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Monetary policy in the EU

1. Role and provisions of the European Monetary System

The European Monetary System is being considered as a first attempt at Economic and Monetary Union, but it is really more like a mechanism devised for creating a ‘zone of monetary stability’. The idea was floated by German Chancellor, Helmut Schmidt and French President, Valery Giscard d’Estating. The Council had adopted the idea, in the form of a resolution ‘on the establishment of the European Monetary System (EMS) and related matters’. The objectives were of stabilizing exchange rates, reducing inflation, and preparing for monetary integration. 

The provisions of the EMS were the following:

1. In terms of exchange rate management, the EMS will be at least as strict as the ‘snake’. In the initial stages of its operation and for a limited period of time, member countries currently not participating in the ‘snake’ may opt for somewhat wider margins around central rates. In principle, intervention will be in the currencies of participating countries. Changes in central rates will be subject to mutual consent. Non-member countries with particularly strong economic and financial ties with the Community may become associate members of the system. The European Currency Unit (ECU) will be at the centre of the system; it will be used as a means of settlement between European Economic Communities monetary authorities.

2. An initial supply of ECUs (for use among Community central banks) will be created against deposits of US dollars and gold on the one hand, and member currencies on the other hand. The use of ECUs created against Member States currencies will be subject to conditions varying with the amount and the maturity.

3. Participating countries will coordinate their exchange rates policies vis-à-vis third countries. Ways to coordinate dollar interventions should be sought of, avoiding simultaneous reserve interventions. Central banks buying dollars will deposit a fraction and receive ECUs in return; likewise, central banks selling dollars will receive a fraction against ECUs.

4. No later than 2 years after the start of the scheme, the existing arrangements and instructions will be consolidated in a European Monetary Fund.

5. A system of closer monetary cooperation will only be successful if participating countries pursue policies conductive to greater stability at home and abroad; this applies to deficit and surplus countries alike.

In essence, the EMS is concerned with the creation of an EC currency zone within which there is discipline in managing exchange rates. The discipline is known as the ‘exchange rate mechanism’ (ERM), which asks a member nation to intervene to reverse a trend when 75% of the allowed exchange rate variation of 2.25% is reached. The EMS asks neither for permanently and irrevocably fixed exchange rates between the member nations nor for complete capital convertibility. Moreover, it does not mention the creation of a common central bank to be put in charge of the member nations’ foreign exchange reserves and to be vested with the appropriate powers. Hence, the EMS was not EMU, although it could be seen as paving the way for one.

2. The Delors Report

By 1987 the EMS and the ERM within it appeared to have achieved considerable success in stabilizing exchange rates. This coincided with the legislative progress towards EMU and other fronts. The EC summit held in Hanover on 27 and 28 June 1988 decided that, in adopting the Single Act, the EC Member States had confirmed the objective of ‘progressive realization of economic and monetary union’. A committee composed of the central banks governors and two other experts, chaired by Jaques Delors, was given the ‘task of studying and proposing concrete stages leading towards this union’. The committee reported just before the Madrid summit, the following year, and its report is referred to as the Delors Report on EMU.

The committee was of the opinion that the creation of the EMU must be seen as a single process, but in stages, progressively leading to the ultimate goal. Thus the decision to enter upon the first stage should commit a Member State to the entire process. Emphasizing that the creation of the EMU would necessitate a common monetary policy and require a high degree of compatibility of economic policies and consistency in a number of other policy areas, particularly in the fiscal field, the Report pointed out that the realization of the EMU would require new arrangements which could be established only on the basis of a change in the Treaty of Rome and consequent changes in national legislations.

According to the Report, the first stage should be concerned with the initiation of the process of creating the EMU. During this stage there would be a greater convergence of economic performance through the strengthening of economic and monetary policy consideration within the existing institutional framework. In the monetary field the emphasis would be on the removal of all obstacles to financial integration and of the intensification of cooperation and coordination of monetary policies. Realignment of exchange rates was seen to be possible, but effort would be made by every Member State to make the functioning of other adjustment mechanisms more effective. The committee was of the opinion that it would be important to include all EC currencies in the exchange rate mechanism of the EMS during this stage. The 1974 Council decision defining the mandate of central bank governors would be replaced by a new decision indicating that the committee itself should formulate opinions on the overall orientation of monetary and exchange rate policy.

