BRITISH MANAGEMENT DATA FOUNDATION

The Benefits of Budgetary Discipline for Growth and Employment

Sound and disciplined public finances are an essential condition for strong and sustainable growth with improved employment creation.

Low budget deficits reduce the public claims on the national product and lessen the burden put on monetary policy; in addition they contribute to low and stable inflationary expectations. In such a context, monetary policy can deliver low interest rates. This fosters growth and employment via crowding-in of private investment with beneficial supply-side effects. Moreover, fiscal discipline, by curbing public debt ratios and hence reducing the interest burden on public debt, will allow government spending to be restructured, by devoting a higher share of public money to political priorities such as infrastructures and education which are important to build long-run growth and employment.

Durable Budgetary Convergence in EMU

In order to harvest the benefits of the single currency, economic and monetary convergence in EMU must be durable. This implies, inter alia, low budget deficits on a sustained basis. These views, which are widely shared and enshrined in the Treaty, led the German Government to present a proposal for a "stability pact for Europe" to ensure budgetary discipline in the final stage of EMU. The Madrid European Council in December 1995 confirmed the crucial significance of budgetary discipline and noted the Commission's intention "to present its conclusions on ways to ensure budgetary discipline and co-ordination in the monetary union...".

The issue has been actively discussed since then benefiting, inter alia, from the progress report presented by the Commission to the European Council in Florence in June 1996, according to which any new arrangements should:
(i) be achieved in the context of the Treaty

(ii) the requirements for participation in EMU (either in the first group or at a later date) should in no way be changed; and

(iii) they should be agreed at EU level, even though full application would only concern the Member States participating in the single currency.

During the informal Ecofin Council in Dublin in September 1996 these basic principles and the main features of a future stability pact gained wide acceptance.

The Commission proposals for a stability pact, in line with its progress report, respect these principles. They take the form of secondary legislation which strengthens and clarifies Treaty provisions related to multilateral surveillance and budgetary discipline. In order to be effective, this will need to be complemented by a strong political commitment from all those involved to apply rigorously the procedures of the Treaty, as further specified and clarified by secondary legislation. This commitment could be enshrined in a declaration by the European Council.

A Preventive and Dissuasive Approach

National budgetary policies in the third stage of EMU need to be set so as to create room for manoeuvre in adapting to exceptional and cyclical disturbances and so as to avoid excessive deficits. In addition, national budgetary policies must be supportive of the stability oriented single monetary policy. The appropriate way for Member States' budgetary policies to ensure such a wide role is through pursuing medium term budgetary objectives of close to balance or surplus. The 3% of GDP reference value for the deficit is therefore to be seen as an upper limit in normal circumstances.

In order to make sure that excessive deficits are avoided, the Commission proposes to have a twin-track strategy:

(a). a preventive, early-warning system for identifying and correcting budgetary slippages before they bring the deficit above the 3% ceiling; and

(b). a dissuasive set of rules, with a sufficient deterrent effect to put pressure on Member States to avoid excessive deficits or to take measures to correct them quickly if they do occur.

Improving prevention: the strengthening of budgetary surveillance Using the possibilities for secondary legislation provided by Article 103(5), the budgetary aspects of multilateral surveillance need to be reinforced so as to provide an early warning system.

This enhanced monitoring would rely on an obligation on Member States having adopted the single currency to submit stability programmes setting out national medium-term budgetary objectives and other relevant information.

National medium-term budgetary targets should be set close to balance or in surplus, but a certain differentiation between countries would be appropriate.

This would not be at odds with historical experience, as a majority of the Member States had a budgetary position close to balance before the first oil crisis. These medium term targets would enable Member States to respect the 3% ceiling in all circumstances, apart from unusually severe economic downturns or other exceptional conditions. Stability programmes should be made public.

Departures from the budgetary objectives of close to balance or surplus set in the stability programmes would prompt a warning from the Commission. This could lead to Council recommendations to the Member State concerned with a view to take the necessary measures so as to avoid the risk of breaching the 3% ceiling.

The strengthening of surveillance procedures at Community level will also allow to give more attention to the co-ordination of budgetary policies at EMU level to ensure that the different budgetary positions form a coherent picture.

