Stability and Growth Pact

thumbnail|200px|Forecast fiscal compliance of EU member states (debt-to-GDP criterion)

The Stability and Growth Pact (SGP) is an agreement, among all the 27 member states of the European Union (EU), to facilitate and maintain the stability of the Economic and Monetary Union (EMU). Based primarily on Articles 121 and 126 of the Treaty on the Functioning of the European Union, it consists of fiscal monitoring of member states by the European Commission and the Council of the European Union, and the issuing of a yearly Country-Specific Recommendation for fiscal policy actions to ensure a full compliance with the SGP also in the medium-term. If a member state breaches the SGP's outlined maximum limit for government deficit and debt, the surveillance and request for corrective action will intensify through the declaration of an Excessive Deficit Procedure (EDP); and if these corrective actions continue to remain absent after multiple warnings, a member state of the eurozone can ultimately also be issued economic sanctions. The pact was outlined by a European Council resolution in June 1997, and two Council regulations in July 1997. The first regulation "on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies", known as the "preventive arm", entered into force 1 July 1998. All EU member states are automatically members of both the EMU and the SGP, as this is defined by paragraphs in the EU Treaty itself. The fiscal discipline is ensured by the SGP by requiring each Member State, to implement a fiscal policy aiming for the country to stay within the limits on government deficit (3% of GDP) and debt (60% of GDP); and in case of having a debt level above 60% it should each year decrease with a satisfactory pace towards a level below. As outlined by the "preventive arm" regulation, all EU member states are each year obliged to submit a SGP compliance report for the scrutiny and evaluation of the European Commission and the Council of the European Union, that will present the country's expected fiscal development for the current and subsequent three years. These reports are called "stability programmes" for eurozone Member States and "convergence programmes" for non-eurozone Member States, but despite having different titles they are identical in regards of the content. After the reform of the SGP in 2005, these programmes have also included the Medium-Term budgetary Objectives (MTO), being individually calculated for each Member State as the medium-term sustainable average-limit for the country's structural deficit, and the Member State is also obliged to outline the measures it intends to implement to attain its MTO. If the EU Member State does not comply with both the deficit limit and the debt limit, a so-called "Excessive Deficit Procedure" (EDP) is initiated along with a deadline to comply, which basically includes and outlines an "adjustment path towards reaching the MTO". This procedure is outlined by the "dissuasive arm" regulation.

The SGP was initially proposed by German finance minister Theo Waigel in the mid-1990s. Germany had long maintained a low-inflation policy, which had been an important part of the German economy's robust performance since the 1950s. The German government hoped to ensure the continuation of that policy through the SGP, which would ensure the prevalence of fiscal responsibility, and limit the ability of governments to exert inflationary pressures on the European economy. As such, it was also described to be a key tool for the member states adopting the euro, to ensure that they did not only meet the Maastricht convergence criteria at the time of adopting the euro but kept on complying with the fiscal criteria for the following years. The Excessive Deficit Procedure (EDP), also known as the corrective arm of the SGP, was suspended via activation of the "general escape clause" during 2020–2023 to allow for higher deficit spending; first due to the COVID-19 pandemic arriving as an extraordinary circumstance, and later during 2022–2023 due to the Russian invasion of Ukraine having sent energy prices up, defence spending up and budgetary pressures up across the EU. Despite the EDP suspension in 2020–2023, Romania still experienced the opening of an EDP in April 2020; but only because of existence of a deficit limit breach being recorded already for its 2019 fiscal year, which required corrective action across 2020–2024, to remedy a budgetary imbalance created before 2020. 16 out of 27 member states had a technical SGP criteria breach, when their 2022 fiscal results and 2023 budgets were analyzed in May 2023; because those breaches were exempted due to the finding of temporary and exceptional circumstances, reflected by the activation of the general escape clause, no new EDPs were opened against those member states. with a compliance check of the 2023 fiscal result and 2024 budget with the existing 2019-version of the SGP rules, although only 3% deficit breaches will be evaluated because no debt limit or debt reduction breach can trigger an EDP in 2024. The European Commission reasoned for its continued deactivation for another year of the debt limit or debt reduction rule in 2023–2024, stating "that compliance with the debt reduction benchmark could imply a too demanding frontloaded fiscal effort that would risk to jeopardise economic growth. Therefore, in the view of the Commission, compliance with the debt reduction benchmark is not warranted under the prevailing economic conditions." In February 2024, the EU approved a revised set of SGP rules, that will introduce acceptance of a slower adjustment path towards respecting the deficit and debt limit of the SGP, and extend the maximum duration of an Excessive Deficit Procedure from four to seven years if certain reform requirements are respected. The new revised rules will be finally adopted by the European Parliament and Council of Ministers before the 2024 European Parliament election; and fully applied starting from the presented drafts for 2025 budgets. The first "national medium-term fiscal-structural plans" guided by the new revised fiscal rules, will cover the four-year period 2025–2028, and need to be submitted by each member state by 20 September 2024.

