The Stability and Growth Pact remains the cornerstone of the EU’s budgetary framework.

The world is confronted with an economic slowdown of a magnitude that has rarely been seen in the past. Governments on both sides of the Atlantic were quick to co-ordinate rescue plans for banks, whose careless accumulation of subprime mortgages in the US ignited a deleveraging process that has spread throughout the highly integrated international financial system and has yet to end.

Due to a mix of capital injections into banks and state guarantees to thaw the interbank lending market, we have avoided a financial meltdown. Hopefully, we will also learn from our mistakes and deliver stronger financial markets and regulatory oversight when we gather in the spring to take stock of the work accomplished since the Washington, DC, meeting on November 15 to reform the international financial institutions and system.

Restoring confidence

In the meantime, we have to contend with restoring consumer and business confidence and restarting the world growth engine. The endorsement by EU heads of government, at their summit in December, of an economic recovery plan equivalent to 1.5% of the EU’s gross domestic product (GDP), or about €200bn, is important as it shows citizens and companies that their governments and Europe will not stand by and watch the millions of jobs created in the past 10 years being destroyed by the vicious spiral of falling confidence, shrinking demand and low investment. The measures already adopted or announced range from direct support to household purchasing power – which absorbs the biggest share of the public resources in the form of income support, lower taxes or support to housing markets – to measures aimed at companies and to stepping up or bringing forward investment in infrastructure.

I hope that such expansionary measures, which come on top of the automatic fiscal stabilisers that are powerful in Europe (public expenditure in the EU averages 46% of GDP, as opposed to 36% in the US), will allow a progressive pick-up in economic activity and will support European jobs.

The right choice

Clearly, the rescue plans for the banks, the discretionary budgetary measures and the free play of the automatic stabilisers are going to take their toll on public finances and this is not something that anybody, certainly not the European Commission, takes lightly. But the choice was between doing nothing and allowing a deterioration of the economic situation, which would result in a potentially deep and long recession, or breaking the vicious spiral by promoting the conditions for a rapid recovery. I believe the second course, proposed by the Commission and followed by EU leaders, was the right one to follow.

The sound budgetary rules created for the Economic and Monetary Union have proved their worth. They enabled the euro area, and the EU as a whole, to reach its best and soundest budgetary position in 2007 at close to balance. And this was achieved despite claims, in 2005, that the reform of the Stability and Growth Pact had signified its death.

The pact is alive and well. It enabled many EU countries to approach this crisis with the necessary budgetary margin of manoeuvre to counter the impact. And it is part of the solution, to ensure that the fiscal deterioration caused by the short-term fiscal stimulus is reversed when the economy starts growing again. This is crucial to safeguard the sustainability of public finances in the long term, in view of the overall high level of public debt (66% in 2007 for the euro area and 59% for the EU) and the looming costs arising from a population that is both shrinking and ageing.

There should be no doubt that the Commission will continue to apply the pact, and EU leaders reaffirmed in the December summit declaration that the pact “remains the cornerstone of the EU’s budgetary framework”. This means the Commission will start the excessive deficit procedure – in other words, the budgetary surveillance exercise – when a deficit is in excess of 3% (unless the excess is caused by exceptional circumstances, stays close to the reference value and is temporary).

The exceptional circumstances have been defined as an unusual event outside the control of the member state and with a major impact on its finances, or a severe economic downturn (itself defined as an annual fall of real GDP of at least 2%). The definition of closeness has not been written, of course, for fear that it would automatically become the new reference value, but the understanding between the Commission and the council of EU finance ministers is that this means a few, not many, decimals of a percentage point.

We have an intrinsic interest in respecting our rules-based budgetary framework to retain its credibility and guarantee that excessive deficits will be duly corrected and, beyond the correction, that member states will resume the road towards their medium-term objectives of balanced budgets once the economy bounces back.

Flexible deadline

The flexibility built into the pact since 2005 involves the deadline recommended for the correction of the excessive deficit, which can be more than one year if justified. The length of the deadline depends mostly on the size of the deficit and the state of the economy. Such flexibility contained in the reformed pact led to an increase in both the quality and the sustainability of the correction, a welcome departure from the use of one-off measures in the past that guaranteed neither.

At the end of 2008, only two countries remained under the excessive deficit procedure – the UK and Hungary – as opposed to 12 in 2006. The Commission’s economic forecasts of early November pointed to a deterioration of the overall budgetary position in the EU to an average deficit of -2.3% in 2009 from -0.9% in 2007 (-1.8% from -0.6% in the euro area). The deterioration – much more marked in countries severely hit by the financial crisis and/or incurring severe corrections of the housing sectors and/or macroeconomic imbalances – was triggered largely by a fall in tax revenues and increases in non-discretionary spending, including unemployment benefits – in other words, the automatic stabilisers.

New Commission forecasts expected on January 19 will show the impact on budgetary positions of the economic deterioration, which at the time of the EU Summit on December 11 and 12 had not bottomed out, as well as of the national fiscal stimulus plans.

It should be clear, however, that the Commission has not proposed one-size-fits-all stimulus plans. It has proposed, and agreed by EU leaders, that member states adopt measures according to their needs and their budgetary margin of manoeuvre; and bearing in mind other challenges, such as macroeconomic imbalances that require action. The Commission also recommended – and EU leaders agreed – that member states must not lose sight of structural reforms to increase their competitiveness and growth potential.

The national recovery plans adopted and announced so far appear to reflect the different needs and starting points as well as the key imperatives of timely, targeted and temporary plans to ensure a rapid effect – but also a rapid reversal of any budgetary deterioration in order not to burden future generations.

Joaquín Almunia is European Commissioner for Economic and Monetary Affairs.

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