The Stability and Growth Pact (SGP) was an agreement among the 17 members of the European Union to facilitate and maintain the stability of the Economic and Monetary Union.
In order to do so, the actual criteria that member states must respect was the following:
-an annual budget deficit no higher than 3% of GDP (this includes the sum of all public budgets, including municipalities, regions, etc)
-a national debt lower than 60% of GDP or approaching that value.
German finance minister Theo Waigel in the mid 1990s was the proponent of the SGP.
The idea was to limit the ability of governments to exert inflationary pressures on the European economy.
The Council of European Ministers failed to apply sanctions against France and Germany, despite punitive proceedings being started when dealing with Portugal (2002) and Greece (2005), though fines were never applied and the the European Court of Justice later declared that decision invalid.
In March 2005, the EU Council, under the pressure of France and Germany, relaxed even more the rules:
http://en.wikipedia.org/wiki/Stability_and_Growth_Pact
"The Ecofin agreed on a reform of the SGP. The ceilings of 3% for budget deficit and 60% for public debt were maintained, but the decision to declare a country in excessive deficit can now rely on certain parameters: the behaviour of the cyclically adjusted budget, the level of debt, the duration of the slow growth period and the possibility that the deficit is related to productivity-enhancing procedures."
The great idea of German fiscal discipline was betrayed by the Germans themselves creating a dangerous moral hazard which lead us to today's European disaster. I always believed in "leading by example": if you want to be respected as a leader, you need to lead by example.
Would the situation be different today if the German and the French had respected prior engagements relating to fiscal discipline? I certainly think so.
How ironic it is today to see Germany clamoring for fiscal discipline in peripheral European countries when a short time ago, they had betrayed the very idea they stood behind for so many years.
In 2003, Pandora's box was opened, with the consequences we are all witnessing today.
If you look at the period of 2000 until 2003, you will notice countries like Belgium, Ireland, Spain were in fact managing much better their public finances than the likes of France and Germany.
GENERAL GOVERNMENT FINANCIAL BALANCES
(% OF NOMINAL GDP)
2000-06
Source: OECD Economic Outlook 76 database
At the time of the violation of the SGP, peripheral countries like Portugal, Ireland and Austria did complain about the case of double standards, because they were trying to abide to the SGP rules.
What were the dire consequences for the violation of the pact?
The ECB had to step in and follow a tighter monetary policy.
Between 2003 and 2004 it allowed real interest rates in the eurozone to fall to zero. The ECB also abandoned the so-called monetary pillar of its strategy -- "a prudent cross-check that looked at the rate at which money supply was growing". For several years, money growth exceeded the ECB's target rate of growth of 4.5 per cent a year. This equated to overreliance on credit in the Eurozone. It made the Eurozone government fiscal balances overdependent on tax revenues from activities that were based on borrowing, namely housing and construction: hence the housing bust in Spain, Ireland, etc.
The basic premise of the SGP made sense. It could not have been possible to launch the euro without a proper framework to promote financial discipline in a currency union not complemented by full political union. But once again, what lead to the current disaster was the lack of discipline of the politicians.
Back in 2003:
http://www.euractiv.com/en/euro/commission-stays-firm-stability-growth-pact/article-116646
"Commission president Romano Prodi stressed that while 'maximum available flexibility' should be applied, the Commission 'must and will apply the treaty for the common good'. Mr Prodi also expressed doubts that higher deficits would help the EU recover from the economic downturn. This strict stance was welcomed by several smaller eurozone members as well as aspirant countries determined to stick to the pact underpinning the euro."
But we know the story Romano Prodi failed and Germany and France jointly betrayed the SGP in 2003, which lead to the ECB having to step in as explained above.
As Mr. Trichet said recently:
"Monetary-policy responsibility cannot substitute for government irresponsibility".
http://online.wsj.com/article/SB10001424052748704739504576067352757709020.html
"Mr. Trichet continued to dwell on perhaps his biggest policy-related defeat of 2010: the rejection by governments of his demand for strict, automatic sanctions on countries that exceed Europe's budget deficit limits. Under a French-German accord reached in October and backed by other governments, the ultimate decision on sanctions will be left in the hands of political leaders and not be applied automatically."
Until automatic sanctions are set up as recommended by Mr Trichet, politicians will still have the ability to postpone structural reforms (in order to seek re-election...).
"We should be inflexible in applying sanctions if rules are breached," Mr. Trichet said, and penalties should include "fines, reduced access to EU funds, and other pecuniary consequences."
I completely agree with Mr Trichet. Unless sanctions are applied automatically, the European system and the SGP will be abused.
Courage under duress? Don't count on European politicians...
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