Pressures on the Stability and Growth Pact from asymmetry in policy

Abstract

We identify pressures on the SGP that stem from asymmetries in economic behaviour and macroeconomic policy in the euro area. The asymmetry in the way the euro economy operates with respect to inflation, growth and unemployment merits an asymmetric policy response. While Eurosystem monetary policy appears to match the concerns, the asymmetry of fiscal policy in the member states means that they tend to develop their stance in a way that is inconsistent with a long-run sustainable balance and debt ratio. This could be because they are persistently too optimistic about growth, thus generating pressure on the deficit limit which they then blame on cyclical causes. However, the main asymmetry is a failure to adjust sufficiently in the up phase of the cycle, either by cutting taxes less or controlling expenditures to offset the unwillingness to raise taxes and control expenditures in the down phase. The asymmetry in the SGP through the excessive deficit procedure helps to offset this political problem.

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