In the second stage, which would commence only when the Treaty has been amended, the basic organs and structure of the EMU would be set up. This stage should be seen as a transition period leading to the final stage; it should constitute a ‘training process leading to collective decision-making’, but the ultimate responsibility for policy decisions would remain with national authorities during this stage. The procedure established during the first stage would be further strengthened and extended on the basis of the amended Treaty, and policy guidelines would be adopted on a majority basis.

In the monetary field, the most significant feature of this stage would be the establishment of the European System of Central Banks (ESCB) to absorb the previous institutional monetary arrangements. The ESCB would start the transition with a first stage in which the coordination of independent monetary policies would be carried out by the Committee of Central Bank Governors. It was envisaged that the formulation and implementation of a common monetary policy would take place in the final stage; during this stage exchange rates realignments would not be allowed barring exceptional circumstances.

The final stage would begin with the irrevocable fixing of Member States’ exchange rates and the attribution to the EC institutions of the full monetary and economic consequences. It is envisaged that during this stage the national currencies would eventually be replaced by a single EC currency. In the economic field, the transition to this stage is seen to be marked by three developments: EC structural and regional policies may have to be further strengthened ; EC macroeconomic and budgetary rules and procedures would have to become binding; and the EC role in the process of international policy cooperation would have to become fuller and more positive.

In the monetary field, the irrevocable fixing of exchange rates would come into effect and the transition to a single monetary policy and a single currency would be made. The ESCB would assume full responsibility, especially in four specific areas:

1. The formulation and implementation of monetary policy.

2. Exchange-market intervention in third currencies.

3. The pooling and management of all foreign exchange reserves.

4. Technical and regulatory preparations necessary for the transition to a single EC currency.

The Report was the main item for discussion in the EC summit in Madrid on 24 June 1989. In that meeting, member nations agreed to call a conference which would decide the route to be taken to EMU. Instead of insisting that the United Kingdom would join the exchange rate mechanism of the EC ‘when the time is ripe’, a surprisingly conciliatory Margaret Thatcher, the British Prime Minster, set out five conditions for joining: a lower inflation rate in the UK, and in the EC as a whole, abolition of all exchange controls (at the time and for two year after, Italy , France and Spain had them), progress towards the single EC market, liberalization of financial reserves and agreement on competition policy. All member nations endorsed the Report and agreed on 1 July 1990 as the deadline for the commencement of the first stage.

3. The Maastricht Treaty

The three stage timetable for EMU did start on 1 July 1990 with the launching of the first phase of intensified economic cooperation during which all Member States were to submit their currencies to the EMS exchange rate mechanism.

The second stage is clarified in the Maastricht Treaty. It was to start in 1994. During this stage the EU was to create the European Monetary Institute (EMI) to prepare the way for a European Central Bank (ECB) which would start operating on 1 January 1997. Although this was upset by the 1992 turmoil in the EMS, the compromised reached in Edinburgh summit in December 1992 did not water down the Treaty too much. Be that as it may, the Treaty allowed Denmark and the United Kingdom to opt out of the final stage when the EU currency rates would be permanently and irrevocably fixed in a single currency floated. However, in a separate protocol, all the 12 EC nations declared that the drive to a single currency in the 1990s was ‘irreversible’.

A single currency, to be managed by an independent ECB, was to be introduced as early as 1997, if seven of the then 12 nations passed the strict economic criteria required for its successful operation, and in 1999 at the very latest. These conditions are as follows:

1. Price stability. Membership required ‘a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1.5 percentage points that of, at most, the three best performing’ EC member countries. Inflation ‘shall be measured by means of the consumer price index on a comparable basis, taking into account differences in national definitions’.

2. Interest rates. Membership required that: ‘observed over a period of one year before the examination, a Member State has had an average nominal long-term interest rate that does not exceed by more than 2% that of, at most, the three best performing Member States in terms of price stability. Interest rates shall be measured on the basis of long-term government bonds or comparable securities, taking into account differences in national definitions.’

3. Budget deficits. Membership required that a member country ‘has achieved a government budgetary position without a deficit that is excessive’ . However, what is to be considered excessive is determined in Article 104c(6) which simply states that the Council shall decide after an overall assessment ‘whether an excessive deficit exists’. The Protocol sets the criterion for an excessive deficit as being 3% of GDP. However, there are provisions if ‘either the ratio has declined substantially and continuously and reached a level that comes closer to the reference value; or…the excess over the reference value is only exceptional and temporary and the ratio remained close to the reference value’.

