The Stability and Growth Pact has been a success in numerous EU countries, especially in guiding them toward underlying fiscal balance ahead of population aging. These countries tend to be smaller, subject to greater macroeconomic volatility, and reliant on a form of fiscal governance that emphasizes targets and contracts. Most of the new members share these characteristics. For the countries less compatible with the Pact, domestic governance reforms that increase the reputational costs for noncompliance can be useful complements to the fiscal framework.

The fiscal policy framework of the EMU is in a states of crisis. Since the start of EMU, fiscal conditions in some member states have slipped considerably beyond the limits set by the Maastricht Treaty and the Stability and Growth Pact. It is clear that the preventive arm of the Stability and Growth Pact has failed to preclude excessive deficits. There is no shortage of proposals to reform the current fiscal framework in this crisis situation. They range from calls for softening their implementation, and to proposals for closer coordination of national fiscal policies. None of these proposals offers a convincing solution to the problem at the heart of the current crisis: how to balance the need for effective long-run fiscal stability in EMU with the need for short-run flexibility of fiscal policy in the member states. After a detailed analysis of the virtues and defects of the current fiscal framework, this report presents a proposal for reform that addresses this issue. The authors argue that EMU should move away from rigid fiscal rules for annual deficits towards a more judgmental process of monitoring the sustainability of fiscal policies. This approach is guided by three principles: independence, transparency, and legitimacy. Together wit the ability to assess the fiscal situation and outlook of each euro-area member state, they are the keys to designing a framework that provides enough flexibility and, at the same time, can build the required credibility and political support. The authors propose the creation of a Sustainability Council for the EMU, and independent body with the sole statutory task of safeguarding the sustainability of public finances in the euro area. The Sustainability Council regularly and openly reports to the public and the European Parliament its assessment of the member states' fiscal policies, taking into account past performance, current perspectives and the future course of fiscal policies. Its mandate is the counterpart of the ECB's principal task of maintaining price stability. However, the Sustainability Council has no operative role in fiscal policy; it relies solely on the pressure of informed public opinion to discipline national governments. The use of the instruments of fiscal policy is entirely left to the national governments, and the Sustainability Council can only be conceived as a judge of national public finances.

The paper analyzes some key policy trade-offs involved in the implementation of the Stability and Growth Pact. Greater "procedural" flexibility in the Pact's implementation may improve welfare. Procedural flexibility designates the enforcer's room to apply judgment on underlying policies and to set a consolidation path that does not discourage high-quality measures. Budgetary opaqueness may hinder the qualitative assessment of fiscal policy; therefore, better monitoring and greater transparency would increase the benefits from procedural flexibility. Overall, a simple deficit rule with conditional procedural flexibility can contain excessive deficits, lower unproductive spending, and increase high-quality outlays.

""Fiscal policy making in the European Union is a national prerogative that is carried out and co-ordinated within the remits of the Stability and Growth Pact (SGP). The SGP Member States have agreed upon a rules-based framework which, abstracting from operational details, aims to ensure long-term sustainability of public finances while allowing for short-term fiscal stabilization. The success of the EU fiscal framework depends to a large extent on the effectiveness and accuracy of the tool-kit of indicators and methods used at the EU level to monitor and assess the fiscal performance of the Member States vis-a-vis the requirements of the SGP. The contributions to this volume examine key aspects of the measurement of fiscal policy making in the context of the EU fiscal surveillance framework. They highlight strengths and weaknesses of current assessment practice, including innovations implied by the 2005 revision of the SGP." "--Jacket.

This report examines the stance of fiscal policy in Europe since the 1980s, and the attempts that have been made to restrain the excessive deficits that have built up over the past 15 years. Some attempts to impose discipline have been successful, but many have not. The authors examine the reasons for this, and draw lessons for fiscal policy-making in the future. Current policies could weaken the euro. When the effects of a high deficit in one state are spread across the whole currency union, there is an incentive to run a more expansionary fiscal policy. Unsustainable debt paths can therefore be inflationary. Moreover, the loss of national monetary policies may have caused many governments to rely on fiscal policies to reach their goals. Fiscal discipline has therefore weakened visibly since EMU started, and this has undermined the institutional structure that was set up to enforce that discipline. A new structure will eventually be needed. A key point seems to be that a significant consolidation did take place as countries tried to meet the Maastricht criteria. But having qualified, many member states then relaxed their fiscal policies.The results suggest that, within five years of the launch of the euro, this 'Maastricht Effect' of greater discipline will have been eroded. The authors also find evidence that the smaller countries have shown more discipline than their larger neighbours. In addition, they find that governments have attempted to expand their economies for electoral gain. Finally, they emphasise the crucial role of growth. In fact, the report finds that the reductions in debt that have been achieved so far have been created almost exclusively through economic growth. This appears to be true even under regimes with the strictest expenditure controls. As a result, the Stability and Growth Pact appears not to have produced much discipline; but it has created pro-cyclical pressures and generated uncertainty when its enforcement has been uneven. These results show that it may be preferable to have growth-friendly policies, and to give a more prominent place to debt reductions in a regime of fiscal restraint.

The paper contributes to the discussions on fiscal governance in Europe. It takes stock of recent reforms, identifies areas for further progress, and discusses a menu of policy options for the medium-term. The issues covered include: (i) the growing complexity of the European framework and ways to simplify it; (ii) the difficulties to measure and implement structural stance indicators; (iii) the challenge of reconciling fiscal sustainability and growth; (iv) the need to enhance coordination in the area of monitoring; and (v) the obstacles to compliance and proposals to strengthen enforcement.