The Stability and Growth Pact (SGP) is regularly criticised for forcing austerity on countries with large deficits when the economy is in difficulty. At the same time, the failure of Member States to comply with European fiscal rules is also often criticised. How do these two observations relate to each other?
Usually strong compliance with corrective arm
Under the corrective arm of the SGP, Member States enter an excessive deficit procedure (EDP) when their budget deficit exceeds 3% of GDP, or when their public debt is too high. At the recommendation of the European Commission, the European Council issues guidance to countries facing an EDP about the extent and pace of measures (austerity measures and tax increases) that are required to bring the deficit below 3% of GDP. The first EDPs were imposed in 2003 on Germany and France. Since then, all the countries in the euro area have been subject to an EDP at some point. This was the case for the Netherlands in 2004-2005 and 2009-2014.
In practice, countries often enter EDPs during economic downturns. After all, during a recession the budget deficit usually goes up, and is therefore more likely to exceed 3% of GDP. As a result, EDP recommendations are procyclical. In other words, governments are asked to tighten their belts during times of economic difficulty.
Whether the recommendations actually have a procyclical effect depends on the level of compliance. When subject to an EDP, Member States are required to implement austerity measures that will result in the required improvements to their structural budget balance (the budget balance adjusted for cyclical and non-recurrent developments). Figure 1 shows the required improvements to the structural balance of the twelve original euro area countries, compared to the actual improvements realised in the years under an EDP. A percentage of 100 therefore means a country has met the recommendations of the European Council exactly, while a percentage above 100 means that the structural budget balance improvement even surpassed European Council requirements.