4. Public debt. The ratio of government debt should not exceed 60% of GDP. But again there is an important provision ‘unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace’. Whether such an excessive deficit exists is open to interpretation and is decided by the Council under qualified majority. In helping the Council decide, the Commission is to look at the medium term and quite explicitly can have the opinion that there is an excessive deficit if there is risk, ‘notwithstanding the fulfilment of the requirements under the criteria’.

5. Currency stability. Membership required that a member country ‘has respected the normal fluctuation margin provided for by the exchange-rate mechanism of the EMS without severe tensions for at least two years before the examination. In particular, [it] shall not have devalued its currency’s bilateral central rate against any other Member State’s currency on its own initiative for the same period.’

The important requirements for a stable system are that no member should be able to run their economy in a way that increases the costs for the others. Provided that the minimum standard set is high enough, then the euro area as a whole will get the finest credit ratings/lowest interest costs.

The timing of these convergence tests has been crucial. If they had occurred in 1992, only France and Luxembourg would have scored full marks, meaning five points. The others would have scored as follows: Denmark and the United Kingdom 4 points each; Belgium, Germany and Ireland 3 points each; the Netherlands 2 points; Italy and Spain 1 point each; Greece and Portugal zero points each. Hence, the EMU could not have been introduced. The position at the end of 1996 was even worse, since only Luxembourg qualified. Hence the third stage of EMU began in 1997. Then, only one country was deemed not to qualify: Greece. And even Greece was able to qualify at the first subsequent reassessment in 2000.

The data on which the decision on 2 May 1998 was based was deemed, in the opinion of the EU Commission, to indicate that 11 nations had passed the test. Of the remaining four, three (Denmark, the U K and Sweden) had already decided not to join in the first wave, and Greece was not in the running. The Commission’s interpretation of the Member States’ performance was clearly ‘flexible’. The following table shows the performances of each of the 15 Member States at that time, regarding the convergence criteria:

Table 1.1: EU Member States’ performance to the convergence criteria.


Government budgetary position

Exchange rates

Long term interest rates d


Existence of an excessive deficitb

Deficit (%of GDP)c

Debt ( per cent of GDP )

ERM participation

January 1998

Change from previous year

March 1998

January 1998

Reference value

2.7 e



Yesg *



Yes *









Yes *



Yes *










Yes *









Yes *



Yes *



Yes *



Yes *



Source: Eijffinger& de Haan (2000)

Fourteen Member States had government deficits of 3% on GDP or less in 1997; Belgium, Denmark, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, Finland, Sweden and the United Kingdom. Member States had achieved significant reduction in the level of government borrowing, in particular in 1997. This remarkable outcome was the result of national governments’ determined efforts to tackle excessive deficits combined with the effects of lower interest rates and stronger growth in the European economy. The Commission’s report critically examined one-off measures which have contributed to some Member States’ 1997 figures. The report concluded that the major part of the deficit reductions were structural. In 1997 government debt was below the Treaty reference value of 60% of GDP in four Member States- Luxembourg, France, Finland, and the United Kingdom. According to the Treaty, countries may exceed this value as long as the debt ratio is ‘sufficiently diminishing and approaching the reference value at a satisfactory pace.’ This was deemed to be the case in almost all Member States with debt ratios above 60% in 1997. Only Germany, where the ratio was just above 60% of GDP and the exceptional costs of unification continued to bear heavily, was there a small rise in 1997. All countries above 60% ratio were expected to see reductions in their debt levels. The Commission concluded that the conditions were in place for the continuation of a sustained decline in debt ratio in future years.

4. Main elements orf Economic and Monetary Union

Economic and Monetary Union has four broad ingredients: the euro and the single European monetary policy; the coordination of European macroeconomic policies through the Stability and Growth Pact (SGP); the Broad Economic Policy Guidelines (BEPG) and related processes; the completion of the internal market; and the operation of the structural funds and other cohesion measures.

