11 OCT 2010
By George Koptis | WSJ
The European Union's Stability and Growth Pact was originally intended to curtail free-rider behavior, where member states would benefit from the single currency without paying the costs—i.e. controlling their budgets. Now the Pact is being redesigned to address sovereign-debt sustainability. But unless budget rules are overseen closer to home instead of in Brussels, fiscal discipline will remain wobbly.
In the early years, compliance with the Pact's budget-deficit limit entailed relatively little effort, given the favorable tailwinds from the so-called great moderation. In 2004, however, the Pact's first major test was met with failure when France and Germany were allowed to disregard the excessive deficit procedure. Thereafter the Pact was amended, shifting the focus from quantitative rules to a more nuanced approach that emphasized the quality of a country's structural measures underpinning budget planning. But relatively little attention was paid to surveillance and enforcement.
Thus the real vulnerability of the Pact surfaced with the onset of the financial crisis. From 2008 onward, financial markets became increasingly sensitive to widening budget deficits, particularly after Athens was caught manipulating its budget figures. Apart from Greece's fiscal profligacy, the ensuing debt crisis could be ascribed to a lack of effective surveillance by the European Commission and Eurostat and, above all, toothless peer pressure.
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