Fiscal Policy in Economic and Monetary Union

Fiscal Policy in Economic and Monetary Union

Theory, Evidence and Institutions

Marco Buti and Daniele Franco

This book explores the origins, rationale, problems and prospects of the European fiscal policy framework. It provides the reader with a roadmap to EMU’s budgetary framework by exploring its theoretical and empirical foundations, uncovering its historical roots and emphasising its supranational nature.

Chapter 9: Politics and the Pact

Marco Buti and Daniele Franco

Subjects: economics and finance, money and banking, public finance


* INTRODUCTION Europe’s Economic and Monetary Union (EMU) is based on an original arrangement of public finance relations between member countries: fiscal policy remains decentralized, but is subject to rules which are meant to combine discipline and flexibility. The Stability and Growth Pact (SGP), which complements and tightens the fiscal provisions laid down in the Maastricht Treaty, is the backbone of fiscal discipline in EMU. The SGP is unquestionably the most stringent supranational ‘commitment technology’ ever adopted by sovereign governments on a voluntary basis in the attempt to establish and maintain sound public finances. The SGP, if applied according to its letter and spirit, will have important implications for the behaviour of budgetary authorities in both the short term (cyclical stabilization, policy coordination) and the long term (sustainability of public finances). The experience of the early years of EMU has, however, been disappointing. While many euro area countries continued the fiscal retrenchment, even moving into surplus, the three largest members – Germany, France and Italy – and Portugal remain trapped in high deficits. This short chapter argues that failure to abide by the SGP’s ‘fiscal philosophy’ can, at least in part, be traced back to resurrection of incentives – once EMU had been accomplished – to run politically motivated fiscal policies during important electoral episodes. The chapter is organised as follows. The next section briefly reviews the budgetary developments in the early years of EMU and discusses the alleged asymmetric working of the Pact in bad times and good times. The third section...

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