Although the euro did not come into existence until 1 January 1999 and then only in financial markets, most of the characteristics of Stage 3 of EMU were operating once the European Central Bank (ECB) opened in June 1998. The ECB in the form of the European Monetary Institute (EMI) had been preparing for that day since 1994 with all of the EU national central banks (NCBs). The form of the coming single monetary policy was known already by 1998, both in framework and instruments. The generalized framework was incorporated in the Amsterdam Treaty.

The European Central Bank

The European Central Bank was established in June 1998,is located in Frannkurt and is given total independence to carry out its mandate.

The ECB and the 12 central banks of the euro adopting nations are known as the Eurosystem, which distinguishes them form the European System of Central Banks (ESCB) since the latter includes the central banks of all the 25 EU nations. The ECB’s primary task is to ensure price stability in the euro area; price stability has been defined to be an annual increase in the consumer price index of less than 2%. To achieve this, a so-called two-pillar strategy is followed:

i) setting a target for the growth of money supply, defined in the broadest sense;

ii) assessing future price trends and risks to price stability by examining trends in wages, exchange rates, long-term interest rates.

It is also responsible for collecting all necessary statistical information, from both the national authorities and economic agents, and for following developments in the banking and financial sectors and promoting the exchange of information between the ESCB and banking authorities. The ECB defines and implements monetary policy of the euro area; holds and manages the foreign exchange reserves of the euro area and conducts foreign exchange operations; issues euro notes and coins; and promotes the smooth operation of the payment systems.

The head of the ECB is its Executive Board, which is responsible for the daily running of the bank, implementation of its monetary policy and transmitting the necessary instructions to the national central bank. It comprises the President, Vice-President and four other members, all six being appointed on the agreement of the nations in the euro area. All six hold non-renewable eight-years terms. They are appointed by common accord of the governments of the member states at the level of the Heads of State or Government, on a recommendation from the EU Council, after it has consulted the European Parliament and the Governing Council of the ECB. The main responsibilities of the Executive Board are:

i) prepare Governing Council meetings;

ii) implement monetary policy for the euro area in accordance with the guidelines specified and decisions taken by the Governing Council. It gives the necessary instructions to the euro area NCBs;

iii) manage the day to day business of the ECB;

iv) exercise certain powers delegated to it by the Governing Council.

The top decision making body of the ECB is the Governing Council, which comprises the six members of the executive board and the 12 governors of the euro area central banks. The president of the ECB acts as its chairperson. Its main responsibilities are:

i) adopt the guidelines and take decisions to ensure the performance of the tasks entrusted to the Eurosystem;

ii) formulate the monetary policy in the Euro area, including, as appropriate, decisions related to immediate monetary objectives, key interest rates and the supply of reserves in the Eurosystem;

iii) establish the necessary guidelines for their implementation.

The Governing Council meets twice a month at the Eurotower in Frankfurt am Main, Germany. At its first meeting each month, the Governing Council assesses monetary and economic developments and takes its monthly monetary policy decisions. At its second meeting, the council discusses mainly issues related to other tasks and responsibilities of the ECB and the Eurosystem. The minutes of the meetings are not published, but the monetary policy decision is announced at a press conference held shortly after the first meeting each month. The President, assisted by the Vice-President, chairs the press conference.

There is also the General Council, consisting of the President and Vice-President of the ECB as well as the governors of the national central banks of all EU nations- 29 members .It carries out the tasks taken over from the European Monetary Institute which the ECB is required to perform in Stage Three of Economic and Monetary Union (EMU) on account of the fact that not all EU Member States have adopted the euro yet. The General Council also contributes to:

i) the ECB’s advisory functions;

ii) collection of statistical information;

iii) preparation of the ECB's annual reports;

iv) establishment of the necessary rules for standardising the accounting and reporting of operations undertaken by the national central banks;

v) taking of measures relating to the establishment of the key for the ECB's capital subscription other than those already laid down in the Treaty;

vi) laying-down of the conditions of employment of the members of staff of the ECB;

vii) the necessary preparations for irrevocably fixing the exchange rates of the currencies of the Member States with a derogation against the euro. In accordance with the Statute, the General Council will be dissolved once all EU Member States have introduced the single currency.

