The Stability and Growth Pact is an agreement between EU member nations to limit budget deficits to 3% of GDP and debt to 60% of GDP. It was amended in 2005 to allow for more flexibility in budgeting for longer business cycles. The pact has been criticized for being too rigid or too soft, and penalties for non-compliance are infrequently used.
The 16 countries that make up the European Union agreed in 1997 that they are governed in relation to national spending and debt by a document called the Stability and Growth Pact. EU member nations signed the pact primarily to hedge against inflation in their individual currencies and the euro. The Stability and Growth Pact was amended in 2005 to give individual nations a little more flexibility in budgeting for business cycles longer than a year.
Under the terms of the pact, EU nations have agreed that budget deficits, including all national and local budgets, will not exceed 3 percent of the nation’s gross domestic product. In addition, the Stability and Growth Pact nations agreed that each nation’s debt would not exceed 60% of its growing domestic product. The term Gross Domestic Product refers to the value of all goods and services produced by a nation over a specific period of time, usually a year.
Not considered a treaty, the Stability and Growth Pact is an agreement at odds with the Maastricht Treaty, which was the legal document that created the European Union. Two articles of this treaty – the Treaty of Rome or the Treaty establishing the European Economic Community – establish the legal basis for the provisions of the Stability and Growth Pact. In addition to debt and spending limits, the pact provides for warnings and therefore penalties if the limits are not respected.
The Stability and Growth Pact has been criticized for being too rigid and too rigid. Those who argue that the need for governments to have latitude on the use of debt and spending to deal with the impact of economic downturns, which can last much longer than a year, is too firm. Others argued that the pact is too soft as the use of creative accounting can mask non-compliance and that penalties are too infrequently used and too lenient to be effective.
In 2005, officials amended the pact, largely at the insistence of Germany and France. The pact was first proposed in the 1990s by Germany. Under the reform, deficit and debt levels of 3% and 60% remained in place, but before assessing sanctions, EU finance ministers could take into account the severity of an economic downturn and calculate compliance on the basis of an adequate budget over the life of the current economic cycle.
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