Timeline

This is a timeline of how the Stability and Growth Pact evolved over time:

1997: The Stability and Growth Pact is decided.
1998: The preventative arm comes into force.
1999: The corrective arm comes into force.
2005: The SGP is amended.
2011: The Six Pack enters into force.
2013: The Fiscal Compact and the Two-Pack are adopted.
2020: The General Escape Clause within the existing regulations is activated, and the SGP fiscal rules suspended for fiscal years 2020–22.
2023: The General Escape Clause within the existing regulations is deactivated, and the SGP fiscal rules will apply again starting from the next evaluation in June 2024, concerning data for fiscal year 2023 and budget year 2024. The Ecofin agreed on a reform of the SGP. The ceilings of 3% for budget deficit and 60% for public debt were maintained, but the decision to declare a country in excessive deficit can now rely on certain parameters: the behaviour of the cyclically adjusted budget, the level of debt, the duration of the slow growth period and the possibility that the deficit is related to productivity-enhancing procedures. The pact is part of a set of Council Regulations, decided upon the European Council Summit 22–23 March 2005.

; Reform changes of the preventive arm

Country-specific Medium-Term budgetary Objectives (MTO): Previously throughout 1999–2004 the SGP had outlined a common MTO for all Member States, which was "to achieve a budgetary position of close to balance or in surplus over a complete business cycle". After the reform, MTOs were calculated to country-specific values according to "the economic and budgetary position and sustainability risks of the Member State", based upon the state's current debt-to-GDP ratio and long-term potential GDP growth, while the overall objective over the medium term is still "to achieve a budgetary position of close to balance or in surplus over a complete business cycle". No exact formula for the calculation of the country specific MTO was presented in 2005, but it was emphasized the upper limit for the MTO should be at a level "providing a safety margin towards continuously respecting the government's 3% deficit limit, while ensuring fiscal sustainability in the long run". In addition it was enforced by the EU regulation, that the upper MTO limit for eurozone states or ERM II Member States should be: Max. 1.0% of GDP in structural deficit if the state had a combination of low debt and high potential growth, and if the opposite was the case – or if the state suffered from increased age-related sustainability risks in the long term, then the upper MTO limit should move up to be in "balance or in surplus". Finally, it was emphasized, that each Member State has the task to select its MTO when submitting its yearly convergence/stability programme report, and always allowed to select its MTO at a more ambitious level compared to the upper MTO limit, if this better suited its medium-term fiscal policy.
Minimum annual budgetary effort – for states on the adjustment path to reach its MTO: All Member States agreed that fiscal consolidation of the budget should be pursued "when the economic conditions are favourable", which was defined as being periods where the actual GDP growth exceeded the average for long-term potential growth. In regards of windfall revenues, a rule was also agreed, that such funds should be spent directly on reduction of government deficit and debt. In addition, a special adjustment rule was agreed for all Eurozone states and ERM-II member states being found not yet to have reached their MTO, outlining that they commit to implement yearly improvements for its structural deficit equal to minimum 0.5% of GDP.
Early-warning system: The existing early-warning mechanism is expanded. The European Commission can now also issue an "opinion" directed to member states, without a prior Council involvement, in situations where the opinion functions as formal advice and encouragement to a Member State for realizing the agreed adjustment path towards reaching its declared MTO. This means that the commission will not limit its opinion/recommendations only to situations with an acute risk of breaching the 3% of GDP reference value, but also contact Member States with a notification letter in cases where it finds unjustified deviations from the adjustment path towards the declared MTO or unexpected breaches of the MTO itself (even if the 3% deficit limit is fully respected).
Structural reforms: To ensure that implementation of needed structural reforms will not face disincentives due to the regime of complying with the adjustment path towards reaching a declared MTO, it was agreed that implementation of major structural reforms (if they have direct long-term cost-saving effects – and can be verified to improve fiscal sustainability over the long term – i.e. pension scheme reforms), should automatically allow for a temporary deviation from the MTO or its adjustment path, equal to the costs of implementing the structural reform, in the condition that the 3% deficit limit will be respected and the MTO or MTO-adjustment path will be reached again within the four-year programme period.