The ECB’s capital amounts to EUR 5.5 billion. The NCBs are the sole subscribers and holders of the capital of the ECB. The subscription of the capital is based on the basis of the EU Member States’ respective shares in the GDP and population of the Community. The fully paid-up subscriptions of euro area national central banks (NCBs) to the capital of the ECB amount to a total of 3.9bn euro. The EU non-euro area NCBs are required to contribute to the operational costs incurred by the ECB in relation to their participation in the European System of Central Banks by paying up a minimal percentage of their subscribed capital. From May 2004 these contributions represent 7% of their subscribed capital, amounting to a total of EUR 111,050,987.95 .

The euro area and the NCBs pay up their respective subscriptions to the ECB capital in full. The NCBs of the non-participating countries pay up 5% of their respective subscriptions to the ECB’s capital, as contribution to the operational costs of the ECB. In addition, the NCBs of the Member States participating in the euro area provide the ECB with foreign reserve assets of up to an amount equivalent to around EUR 40 billion. The contributions of each NCB are fixed in proportion to their share in the ECB’s subscribed capital, while in return each NCB is credited by the ECB with a claim in euro equivalent to its contribution. The non-euro area NCBs are not entitled to receive any share of the distributable profits of the ECB, nor are they liable to fund any losses of the ECB.

It should be stressed that the Eurosystem is independent. When performing Eurosystem-related tasks, neither the ECB, nor any member of their decision making bodies may seek to take instructions from any external body. The Community institutions and bodies and the governments of the Member States may not seek to influence the members of the decision-making bodies of the ECB or of the NCBs in the performance of their tasks. Both the Eurosystem and the ESCB are not legal persons. According to the international public law, ECB is the core of the complex structure of the Eurosystem.

The pursuit of monetary policy by the Eurosystem runs into a number of difficulties. In the Governing Council of the ECB, the Executive Board (6 persons) is a minority compared to the now 12 governors of the national central banks. The present ECB design could induce the Council to yield too much to the national interests of the governors. It will probably take quite a while before it is possible to shift to a majority of Council members appointed explicitly for the system as a whole. The problem is that, over the next 10-15 years, the imbalance can only grow worse, once candidate countries and perhaps today’s ‘outs’ join the euro.

There is also a fundamental problem in the Eurosystem of ‘one size fits all’ and there has been a debate on the technical virtues of inflation-targeting versus monetary targeting.

5. The Eurosystem

The institutional system behind the single monetary policy is quite complex, because it has to deal with the fact that some EU members are not participants in Stage 3 of EMU (yet). The Treaty sets up the European System of Central Banks (ESCB), the ECB and the participating NCBs form the Eurosystem, which is what is running the monetary side of the euro area. The term ‘Eurosystem’ has only been coined by its members, in order to make the set up clearer.

The Eurosystem is relatively decentralized. It operates through a network of committees, where each national central bank and the ECB have a member. The ECB normally provides the chairman and the secretariat. The Governing Council takes the decisions but the Executive Board coordinates the work of the committees and prepares the agenda for the Governing Council. The Eurosystem also has a Monetary Policy Committee, but unlike the UK and many other central banks round the world, this is not the decision making body on monetary policy. It organizes and discusses the main evidence and discussion papers to be put before the Governing Council on monetary matters.

The Eurosystem bank has a high degree of independence from political influence in exercising its responsibility. Not only is the taking or seeking of such advice explicitly prohibited, but the Governing Council members are protected in a number of ways in order to shield them from interest group pressures:

-They have long terms of office, eight years in the case of the Executive Board (and not renewable), so that they are less likely to have any regard for their prospects for their next possible job while setting the monetary policy;

-The proceedings are secret, so the people cannot find out how they voted. Each member is supposed to act purely in a personal capacity and solely with the aims of price stability at the euro area level in mind, and without regard to national interests. No system can ensure this, but a well-designed one increases the chance of this happening substantially. More importantly, it can reduce any belief that the members will act with national or other interest in mind.

-The Eurosystem is explicitly prohibiting from ‘monetizing’ government deficits.

The point of trying to achieve this independence is simply ‘credibility’- try to maximize the belief that the Eurosystem will actually do just what it has been asked to- namely maintaining price stability. This credibility comes from other sources than independence. The structure of the Governing Council is strongly reminiscent of that of the Bundesbank. The Bundesbank was highly successful in maintaining low inflation. By having a similar structure (probably assisted by the Frankfurt location, just a few kilometers down the road), the Eruosystem can hope to ‘borrow’ much of the Bundesbank’s credibility.

