Europe Is Dealing With Deficits

The economic debate in this election year has centered on the costs of proposed policies. Politicians have been trying to put the cart before the horse, as they make plans to spend money before being certain that the money will be available.

The debate on this front has been particularly active in Europe, where rules on national budgets underpin the monetary union. Tensions over how those rules should be applied have simmered frequently since they were first adopted, but they may be on the verge of boiling over.

The first Stability and Growth Pact (SGP) was adopted in 1997. It established caps on annual government deficits and aggregate public debt for countries using the euro. The Pact has been updated and amended several times, most recently late last year. We expressed concern about the most recent edition in this January commentary.

The reformed rulebook retains the two goals of maintaining public debt below 60% of gross domestic product (GDP) and deficits below 3% of GDP. However, it allows a slow but steady pace of deficit and debt reduction over four to seven years, with the longer option available if a country undertakes reforms and investments that are in line with the bloc’s strategic priorities.

The SGP calls for the European Commission (EC) to enforce the standard. The vehicle through which this is achieved is called an Excessive Deficit Procedure (EDP), which initiates a timetable for countries to get their fiscal positions back within guidelines.

The EC can also levy penalties if a country fails to take corrective action. This step has never been taken, given the potential for adverse political and economic reactions.