; Reform changes of the correcting arm

In order to stabilise the Eurozone, Member States adopted an extensive package of reforms, aiming at straightening both the substantive budgetary rules and the enforcement framework. The result was a complete revision of the SGP. The measures adopted soon proved highly controversial, because they implied an unprecedented curtailment of national sovereignty and the conferral upon the Union of penetrating surveillance competences. The new framework consists of a patchwork of normative acts, both within and outside the formal EU edifice. Consequently, the system is now much more complex.

Treaty on Stability, Coordination and Governance

The Treaty on Stability, Coordination and Governance (TSCG), commonly labeled as European Fiscal Compact, was signed on 2 March 2012 by all eurozone member states and eight other EU member states and entered into force on 1 January 2013. As of today, all current 27 EU member states ratified or acceded to the treaty, while the main opponent against the TSCG (the United Kingdom) left the EU in January 2020. The TSCG was intended to promote the launch of a new intergovernmental economic cooperation, outside the formal framework of the EU treaties, because most (but not all) member states at the time of its creation were willing to be bound by extra commitments.

Despite being an intergovernmental treaty outside the EU legal framework, all treaty provisions function as an extension to pre-existing EU regulations, utilising the same reporting instruments and organisational structures already created within the EU in the three areas: Budget discipline enforced by Stability and Growth Pact (extended by Title III), Coordination of economic policies (extended by Title IV), and Governance within the EMU (extended by Title V). The full treaty applies for all eurozone member states. A voluntary opt-in for non-eurozone member states to be bound by the fiscal and economic provisions of the treaty (Title III+IV) has been declared by Denmark, Bulgaria and Romania, while this main part of the treaty currently does not apply for Sweden, Poland, Hungary and Czech Republic – until the point of time they either declare otherways or adopt the euro.

Member states bound by Title III of the TSCG have to transpose these fiscal provisions (referred to as the Fiscal Compact) into their national legislation. In particular, the general government budget has to be in balance or surplus, under the treaty's definition. As a novelty, an automatic correction mechanism has to be established by written law in order to correct potential significant deviations. Establishment is also required of a national independent monitoring institution to provide fiscal surveillance (commonly referred to as a fiscal council), with a mandate to verify all statistical data and fiscal budgets of the government are in compliance with the agreed fiscal rules, and ensure the proper functioning of the automatic correction mechanism.

The treaty defines a balanced budget exactly the same way the SGP did, as a government budget deficit not exceeding 3.0% of the gross domestic product (GDP), and a structural deficit not exceeding a country-specific Medium-Term budgetary Objective (MTO). The Fiscal Compact however introduced a more strict upper MTO-limit compared to SGP, as it now at most can be set to 0.5% of GDP for states with a debt‑to‑GDP ratio exceeding 60%, while only states with debt levels below 60% of GDP will be subject to respect an upper MTO-limit at the SGP-allowed 1.0% of GDP. The exact applying country-specific minimum MTO is recalculated and set by the European Commission for each country every third year, and might be set at levels stricter than the greatest latitude permitted by the treaty.

The treaty states that the signatories shall attempt to incorporate the treaty into EU's legal framework, on the basis of an assessment of the experience with its implementation, by 1 January 2018 at the latest. The ECB proposed several clarifying amendments to this proposed Council Directive in May 2018, while noting a potential adoption of this Directive should only happen together with an amendment of the pre-existing Council Regulation 1466/97, in order to reflect the TSCG had introduced a stricter upper limit for the structural deficit (MTO) at 0.5% of GDP for member states indebted by a debt-to-GDP ratio above 60%, which was a stricter limit than the maximum 1% of GDP being allowed by Council Regulation 1466/97 for all eurozone member states regardless of their debt-to-GDP ratio. If the Council Directive is adopted, it will align the EU fiscal rules with the TSCG fiscal rules. As the content of the Directive does not cover all articles of the TSCG, it will however not replace it, but continue to coexist with TSCG.