The Eurosystem has a simple single objective of price stability. But for monetary policy to be credible, it is necessary that the objective should be clear enough for people to act on and that the central bank’s behaviour should be both observable and understandable. Here the ECB had to define the objective, since the Amsterdam Treaty’s concept of price stability is far too vague to be workable. They opted for inflation over the medium term of less than 2%. The inflation they were talking about, was defined as that in the Harmonized Index of Consumer Prices. After a swift clarification that this meant zero inflation was the lower bound, the specification was widely criticized for being too inexact. Not only is the length of the medium term not spelt out, but it is not clear how much and for how long prices can deviate from the target. Nor is there indication of how fast inflation should be brought back to the target after a shock hits.

This means that a wide range of policy settings would be consistent with such a generalized target. Policy is thus not very predictable –something the Governing Council has sought to offset by trying to give clear signals about interest rate changes. The inevitably diffused structure of decision making with 18 independent decision makers means that the Eurosystem cannot offer a single and closely argued explanation of how it regards the working of the economy.

Thus far, policy has been fairly successful, but since mid-2000, inflation has been stubbornly above 2%. Although it has been possible to blame the rapid rise in oil prices and some other shocks, the deviation is getting to the stage where it could have an effect on expectations. Until now, price inflation expectations have remained a little below 2%.

6. The Stability and Growth Pact and Excessive Deficit Procedure

To support the likely success of the Euro in case of the fiscal criteria, the Stability Pact was agreed at the Dublin Council of December 1996 and confirmed in Amsterdam in June 1997 as follows:

The reference value of a 3% deficit would constitute an absolute ceiling, except if the country concerned experiences a fall in GDP of over 2%.

If a country is found (during the semi-annual evaluation performed by the Commission) to have a deficit in excess of 3% of GDP, it would have to make a non-interest-bearing deposit equivalent to 0.2% of GDP plus 0.1% for each point of the excess deficit. The variable part applies only for deficits up to 6% of GDP; the total is thus capped at 0.5% of GDP.

The deposit will be returned as soon as the deficit goes below 3%; if the excess deficit persists for over two years, the deposit becomes a fine.

This pact should help to prevent from substantial excessive deficits in a single country of the EMU and it is also supported by the second principle of the ECB, the political independence. The latter is seen as a necessary condition to ensure that printing money will not finance the budget deficits. The Stability Pact should help to keep fiscal discipline in the countries of the EMU in order to fulfill the target of the narrow fiscal convergence criteria every year.

From time to time, the SGP has come under pressure, the greatest pressure not surprisingly coming in 2002 and 2003 when EU economy was not performing well. France, Germany and Portugal all triggered the first steps in EDP. However, while the second two countries have shown some embarrassment and regret, France refused to alter its stance on the grounds that it was not actually exceeding the 3% deficit, its debt ratio would remain inside 60%, and the results would be good for growth and the achievement of the longer term objectives of the EU. While breaches of the target ratios are unfortunate, the SGP is actually strengthened when the penalty system is seen to come into operation and have an effect. Refusal to follow the requirement of the Pact, even while inside the limits, weakens the credibility of the system. It is clear that for Germany and France, the euro area has reached the point for the first time, where appropriate monetary policy for those countries on their own differs from that for the area as a whole. It is thus an unusual experience for what thought itself the core of the system to have to adjust to match the needs of the whole.

Various proposals have been put forward for reforming the SGP and indeed the Commission has itself advanced proposals. EU finance ministers reached a hard won deal on reforms to the Stability and Growth Pact at an extraordinary meeting in advance of the EU summit of heads of state and government on 22 and 23 March 2005. 

In essence, big countries such as France and Germany have won concessions making the pact more ‘flexible’ in various parts, adding up to a considerable relaxation of the rules. In return, countries like Austria and Netherlands have won references to ‘enhanced surveillance, peer support and peer pressure’. The two thresholds- 60% for debt and 3% for deficit remain unchanged. However, the following has changed:

Trigger for an excessive deficit procedure: No excessive deficit procedure will be launched against a member state experiencing negative growth or a prolonged period of low growth. Previously, the exception was for countries in a recession defined as 2% negative growth, something which has been virtually unheard of among EU members.

