Theory, Evidence and Institutions
* 1. INTRODUCTION The European Economy and Monetary Union (EMU) is built on solid ﬁscal discipline requirements. The Stability and Growth Pact (SGP), which aims to uphold ﬁscal discipline once in EMU, demands that member states achieve a budgetary position which allows them to respect the Treaty’s deﬁcit criterion, even during periods of unfavourable growth. The SGP makes it clear that the 3 per cent of GDP reference value can be breached only temporarily and in exceptional circumstances. The waivers foreseen in the SGP are subject to such stringent conditions that the 3 per cent of GDP threshold becomes de facto a strict upper limit for the deﬁcit, which EMU members will want to avoid breaching in order not to be put into excessive deﬁcit and risk incurring sanctions. Countries participating in the euro area need to attain a sound ﬁscal position to face the budgetary consequences of adverse economic developments without having to resort to pro-cyclical behaviour. As spelled out in the Resolution of the European Council on the SGP, ‘adherence to the objective of sound budgetary positions close to balance or in surplus will allow all member states to deal with normal cyclical ﬂuctuations while keeping the government deﬁcit within the value of 3 per cent of GDP’. Fiscal discipline and ﬂexibility are thus the main principles governing budgetary policy in EMU. Fiscal discipline strengthens the credibility of monetary policy, while ﬂexibility is required to deal with country-speciﬁc shocks (European Commission, 1990). The Pact...
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