The SGP ramifications of the Greek Crisis

I was just at a conference of Europeanists in Montreal a couple of weeks ago, and although many of them didn't show because of the lack of transatlantic flights due to the Icelandic volcano ash clouds, there were enough delegates to get a good guage on what Europeanists are thinking about in terms of the future of the European Union and the euro and the ongoing Greek crisis.

The main ramification that I got from chatting with other delegates is that the Stability and Growth Pact (SGP) is essentially dead, with the Greek situation putting the final nail in the coffin!!  The SGP was originally a German idea back in 1997, which was meant to allay German fears that they were giving up their beloved Deutschmark for something not as robust and that they had less control over.  The main condition in the SGP (which was actually just a continuation of the main Maastricht criteria for fiscal policy) was the budget deficit criteria which specifies that member states need to keep their government budget deficits below 3% of GDP. 

Academics like Willem Buiter had already criticized the budget deficit criteria as a little meaningless, not just because it was seemingly an arbitrary number, but also because it is usually debt that matters for fiscal sustainability rather than deficits.  For example you can have a very low debt and then have some kind of event where you need to stimulate your economy big time - Finland went through something like this in the 1990s, and the US is clearly going through something similar right now - so that your budget deficit balloons during that period.  To put this more simply, it is like focusing on the most recent additions to your credit card debt (if you have any!), rather than focusing on the total that you owe.  Clearly the total is the most important figure, not what you've just added to the total. 

The SGP then specified that if you ran a deficit above 3% you would attraction the attention of the European Commission and then a complex process would begin such that you would have time to put your house in order and if you didn't you'd first be sanctioned and then fined.  There were let-outs for recessions and other uncontrollable events, but essentially during normal times a member state's budget deficit was supposed to be under 3% of GDP.

The way the SGP was supposed to work was that governments would report their deficits and debts to the Commission and then they would decide what the situation was, and then the Commission would prepare a report and if any action was needed would pass this on to the European Council for a decision - and some of these decisions were supposed to be almost automatic.  Back in 2004 both France and Germany were found to be violating the 3% limit and the European Council decided to do nothing, violating the spirit of the SGP and prompting some soul-searching on what kind of conditions should allow a member state to run deficits that were greater than 3%.  The so-called SGP II was launched, which was softer on member states when they ran deficits and also had a greater focus on debt, but essentially it was the same "monster", wrapped up in a little more sensible clothing.  But apart from the aforementioned problems, there were other fatal flaws with it ( - described in many of my earlier papers on this topic). 

First, the EU member states did the public accounting to construct the measures needed for the SGP - so as Greek did, you could easily "fix" the figures and the Commission would be none the wiser.  It seems to me that if the SGP was to be taken seriously the Commission should at least have had a representative working in every finance ministry in the euro area.  They didn't.  When the IMF needs to evaluate what is going in a country, a team is sent out - and obviously the veracity of the figures is evaluated at the same time.  There is no Commssion equivalent.

Second, it was all stick and no carrot.  Where was the reward for being good?  With the IMF if you do what they say you get money...money in the form of a loan that you desperately need.  With the European Commission you got nothing more than you otherwise likely would get - so there is basically no incentive to be good.

Third, even if the SGP was mostly stick, the stick was hidden from view, as there was a tacit acknowledgement that the penalties would (likely) never be used - to fine a member state that was already running a deficit seems a little counterintuitive - shouldn't the rest of the EU be helping them, not punishing them?

Fourth, having the SGP gave the financial markets more "comfort" than they should have had, as it probably hindered them from properly evaluating the risk of default from any one member state.  So when there was a realization that the Greek situation was much worse than thought, the yield on Greek bonds really took off. 

So the Greek situation has really broken the SGP - and good riddance to it in my opinion.  Monitoring member states and reporting back on their fiscal situation seems like a sensible idea, but it has to be constructed in a way that makes sense and the SGP never made a lot of sense to me, not only in its essential ingredients, but also in the way it was implemented.