Europe Agrees on Tougher Fiscal Measures

Sources:
Economist: “A Deal, But to What End?”
EU: Treaty on Stability, Coordination and Governance in the Economic and Monetary Union
Washington Post: Britain, Czechs snub Europe’s fiscal pact but won’t forge an alliance of critics
WSJ: Europe Tightens Fiscal Ties

On Monday, European leaders agreed on a new fiscal plan to combat the region’s debt crisis and restore investor confidence in the Europe. The plan sets tough budget and deficit limits as well as strict enforcement mechanisms to prevent Eurozone countries from accumulating the large amounts of debt that have put the entire region in jeopardy. As of now, twenty-five member countries have agreed to sign the treaty, including all seventeen Eurozone nations and eight other European Union (EU) countries. The United Kingdom and the Czech Republic are the only two EU countries that have yet to approve.

The new “fiscal compact” treaty states that member countries must maintain their structural deficits (deficits over a prolonged period of time) either balanced—meaning deficits cannot exceed 0.5% of the country’s gross domestic product (GDP)—or in surplus. In addition, the pact will require governments to reduce their total debts to 60% of GDP or below over time. If a country’s debt-to-GDP ratio is significantly below 60%, it will be allowed to have a deficit of up to 1%. At this time, the Stability and Growth Pact (which currently controls the deficit and debt limits of countries in the European Monetary Union) limits annual budget deficits to 3% of GDP and government debt to 60% of GDP. However, the SGP has shown to be ineffective in its enforcement mechanisms, as countries have been able to accumulate large amounts of debt and reach deficits well above the 3% limit without consequences.

Another important aspect of the new fiscal plan is that if a country deviates significantly from the agreed limits, a correction mechanism will be triggered automatically. The European Court of Justice will have the power to impose fines of up to 0.1% of GDP to countries that have excessive deficits, which means, for instance, that Italy could have to pay fines as high as $2 billion. However, countries will be allowed to deviate from the set limits in exceptional circumstances such as during periods of severe economic decline.

The treaty will likely come in to force on January 1, 2013. However, countries are not expected to immediately abide by the rules. Instead, the European Commission will establish the time frame under which governments need to comply on a case-by-case basis to take into account each country’s economic situation.