EU economic governance

Introduction

The European Union (EU) rules on government debt and deficits are set out in the treaties which govern the EU and in a series of EU laws. The two major rules are contained in Article 126 and Protocol No 12 of the Treaty on the Functioning of the European Union (pdf). The detailed rules on implementing these major rules are generally contained in EU Directives and Regulations. The collection of rules is called the Stability and Growth Pact.

Stability and Growth Pact

The Stability and Growth Pact (SGP) came into force in 1998. It has been amended a number of times since then and particularly in December 2011 when the so-called Six-pack came into effect.

The SGP originally focused on monitoring member states' compliance with the agreed targets for their budget deficits. Now, a similar process is also in place for their public debt levels. In addition, the focus has shifted from correction to prevention - member states must focus more on long-term sustainability and must correct unsustainable policies as soon as they are identified, before acute problems arise. Although it applies to all EU countries, the SGP has stricter enforcement mechanisms for euro area members.

In May 2013, a new package of legislation (the Two-pack) for euro area member states only, came into force with 2 key objectives:

  • To improve budgetary coordination by introducing a common budgetary timeline for the euro area member states and allowing the European Commission to assess national budgetary plans prior to their adoption
  • To improve economic and financial surveillance in the euro area through a system whereby a member state experiencing serious financial difficulties or financial sector instability would be subject to enhanced surveillance by the European Commission

As part of the common budgetary timeline, euro area member states are required to present their draft budgets at the same time each year (15 October) and the Commission has the right to assess them. The Commission could issue an opinion on them or could request that they be revised if they were inconsistent with the SGP. Euro area member states are required to have independent fiscal councils and to base their budgets on independent forecasts.

Prevention and correction

The SGP is sometimes described as having a preventative arm and a corrective arm. The preventative arm involves mutual surveillance on member states. The corrective arm involves intervention to correct breaches of the rules.

The 2 major rules on the level of government debt and deficits are:

  • Total government debt must not be more than 60% of gross domestic product (GDP)
  • The government deficit must not be more than 3% of GDP except in particular circumstances

If a member state is in breach of this requirement, an excessive deficit procedure comes into operation. This means, among other things, that the member state in question is subject to overall EU surveillance and must comply with the EU decisions of how to deal with the problem. Member states must make significant progress towards reaching their medium-term budgetary objectives within the transition period set for them.

If a member state deviates significantly from the plan to reach the medium-term budgetary objective a warning is addressed to it by the Commission and the Council. Since December 2011, financial sanctions may apply to euro area member states that do not take adequate action to deal with their problems. A decision to apply a financial sanction can be made by what is called the reverse qualified majority voting procedure (see below).

The excessive deficit procedure may be used in cases of breaches of the debt requirement as well as breaches of the deficit requirement. Again, member states are given a transition period to work towards the requirement – in general, the debt must be reduced by one twentieth each year. Countries which are already in the excessive deficit procedure because of not meeting the 3% criterion are expected to work towards reducing their debt as well. They have a further 3 years to meet the 60% criterion after they have achieved the 3% criterion.

At present a number of EU member states, including Ireland, are in the excessive deficit procedure. Ireland has until 2015 to meet the deficit requirement of 3% of GDP and has until 2018 to meet the debt requirement.

Reverse qualified majority voting

In general, EU decisions are made in the following manner:

  • The Commission makes a proposal
  • The European Parliament and the Council then decide on that proposal by means of a qualified majority

Any decision to impose a financial sanction is taken differently:

  • The Commission makes a recommendation to the Council
  • The Council imposes the financial sanction unless a qualified majority of its members vote against it

This is known as reverse qualified majority voting.

Macroeconomic imbalances procedure

A macroeconomic imbalances procedure(MIP) is a surveillance mechanism that was introduced in December 2011 to deal with economic problems other than debt and deficits (for example, major changes in international investment, exports, labour costs, private sector debt or housing costs). This involves the Commission and the Council intervening at an early stage to prevent macroeconomic imbalances occurring and then setting requirements for correcting those imbalances. Failure to correct them may result in financial sanctions in the same way as failure to address the deficit and debt requirements (see ‘Prevention and correction’ above). Decisions on these will also be taken by reverse qualified majority.

The first Alert Mechanism Report on macroeconomic imbalances was issued in February 2012. This is the start of the surveillance procedure. It aims to identify countries which may need further analysis. It involves the examination of a number of economic indicators to identify possible imbalances. Countries such as Ireland that are implementing a programme of reforms negotiated with the Commission and supported by external financial assistance are not assessed as they are already subject to enhanced economic surveillance.

If the Commission considers that there could be a macroeconomic imbalance, it makes a recommendation to the member state concerned to correct the imbalance or prevent an imbalance from occurring. If the degree of the macroeconomic imbalance is considered severe or may jeopardise the proper functioning of the Economic and Monetary Union, the Commission can recommend to the Council to place the member state under an excessive imbalance procedure.

In the February 2012 review, the Commission considered that 12 countries warranted an in-depth review. In May 2012 in-depth reviews for the 12 member states were published. Appropriate policy responses to the identified imbalances were integrated in the set of country-specific recommendations issued by the Council in July 2012 under the European Semester.

The European Semester

The European Semester is the economic policy cycle that covers economic, budgetary and structural changes as well as measures to improve growth.

Governments in the euro area countries present stability programmes (dealing with fiscal policies) in April. (Governments in the non-euro countries present convergence programmes.) These programmes include an outline of the planned next budget. So the stability programmes presented by the member states in April 2013 have an outline of the 2014 budget.

Governments also present National Reform Programmes which deal with structural changes in April.

In June, the Commission will propose a set of recommendations which are specific to each country and/or draft opinions attached to a single-country report and an overall report for the euro area.

Broad Economic Policy Guidelines

The Broad Economic Policy Guidelines (BEPG) deal with macroeconomic and structural policies for both the EU as a whole and for the individual member states. They are agreed by the Council of Finance Ministers (generally known as Ecofin). They are not legally binding on the member states but Ecofin may issue recommendations for corrective action. The Eurogroup is the finance ministers from the member states which use the euro. It monitors the euro member states’ adherence to the BEPGs.

Page edited: 5 November 2013