Enhancing dissuasion: the strengthening of the excessive deficit procedure The application of the excessive deficit procedure (including the final step of sanctions) needs to be clarified and accelerated so that it acts as a genuine deterrent. The main elements of the proposed legislation include:
- setting time limits for the key steps of the procedure so that sanctions would be imposed, where appropriate, within the calendar year following the year in which the excessive deficit occurs;

- in this context, defining the "exceptional and temporary" circumstances when the reference value can be breached;

- pre-determining the scale of the pecuniary sanctions.

The Commission considers that the. scope of its proposals for secondary legislation requires the use of Article 104c(14), 2nd sub-paragraph as legal basis. Under this subparagraph, which covers any aspect of the excessive deficit procedure, the Council must act unanimously, after consulting both the European Parliament and the ECB. The Commission believes that the credibility of the stability pact, in which all countries commit themselves to budgetary stability, will benefit from a unanimous vote of the Member States. Accordingly, the proposed regulation and the provisions of Protocol no.5, whose present content is left unchanged, will form a new integrated set of rules.

The excessive deficit procedure can be speeded up substantially by setting time limits for the completion of key steps. It is suggested that in the standard scenario [(see Annex 1) - not shown] the decision on the existence of an excessive deficit and the issuing of recommendations should be completed by May in the year following that in which an excessive deficit emerges; in the event that the Council judges that insufficient effective action is being taken by a Member State to correct the excessive deficit, then the remaining steps of the procedure and the imposition of sanctions should be completed by December of the same year. It would be possible to activate the procedure earlier in situations where planned deficits already exceed the 3% limit and/or recommendations to take corrective action have already been made by the Council using the early warning system of Article 103 procedures; however, the decision on the existence of an excessive deficit should normally be taken on the basis of the data reporting in March.

In the context of the identification of the existence of an excessive deficit, some of the definitions of Article 104c can be clarified to remove uncertainty, although there will always have to remain some room for Council discretion. In particular, the interpretation of the term "exceptional and temporary" can be clarified to a degree. Although it is unlikely that all possible relevant situations can be covered explicitly, an attempt is made to illustrate quantitatively what a severe economic downturn may mean.

Speeding up the later steps of the procedure will rely crucially on how "effective action" is to be assessed. The Commission proposes to consider publicly announced government decisions as the basis for assessing the appropriateness of the corrective measures. The association of national parliaments to the enactment of such measures, when required by national law, should not hinder the expeditious application of the excessive deficit procedure and detract from its urgency. It is therefore suggested that there would be a relatively short period by the end of which a government should have adopted measures (e.g. at most four months after the issuing by the Council of the Article 104c(7) recommendation). If the government brought forward no measures within the time limit or the measures proposed were judged by the Council to be insufficient, then the next step of the procedure would be engaged. If, subsequent to a favourable Council assessment of a package of measures, a government withdrew measures or they were voted down by parliament without other sufficient measures being substituted, then the Council could immediately decide to move on to the next step of the procedure.

In any event, the maximum length of the overall procedure including the presumed decision on sanctions should not exceed ten months. While the time delays according to the above schedule may at first sight seem short, it should be recognised that the issuing of a Council recommendation or the later steps of the procedure will come as no surprise to a government, which will effectively have had a much longer period in which to prepare corrective measures. Moreover, the seriousness in stage three of moving into excessive deficit should call for urgent action from all those involved.

Further specification of how sanctions would be applied is also necessary. To this end, it is proposed that, as a rule, a non-interest-bearing deposit will be requirred whenever sanctions are triggered, possibly supplemented by the non-pecunary sanctions foreseen by the Treaty, to be decided at the discretion of the Council.

The scale of the deposits, which are to be calculated as a % of GDP, should be sufficiently high in order to have a deterrent effect, without however becoming unbearable and thereby losing credibility or being counter-productive. According to these principles, the Commission proposes that annual deposits would include a fixed component, equal to 0.2% of GDP, and a variable component equal to one tenth of the excess of the deficit over the 3% reference value, and would be subject to a ceiling of 0.5% of GDP. These values imply that any deficit above 6% of GDP would not carry a proportionally higher sanction. [The graph in Annex depicts the quantitative implications ofthe proposed rule (not shown).]

The initial deposit would be transformed into a fine if, after two years, sufficient action to correct the excessive deficit has not been taken. Deposits would be lodged with the Community and the interest on deposits, and fines, would be resources of the general budget of the European Communities.