The Stability and Growth Pact is an agreement among EU member countries to limit budget deficits to 3% of GDP and debt to 60% of GDP. It has been criticized for being too rigid, but was modified in 2005 to allow for more flexibility during economic cycles.
The 16 countries that make up the European Union agreed in 1997 to be governed in terms of spending and national debt by a document called the Stability and Growth Pact. EU member countries signed the pact primarily to hedge against inflation in their individual currencies and the euro. The Stability and Growth Pact was modified in 2005 to give individual nations a little more flexibility in budgeting for economic cycles longer than one year.
Under the terms of the pact, EU countries agreed that the budget deficit, including all national and local budgets, will not exceed 3% of the country’s Gross Domestic Product. In addition, Stability and Growth Pact nations agreed that each nation’s debt would not exceed 60% of GDP for Growth. The term Gross Domestic Product refers to a value of all goods and services produced by a nation during a specified period, usually a year.
Not considered a treaty, the Stability and Growth Pact is an agreement in opposition to the Maastricht Treaty, which was the legal document that created the European Union. Two articles of that 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 allows for warnings and then sanctions if limits are not met.
The Stability and Growth Pact has been criticized for being too firm and too rigid. Those who say it is too firm point to the need for governments to have latitude in their use of debt and spending to deal with the impact of economic downturns, which can last well beyond a year. Others claimed that the pact is moderate, as the use of creative accounting can mask non-compliance and sanctions are too rarely used and too lenient to be effective.
In 2005, the authorities amended the pact, largely at the insistence of Germany and France. The pact was first proposed in the 1990s by Germany. Under the reform, the 3% and 60% deficit and debt levels remained in place, but before sanctions were assessed, EU finance ministers could take into account the severity of an economic crisis and calculate compliance based on a budget adjusted over the life of the current economic cycle.
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