‘Relevant factors’ letting a country off an EDP: Member states recording a ‘temporary’ deficit or one close to the 3% reference value will be able to refer to a series of ‘relevant factors’ to avoid an EDP. Factors will include potential growth, the economic cycle, structural reforms, policies supporting R&D plus medium-term budgetary efforts. Rather than referring to an exhaustive list of ‘relevant factors’ as had been mooted at one stage, the deal sets out chapter headings. These will take the form of general principles whose application will be thrashed out between member states and EU institutions.

Leeway will be given where countries spend on efforts to 'foster international solidarity and to achieving European policy goals, notably the reunification of Europe if it has a detrimental effect on the growth and fiscal burden of a member state'.

The first part of this phrase will go some way to pleasing France, which wanted public money to development and some military expenditure. Germany will also be pleased as it wanted special treatment for what it regards as its high contribution to the EU budget and will no doubt try to justify this as part of efforts 'to achieve European policy goals'. Germany also appears to have got its way as regards the last part of the above text in that it is expected to cite the cost of German reunification.

The Council and Commission have recognized the importance of pension reforms in an ageing society by agreeing to give 'due consideration' to the implementation of these reforms in their budgetary assessments relating to the excessive deficit procedure. They note that carrying out such reforms leads to a short-term worsening of public deficits but a long-term improvement in the sustainability (public debt) of public finances.

Extension of deadlines in connection with excessive deficit procedures: Countries will have two years (previously one) to correct an excessive deficit. This may be extended in cases of 'unexpected and adverse economic events with major unfavorable budgetary effects occurring during the procedure'. To benefit from these, countries must show proof that they have adopted the correction measures that were recommended to them. Member states have committed to using unexpected fiscal receipts during periods of strong growth to reduce their deficits and debt.

Country-specific medium-term objectives: Medium-term objectives will be tailored to individual member states based on their current debt ratio and potential growth. This will vary from -1% of GDP for low debt/high potential growth countries to balance or surplus for high debt/low growth countries.

Reliability of statistics provided by member states :The Council wants to beef up Eurostat's resources, powers, independence and accountability. As a reaction to the Greek underreporting of statistics, it says that imposing sanctions on a member state 'should be considered' when there is infringement of the obligations to duly report government data. The Commission unveiled a proposal to improve the reliable reporting of statistics on 22 December 2004.

Involvement of national parliaments in the process Member states' governments have been called on to present stability/convergence programs and Council opinions on these to their national parliaments.

Debate concerning the Stability and Growth Pact has continued after the reform, also. Some are of the opinion that the pact has been politicized and is now unlikely to ‘bite’ at least in the case of the big countries. Or that the reform was a ‘regrettable backward step for European currency stability’.

Others are very pleased with the new pact, especially Germany, France or Italy. Italian Prime Minister, Silvio Berlusconi noted that 'all the governments think that the flexibility allows them to carry out costly but necessary reforms for the future'. Germany’s Finance Minister, Hans Eichel spoke of a ‘new start’ and said that ‘Europe’s credibility’ hinged on closer cooperation between ministers, Commission and the ECB.

In 1972, the six Member States-Belgium , France, West Germany, Italy, Luxembourg and Netherlands- set up a ‘snake in the tunnel’ mechanism to narrow the fluctuation margins between the Community currencies (the snake), in relation to fluctuations against the US dollar (the tunnel).

An abstract currency, a standard legal tender used to calculate the budgetary contributions of each Member State; it represented a basket of currencies adjusted periodically, to reflect the relative economic power of each Member State.

Article 109i

a Percentage change in arithmetic average of the latest 12 monthly-harmonized indices of consumer prices (HICP) relative to the arithmetic average of the 12 HICP of the pervious year.

b Council decisions of 26.09.94, 10.07.95, 27.06.96 and 30.06.97.

c A negative sign for the government deficit indicates a surplus.

d Average maturity 10 years; average of the last 12 months.

e Definition adopted in this report: simple arithmetic average of the inflation rates of the three best performing Member States in terms of price stability plus1.5 percentage points.

f Definition adopted in this report: simple arithmetic average of the 12 month average of interest rates of the three best performing Member States in terms of price stability plus 2 percentage points.

g *Commission recommended abrogation.

h Since March 1998.

i Average of the available data during the past 12 months.

j ** Since November 1996, October 1996.

k Since October 1996.

27 governors+2

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