue of what can be learnt from the past budgetary behaviour for the implementation of the Stability and Growth Pact and, more generally, how budgetary authorities actually behaved in different economic circumstances.The following areas were not or were only partially covered, and therefore, provide scope for further research:Budgetary policies over the full cycle: this paper has focused essentially on recession episodes. The exercise could therefore be extended to other cyclical phases besides the recession. Indeed, as already indicated in this paper, the problem in the past has not been so much that Member States let budget deficits get out of hand too much during recessions but that they did not seize the opportunity presented by post-recession economic recovery to immediately correct their budgetary position.Composition of budgetary policies: the paper addressed the issue of the composition of budgetary policy reactions to recessions via a preliminary analysis of the overall revenue and expenditure components. Two extensions can be envisaged: first, an analysis of the composition of retrenchment policies over the years following the recession to assess, for instance, whether the length of the adjustment depends on the composition of budgetary consolidation; second, a further disaggregation of the overall components into more detailed government revenue and expenditure categories is necessary. This detailed analysis would allow conclusions to be drawn on the mechanisms causing budgetary policies to become unsustainable, as well as on the possible effectiveness and durability of budgetary consolidation efforts.recessions, modelling, fiscal policy, public finances

Revisiting the Stability and Growth Pact: grand design or internal adjustment?

The Stability and Growth Pact is under fire. Problems have appeared in sticking to the rules. Proposals to reform the Pact or ditch it altogether abound. But is the Pact a flawed fiscal rule? Against established criteria for an ideal fiscal rule, its design and compliance mechanisms fare reasonably well. Where weaknesses are found, they tend to reflect trade-offs typical of supra-national arrangements. In the end, only a higher degree of fiscal integration would remove the inflexibility inherent in the recourse to predefined budgetary rules. This does not mean that the EU fiscal rules cannot be improved. However, given the existing degree of political integration in EMU, internal adjustment rather than attempting to re-design the rules from scratch appears a more suitable way to bring about progress. Redefining the medium term budgetary target, improving transparency, tackling the pro-cyclical fiscal bias in good times, moving towards non-partisan application of the rules and improving transparency in the data can achieve both stronger discipline and higher flexibility.sgp, stability and growth pact, Buti, Eijffinger, Franco

Fiscal policy in EMU: Rules, discretion and political incentives

The fiscal philosophy of EMU's budgetary rules is to bring deficits close to balance and then let automatic stabilisers play freely. Given the large tax and benefit systems in Europe, relying mainly on automatic stabilisation would allow a relatively high degree of cyclical smoothing while avoiding the typical pitfalls of fiscal activism. While this is, in most circumstances, good economic policy, it is evidently not regarded as good politics. The current difficulties of EMU's fiscal policy framework have little to do with its alleged fault lines and much to do with the resurgence of electoral budget cycles amid a weak system of incentives to abide by the agreed rules.EMU, economic and monetary union, fiscal policy, taxation, budgetary regulation, Marco Buti, van den Noord

What is the impact of tax and welfare reforms on fiscal stabilisers? A simple model and an application to EMU

Reforms aiming at lowering the tax burden and cutting social benefits may boost efficiency and output, and improve market adjustment to shocks, but, by reducing the size of automatic stabilisers, may also imply less cyclical smoothing. This would be problematic in EMU given the loss of national monetary autonomy. This paper argues that the alleged trade-off between efficiency/flexibility and stabilisation depends on the typology of shocks affecting the economy.taxation, tax reforms, fiscal policy, social welfare, social benefits, fiscal stabilisers, automatic stabilisers, economic and monetary union, EMU, shocks, Buti, Van den Noord