Regulation 1176/2011 introduced the Macroeconomic Imbalance Procedure (MIP), a new procedure based on the macroeconomic clauses of the treaties. This procedure is not concerned with budgetary rules, but with the reduction of "macroeconomic imbalances". The latter consists of economic trends experienced by one member state that can upset the normal functioning of the economy. An example of such trends might be the development of a housing bubble like the one that busted in Ireland in 2010, or of an uncontrolled current account surplus or deficit.
Regulations 1173/2011 and 1174/2011 modified the framework for the imposition of sanctions in the context of both the EDP and the MIP. A semi-automatic mechanism was introduced: the establishment of a budgetary infringement would trigger a fining decision within the Council unless a qualified majority vote expresses a contrary opinion. Furthermore, as the infringements persist, less afflictive sanctions (such as interest-bearing deposits) are automatically transformed into more afflictive ones (either non-interest-bearing deposits or fines).
Regulation 1175/2011 amended the preventive arm (Regulation 1466/97), and introduced the European Semester. This is a procedure meant to provide a forum for ex ante coordination of economic and budgetary policies of Member States on an annual basis. In particular, every year in April all eurozone member states submit their "stability programmes", while all non-eurozone member states submit "convergence programmes" that except of a different title provides identical content. These documents outline the main elements of the member states' budgetary plans and are assessed by the commission for compliance with the SGP criteria both within the preventive arm (MTO achievement) and corrective arm (EDP correction). An important part of the assessment addresses compliance with the minimum annual benchmark figures set for each individual country's structural budget balance, striving towards either a minimum improvement for the structural budget balance to be on the set path to correct an ongoing Excessive Deficit Procedure within the corrective arm, or striving towards achievement of the country-specific Medium-Term budgetary Objective (MTO) – or being assessed to be on an appropriate adjustment path towards this MTO within the preventive arm. Based on its assessment of the stability and convergence programmes, the commission also draws up Country-Specific Recommendations for all EU member states, on which the Council adopts opinions in July. These include recommendations for appropriate economic and fiscal policy actions. All CSRs adopted in the context of the European Semester since 2011 are registered in the CSR database, which is the main tool for recording and monitoring each member state's annual progress with the implementation of CSRs. Furthermore, the Council adopts recommendations on economic policies that apply to the euro area as a whole.
Directive 2011/85/EU outlined requirements for annually submitted budgetary frameworks of all member states, and shall be implemented by each member state no later than 31 December 2013.

New debt reduction rule (Regulation 1177/2011)

The corrective arm of the SGP (Regulation 1467/97) was amended by Regulation 1177/2011. By an entirely rewritten "article 2", this amendment introduced and operationalised a new "debt reduction rule", commonly referred to as the "debt brake rule", and legislatively referred to as the "1/20 numerical benchmark for debt reduction". The new debt reduction rule entered into force at the EU level on 13 December 2011.

:* Backwards-checking formula for the debt reduction bechmark (bbt): bbt = 60% + 0.95*(bt-1-60%)/3 + 0.952*(bt-2-60%)/3 + 0.953*(bt-3-60%)/3. The bb-value is the calculated benchmark limit for year t. The formula feature three t-year-indexes for backwards-checking.

:* Forwards-checking formula for the debt reduction bechmark (bbt+2): bbt+2 = 60% + 0.95*(bt+1-60%)/3 + 0.952*(bt-60%)/3 + 0.953*(bt-1-60%)/3. When checking forwards, the same formula is applied as the backwards-checking formula, just with all the t-year-indexes being pushed two years forward.

:* The year referred to as t in the backward-looking and forward-looking formula listed above, is always the latest completed fiscal year with available outturn data. For example, a backward-check conducted in 2024 will always check whether outturn data from the completed 2023 fiscal year (t) featured a debt-to-GDP ratio (bt) at a level respecting the "2023 debt reduction benchmark" (bbt) calculated on basis of outturn data for the debt-to-GDP ratio from 2020+2021+2022, while the forward-looking check conducted in 2024 will be all about whether the forecast 2025-data (bt+2) will respect the "2025 debt reduction benchmark" (bbt+2) calculated on basis of debt-to-GDP ratio data for 2022+2023+2024. It shall be noted, that whenever a b input-value (debt-to-GDP ratio) is recorded/forecast below 60%, its data-input shall be replaced by a fictive 60% value in the formula.

:* Besides of the backward-looking debt-brake compliance check (bt <math>\scriptscriptstyle\leq</math> bbt) and forward-looking debt-brake compliance check (bt+2 <math>\scriptscriptstyle\leq</math> bbt+2), a third cyclically adjusted backward-looking debt-brake check (b*t <math>\scriptscriptstyle\leq</math> bbt) also form part of the assessment whether or not a member state is in abeyance with the debt-criterion. This check applies the same backwards-checking formula for the debt reduction bechmark (bbt), but now checks if the cyclically adjusted debt-to-GDP ratio (b*t) respects this calculated benchmark-limit (bbt) by being compliant with the equation: b*t <math>\scriptscriptstyle\leq</math> bbt. The exact formula used to calculate the cyclically adjusted debt-to-GDP ratio for the latest completed year t with outturn data (b*t), is displayed by the formula box below.

! rowspan="2" data-sort-type=number style="font-size:100%"| Fiscal years with a deficit above 3.0%