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EMU and Economic Policy in Europe

The Challenge of the Early Years

Edited by Marco Buti and André Sapir

EMU is a completely new policy regime which has significant economic implications and which, it is hoped, will ultimately enhance the role of Europe on the world stage. EMU and Economic Policy in Europe takes stock of the initial experiences of EMU and assesses the challenges which will have to be addressed in the early years of its existence to ensure its long-term objectives are successfully achieved.
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Chapter 6: Fiscal Policy in the Early Years of EMU

Anne Brunila and Carlos Martinez-Mongay


Anne Brunila and Carlos Martinez-Mongay 1. INTRODUCTION The new policy framework of EMU with a single monetary authority and multiple fiscal authorities poses unique challenges for economic policy making. By underpinning the creation of a genuinely integrated single market, EMU increases economic interdependence and policy spillovers between its members. Within this framework, fiscal policy, in carrying out its objectives of maintaining budgetary discipline, providing cyclical stabilization and enhancing the long-run performance of the economy, has to take into account not just national considerations but also the area-wide dimension and the appropriateness of the resulting policy mix. To face such challenges and ensure smooth functioning of EMU, Member States agreed on a set of institutional arrangements and procedures in the Treaty of Maastricht, adopted in 1992, and five years later in the Stability and Growth Pact (SGP).1 The Treaty laid down the fiscal criteria for joining EMU and established the Excessive Deficit Procedure (EDP) with a view to restraining persistent budget deficits higher than 3 per cent of GDP, and high debt levels. The SGP was adopted to clarify the Treaty provisions and to ensure the continuation of fiscal discipline in EMU. To guarantee that the 3 per cent deficit ceiling is not breached, government budgets should be ‘close to balance or in surplus’ in the medium term. The rationale behind this close-to-balance provision not only concerns discipline, but also recognizes that a certain degree of flexibility and room for manoeuvre for fiscal stabilization is needed in...

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